Fund in Focus: Multi-Cap Growth

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Fund in Focus: Multi-Cap Growth

[00:00:00] Nick Peters: Hi, this is Nick Peters, investment advisor at Marlborough, and for today's podcast, I'm joined by Richard Hallett, the fund manager of Marlborough's Multi-Cap Growth Fund.

[00:00:18] Nick Peters: Hi, Richard.

[00:00:19] Richard Hallett: Hi, Nick.

[00:00:20] Nick Peters: How's it going?

[00:00:21] Richard Hallett: Not so bad. It's good to be talking with you.

[00:00:23] Nick Peters: Thank you for coming. Okay, and as usual, we'll start with a gentle opener.

[00:00:28] Nick Peters: So just remind us of the fund's philosophy. And your approach to stock picking, please?

[00:00:34] Richard Hallett: No problem at all. As you know, essentially what we're looking to achieve for investors is strong growth over a number of years. We do this by investing in about 40 to 50 really exceptional companies, which fulfil some of our fairly demanding criteria within our investment process and really just holding onto these stocks for the longer term.

[00:00:56] Richard Hallett: And whilst our primary focus is, of course, UK companies, we also hold some outstanding overseas stocks, and we also really do have the freedom to roam right the way across the market cap spectrums.

[00:01:08] Richard Hallett: We're looking for companies with large addressable markets, which give them a really long runway for potential growth and valuation is also incredibly important as well, and we're looking at this from a range of metrics, including cash flow yields, but really on a medium term basis.

[00:01:26] Richard Hallett: So we've got really well established investment process, which has got a sector leading performance track record over many business cycles and is consistent and scalable.

[00:01:37] Richard Hallett: And principally what we're looking for are companies with a sustainable competitive advantage. That really give these businesses the resilience to grow regardless of what's going on in the wider economy, and that competitive edge may be an innovative product, strong management or a great brand that people love.

[00:01:56] Richard Hallett: But in reality it's normally a combination of these sorts of factors and the type of business they're operating in is also incredibly important. We're looking for leaders in niche areas where there isn't too much competition, but crucially where these sectors are benefiting from longer term underlying structural growth trends.

[00:02:17] Richard Hallett: And a good example here is data analytics, this is an area that's been used for many years by businesses, but is really accelerated of late due to the advent of cloud computing, open AI, and large language models, which is really accelerating the opportunity for businesses to improve their efficiencies, assess risk, and optimize pricing by crunching loads of data sets.

[00:02:42] Richard Hallett: We've identified this as a longer term structural growth trend and many of the stocks in the portfolio benefit from this. But one of our largest positions is a company called RELX Group.

[00:02:53] Richard Hallett: It's a provider of information based analytics and decision tools, and has its own proprietary data sets built over many decades, which are just really hard to replicate and it is making it a formidable competitor, which is really setting it up for a long period of sustainable growth.

[00:03:12] Nick Peters: You mentioned the sector leading performance over the long term, and 2023 was a very good year for the fund after a disappointing period. Can you maybe explain to listeners some of the drivers of that performance?

[00:03:25] Richard Hallett: Yes, as you're aware, we have a really high conviction approach supported by sector leading performance. Track records over a one year. 5 year, 10 year, and indeed 18 year track records since inception.

[00:03:39] Richard Hallett: But undoubtedly '22 was a poor year for the fund and '23 was much better. And the reason for that is, as we see it, is that because we invest in high quality growth companies which attract an above average market valuation, it is precisely these sorts of businesses, which in a world of higher bond yields, they've become less attractive to investors.

[00:04:01] Richard Hallett: And what we saw during '22 was that investors became more risk averse and they decided to rotate out of growth stocks into fixed interest securities and cash deposits, which has started to offer more reasonable returns.

[00:04:18] Richard Hallett: And it is due to this massive change in monetary policy that despite continued good trading updates from our stocks, that the fund's holdings continued to sell off during 2022, leading to quite significant underperformance in that year.

[00:04:34] Richard Hallett: But during '23, whilst bond yields continue to be volatile, they remain range bound and more recently have started to trend downwards. And this has provided a more stable backdrop for growth stock valuations, and investors we note, have more recently started to think about company fundamentals again.

[00:04:53] Richard Hallett: And this is a much more positive environment for our companies, with most fund holdings having rebounded quite strongly from the extreme lows.

[00:05:01] Richard Hallett: And what is really pleasing for us is that despite the more challenging economic backdrop, the vast majority of our companies have continued to trade strongly, issuing trading statements in line or sometimes ahead of expectations, and it is precisely these sorts of stocks that we think will continue to perform into the longer term.

[00:05:22] Nick Peters: Thank you. You mentioned earlier about the exposure to overseas companies, maybe you can talk a little bit more about that, and I understand actually that overseas exposure has been reducing of late.

[00:05:34] Richard Hallett: Yeah, with the Multi-Cap Growth Fund, it is, of course, a UK fund, and it benefits from this really deep pool of world class companies in the UK, many of which are global leaders in their fields, and these will always be representing the vast majority of the portfolio.

[00:05:49] Richard Hallett: But our investment process needs to be global, and it's only if we come across best of breed businesses, benefiting from secular trends, which we can't find available in the UK, and only if it fits within the portfolio will we offer it a place in the fund.

[00:06:05] Richard Hallett: And yes, we have recently reduced a few of the larger positions that have performed well and where valuations have crept up.

[00:06:13] Richard Hallett: And good examples of these are Microsoft and Novo Nordisk, but broadly, given the compelling valuations on offer in the UK at the moment, we've reinvested the proceeds back into small and mid- cap stocks.

[00:06:26] Richard Hallett: And examples here include Senior PLC, Hilton Foods, IQE, and Indivior PLC, but part of the proceeds we have also reinvested back into a company called Eli Lilly, which is a more diversified competitor to Novo Nordisk in the rapidly growing diabetes and obesity markets, and both these companies we find are better fitting our investment process than many of the larger pharma businesses in the UK.

[00:06:55] Richard Hallett: Despite these recent sales though, which have reduced our allocation to overseas stocks, the overseas tranche of the fund has continued to perform exceptionally strongly.

[00:07:06] Nick Peters: Okay, thank you very much. You touched on a few of the trades that you've done recently, but are there any other recent purchases and sales that you'd like to highlight to the listeners?

[00:07:17] Richard Hallett: Yes, of course. I mean, we've only traded or bought and sold relatively few stocks over the last couple of years. And that's generally because we've been very pleased with the operational performance and resilience shown by most of the companies in the portfolio. And it's also because we tend to take a longer term view of a company's prospects.

[00:07:36] Richard Hallett: But a good example of a recent purchase is BAE Systems, which is a FTSE 100 listed provider of some of the world's most advanced technology led defence, aerospace, and security solutions. It's a real beneficiary of increasing global spend on defence.

[00:07:55] Richard Hallett: And given the geopolitical backdrop, we see this as a trend that is only likely to increase for many years to come. BAE will also benefit from a recent acquisition of a company called Ball Aerospace, really boosting BAE's position in the US in the defence, space and nuclear deterrence industries which are growing strongly.

[00:08:15] Richard Hallett: The company is forecast to grow its earnings at more than 15 percent per annum for the next five years from growth in its order books. But it's also increasing operational efficiency and indeed its margins. And an additional benefit is that it trades at a discount to many of its US peers.

[00:08:33] Richard Hallett: Moving on to an example of a sale is JD Sports, and in a recent trading update from the company, it said that the CEO announced it was seeing an increasingly promotional peak season trading environment, which wasn't taken well by the market.

[00:08:48] Richard Hallett: What we're thinking is that we see the market there being undermined by really well funded competitors in the apparel sector led by the likes of Shein and Temu, which are selling direct from China and this is just making the market much more commoditised.

[00:09:04] Richard Hallett: And another factor for the sale is that we've been worried about management change with the once really well regarded prior CEO, Peter Cowgill, departing the business in the last year.

[00:09:16] Nick Peters: Again, something you mentioned earlier was how cheap the UK equity market is. Can you give us a flavour of how your portfolio looks from a valuation perspective?

[00:09:28] Richard Hallett: Of course. Precisely because we invest in quality, best of breed growth businesses, our portfolio tends to comprise of companies trading at a premium valuation, in the UK market at least.

[00:09:41] Richard Hallett: But the way we think about it is that if you look forwards enough, and look at the faster earnings growth from these businesses, the valuation rapidly reduces back to sector norms.

[00:09:51] Richard Hallett: And another factor is that our companies continue to trade at a significant discount to global comparators, and a good example of this is the London Stock Exchange Group, which still trades at a 30 percent discount to other global information service providers like Moody's or MSCI or indeed Rentokil, which is another longer term holding, trades at approximately half the valuation of US competitor Rollins.

[00:10:17] Richard Hallett: Something else we're seeing is that several portfolio companies with significant US facing exposure are making the decision to move their share listing to North America to benefit from what they see as a higher valuation rating.

[00:10:31] Richard Hallett: Good examples here include the likes of CRH, Ferguson and Burford Capital. In these instances, when we continue to believe in the company's growth strategies, we will continue to hold the shares and benefit from any future re rating that may be attained.

[00:10:47] Nick Peters: Just looking outside of the fund for the last couple of questions, 2024 has seen a sort of volatile start for markets and the macro picture perhaps not as clear cut as many thought towards the end of last year.

[00:11:02] Nick Peters: How does that macro picture impact your investment decisions?

[00:11:06] Richard Hallett: One of the key points about the fund and the investment process is that we don't make investment decisions based on macroeconomic forecasts.

[00:11:14] Richard Hallett: That is because, in our view, they are just so hard to get right on any consistent basis at all, and instead what we do is we look for companies which we believe have an underlying strength to them, enabling them to grow regardless of the wider economic backdrop.

[00:11:26] Richard Hallett: And typically we take a 2 to 5 year view on a companies prospects rather than any sort of shorter term view on markets. That said we do keep a watching eye on what's going on in the bigger picture and the outlook, we generally believe, is much brighter than it has been for quite a while.

[00:11:46] Richard Hallett: With inflation trending downwards in developed markets, including the UK, and China actually moving into deflation in January.

[00:11:55] Richard Hallett: So whilst wage inflation is still an issue, with a softer employment market that we're seeing at the moment, we believe this is currently levelling off. And during the last quarter of '23, we believe that market expectations for interest rate cuts probably got a little ahead of themselves.

[00:12:11] Richard Hallett: But whilst inflation data is likely to remain volatile, it does look to us to be trending downwards in the right direction.

[00:12:18] Richard Hallett: So whilst the short term may be bumpy, with this tricky inflationary picture, what we believe is that interest rates will begin to fall over the next 12 months, and as that does so, then risk appetite will start to increase.

[00:12:32] Richard Hallett: And also with inflation's due in the US and the UK over the next year, we can expect political uncertainty to reduce.

[00:12:40] Richard Hallett: So we're looking for rising confidence to move across to the UK where What we're seeing is sentiment and valuation still at multi decade lows, and indeed, we've already started to see signs of this in the last few months.

[00:12:53] Nick Peters: Okay, the last question. The team generally prides itself on its access to management, and you spend a lot of time meeting with management teams.

[00:13:02] Nick Peters: Can you pick out any trends from those recent meetings?

[00:13:05] Richard Hallett: Of course, with respect to sectors though first, given recent weak trading updates from the likes of Watches of Switzerland and indeed, as already mentioned, JD Sports, we have identified weakness in the consumer sector as a risk.

[00:13:19] Richard Hallett: Also, looking across portfolio companies, we've seen downgraded earnings from recruitment companies, industrial businesses, and indeed property sectors, which to us indicate a slowdown in cyclical and interest rate sensitive parts of the economy.

[00:13:35] Richard Hallett: Fortunately, though, our investment process naturally underweights these sectors within the portfolio.

[00:13:41] Richard Hallett: There are, however, several good pockets of strength in the portfolios, and we see this from portfolio companies operating in the aerospace, defence, technology, particularly sort of digital transformation areas, but also travel and healthcare sectors. And you'll be pleased to hear we're well represented with overweight positions in those areas as well.

[00:14:03] Richard Hallett: Another notable trend we're seeing in the UK listed sector is a significant increase in share buybacks.

[00:14:09] Richard Hallett: When we're talking to management teams, we see them as becoming better focused on capital allocation, and they are seeing an effective opportunity at the moment to add shareholder value in a really low risk way by buying back their own stock.

[00:14:24] Richard Hallett: And we see this as a really positive catalyst acting as a sort of stabilization mechanism during this temporary period of market weakness.

[00:14:33] Nick Peters: Thank you, Richard. Excellent summary as always. Thank you very much for joining us.

[00:14:38] Richard Hallett: Pleasure, Nick. Hope that's answered your questions satisfactorily.

[00:14:41] Nick Peters: Indeed it has. That was Richard Hallett, fund manager of Marlborough's Multi-Cap Growth Fund. If you'd like to find out more information about the fund, please go to our website at marlboroughgroup.com. Thank you very much.

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Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.