This week’s Investment Soundbite Q&A from FundCalibre is with Anjli Shah, manager of the abrdn SICAV I Global Mid-Cap Equity fund, who demonstrates the effectiveness of the fund’s ability to run small-cap winners and buy future large-caps early and explains why interpreting management meetings is an art.
(Recorded 19 June 2023)
The fund has just had its third anniversary. What have been the highs and lows in the last 3 years?
We launched on 22nd April 2020 and in the intervening 3 years, AUM has grown from US$5m to close to US$95m. What’s been particularly encouraging for me is that we’ve seen a number of the mid-cap stocks held in our portfolio graduate into large-cap status, so we can see the process of buying tomorrow’s large-cap today, actually working in practice.
2022 was a more challenging year from a performance perspective. Was that due to the style rotation that we saw in markets globally, or were there some mid-cap factors attached to that as well?
Yes, unfortunately performance was challenged in 2022, but I think you have to take that holistically and look back at performance over the last few years. We saw very strong performance in 2020 and 2021, and last year we saw the X-ing out of some of those excess gains. What’s interesting is that both mid-caps and large-caps underperformed last year, so it wasn’t just a mid-cap specific phenomenon. But within that we saw that mid-cap growth in particular was challenged. And the reason for that is because we’ve had much higher inflation prints from much of the developed world, and, as a result, central banks have been able to frontload their interest rate hikes – people having to adapt to those higher rate expectations and the magnitude of that at a much faster pace – so that led to a compression in the multiples of growth stocks in particular.
But we’re confident that investing in companies with quality growth and momentum characteristics will work going forward, particularly as we’re more concerned about the global macroeconomic downturn. We should see higher quality companies do better and much of that growth multiple compression or de-rating now appears to be largely behind us. Valuations are looking much more supportive as well. We think that mid-caps have that ‘bounce-back ability’, where they typically perform better in market recovery environments, with the rebound happening faster than most people think.
You would expect to see large-caps outperform prior to and at the start of a recession, given that people think their earnings come under less pressure. These are more mature, established companies and people are just generally more risk adverse. Those factors then get turned on their head in recovery phases where mid-caps, because of their size, are much more nimble; they’re able to adapt to the changing environment around them and are able to take advantage of what a growing economy has to offer. But actually, what we find is that mid-caps start outperforming large-caps soon after a recession has already started, and that’s because markets are anticipating a macro economy recovery before it actually happens.
How has turnover been in the three years that you’ve run the fund and are there many names that have been in the fund since launch?
A third of the Global Mid-Cap portfolio is what we call small-cap graduates, meaning names that we have held in our small-cap fund that have graduated into the mid-cap index that we now hold in the mid-cap fund. And actually, turnover is low, and we still have about 18 stocks out of the current 44 stock portfolio – so about 40% – which were held in the portfolio at the time of launch, that are still held today. And I’m pleased to say that a number of these stocks have been our strongest contributors to performance and some of them have even graduated into large-cap status now, again demonstrating that process in action working, of buying tomorrow’s large-cap today.
Tell us about a couple of your top 10 stocks, Cādence [Design Systems, Inc.] and Moncler [S.p.A].
First of all, Cādence is a US-listed company that is a provider of computational software tools that are used to design and test cutting edge semiconductors. The growth drivers here relate to the fact that there’s a growing use case for semiconductors and also they’re getting more and more complex because they’re getting smaller and need faster and higher throughput, better power. Alongside these structural drivers, the electronic design automation industry plays a critical role within the semiconductor industry. Simply put, they help to minimise design errors. It’s an industry with very high barriers to entry, taking years of training for an engineer to learn how to use these tools. And they’re deeply integrated into the semi-value chain. As a result, revenues are very sticky. Customers are very sticky – Cādence actually has 90% of revenues which are recurring and that really provides you with a lot of visibility. And this is a company that has consistently beaten expectations, raised guidance, and delivered strong returns.
Cādence has also been one of the strongest performers in our portfolio, year to date. It’s gone up very strongly because, as we are seeing this demand for AI coming through, with more and more people talking about it, AI needs semiconductor chips. And you know, a company like Cādence is between those kind of platform companies like NVIDIA, and systems companies like Apple, which are increasingly designing their own semiconductors to drive differentiation. Cādence has absolutely been a beneficiary of the AI trend. When I met the CFO in London just last week, what was really interesting to me is that he said to me, “When you take computational software and apply it to data, that’s AI. We’ve been doing that for the last 35 years.”
Moncler is very different. It is an Italian-listed company that is a luxury brand with a focus on outerwear – they’re particularly famous for their alpine down jackets. The company has a consistent track record of delivery. It’s got one of the best margins in the luxury sector and growth here is driven by growing brand awareness and this kind of exclusivity around the brand, as well as the continued retail store rollout, particularly in the Asian market, pushing into new categories, so things like knitwear for example. And also, the recent deal that they’ve done with Stone Island, which is targeting a younger audience. And this is a company that has continued to deliver very strong sales momentum, so even in Q1, they had very strong sales in China and the US and they’re also launching products to coincide with their 70th anniversary this year.
As a bottom-up stock picker, you obviously care about companies and their growth and their revenue and their valuations and their momentum. Yet you must have to meet lots of management. How do you work out what good management looks like?
I do really think it is an art rather than a science. I think first of all, it’s always important to meet management before you invest in these companies, to hear them articulate how they think about their own strategy, their vision and their plans for getting there. And often you’re looking for softer things as well – so, for example, how does the CEO interact with the CFO? Is he completely speaking over him or is he allowing other people to shine? There are all these kind of softer attributes that come from meeting with management teams. You also get a feel for whether someone comes across as relatively well thought-out or is conservative in nature. And I think it’s important to get a feel for the individuals because at the end of the day they’re the ones running the company.
And a lot of mid-cap companies still have a kind of ‘founder’ element or the family may still be involved in some way, or the management team themselves are significant shareholders in the company. That alignment of interest is important again, so actually, meeting the management of these companies is important.
Tell us more about abrdn’s in-house proprietary tool called the Matrix.
The Matrix is a dynamic tool which rates stocks relative to each other as part of the wider universe. The Matrix basically has 13 factors, and the largest weightings are given to earnings momentum, quality, and growth. And the reason earnings momentum is given such a large weighting is because when you do back testing of the Matrix, it reveals that earnings momentum is the most predictive factor of future performance. I think what’s interesting is when you look at the Matrix right now and the ideas that are coming through – particularly those top quintile names – they’re not concentrated in any one geography or any one sector, it is quite a broad base.
There’s certainly a debate for some people around whether we’re going to see Asian or emerging market stocks do particularly well, given that these countries have inflation that is closer to the target range. Their central banks are near or already at the end of their hiking cycle, and that contrasts to some of the developed markets and whether that provides more opportunities for those Asian EM stocks.
One stock that we bought in the portfolio in Q1 2023 was Proya Cosmetics Co., Ltd. in China. It was a name that was screening well on our Matrix and the reason for that is because they’ve continued to reveal results that have beaten expectations. For those not familiar with Proya, this is a company that specialises in cosmetics, so particularly skincare, for a mass market, Chinese domestic audience. And this is a company that is growing because of ‘premiumisation’, expanding from being a single product to a collection, and really going after the younger demographic in those Tier One and Tier Two cities. And it’s a high-quality company that’s continued to beat expectations.
Finally, is there one exciting small cap graduate you’d like to highlight?
One example that really stands out for me is a US-listed company called Insulet Corporation which is a manufacturer of tubeless insulin pumps. We bought this stock in our Global Small-Cap fund back in 2016/17 as a small-cap, and it’s continued to be a really strong performer. And the reason for that is they’ve increased their penetration rate amongst diabetics, which unfortunately as we know, is a growing population group, to do with lifestyle and diet factors. Not only is there a growing demographic, but this company has also really helped to broaden access and reimbursement, because their device is available through the pharmacy channel in the US, thus eliminating the upfront cost associated with getting the device.
Insulet then graduated into mid-cap status, which we bought in the Global Mid Cap fund at the time of inception. And again, it has continued to do well. It’s actually now just launched its first automated insulin delivery system called Omnipod 5, which is, if you like, a step closer to an artificial pancreas helping to target Type 2 diabetics as well, which is an even larger population size. Insulet is basically on the cusp of becoming a large cap now. So that is a example of a stock that’s gone from small to mid to now potentially going into large-cap status.
Listen to the full interview here:
