Despite negative sentiment for much of 2023, global equities have cast off the fears over inflation, recession and war to enter the fourth quarter with double-digit returns[1]. Much of the heavy lifting, particularly during the first half, has been done by a handful of technology stocks which have benefitted most from investors’ enthusiasm for Artificial Intelligence (AI). These ‘Magnificent Seven’ have provided around two thirds of the entire market’s gains and now represent 16.4% of the global index, greater than the weightings of Japan, UK, China and France combined[2].
For SKAGEN Global – and many other global equity funds – so few companies driving so much performance has made it difficult to keep pace with the market. Not owning five of the seven AI torchbearers has contributed to the fund lagging the index by around 4.5%, despite generating a solid absolute return over the first nine months of the year.
“With the stock market being so narrow this year it has been challenging to beat the index without having even more concentrated exposure to a small number of stocks which is clearly very risky,” explains Knut Gezelius, Lead Portfolio Manager of SKAGEN Global. “We invest without considering the benchmark over a multi-year horizon and believe this still the best way to maximise long-term returns.”
AI exposure at the right price
The two ‘Magnificents’ that SKAGEN Global does own – Microsoft and Alphabet (Google) – have been in the portfolio for many years and are both top ten positions in the fund. True to its long-term investment philosophy, SKAGEN Global has owned Microsoft since 2010 and Alphabet since 2012. The pair are at the forefront of AI technology but, unlike some of the others, have proven business models and are not reliant on it to grow. They also continue to trade at attractive valuations with an estimated upside of 40% and 33% respectively over the next 2-3 years according to the portfolio managers.
Two of the fund’s other long-term holdings which have contributed positively to returns this year are playing a more discreet but similarly important role in AI development, as Gezelius points out: “Samsung, a marathon holding in the portfolio since the late 1990s, is one of the world’s biggest producers of the semiconductors needed for AI to function. We also own the Dutch technology giant ASML, which has a near monopoly on the photolithography machines used to produce computer chips. Both companies are driving AI behind the scenes and stand to win regardless of which big tech companies grab the headlines.”
Alongside Microsoft and Alphabet, DSV has been the main driver of Global’s positive absolute returns this year. The Danish transport and logistics company has navigated the global freight market well even though rates have been normalising after the artificial spike experienced during the pandemic when supply-chain bottlenecks sent prices soaring. However, DSV recently announced that its highly reputable CEO is stepping down in late 2024 and this takes some of the shine off the investment case, although the upside remains robust with 70% over the next 2-3 years.
The biggest drags on SKAGEN Global’s portfolio in 2023 have been its two holdings from the consumer staples sector which are both feeling the after-effects of the pandemic. Dollar General, the US discount retailer, has struggled as its lower income customers have cut spending in the face of persistent inflation while cosmetics giant Estee Lauder has been hit by lower-than-expected sales in China as result of the county’s slow economic recovery from COVID.
Although disappointing, the portfolio managers believe these to be blips in the companies’ performance without lasting damage and that their long-term investment cases remain intact. Gezelius explains: “The operating environment for many consumer companies is difficult with slow growth and inflation fuelling rising costs and a cost-of-living crisis. We met recently with DG and are confident that the experienced management team will get things back on track and Estee Lauder can similarly rectify things without any lasting impairment to its brand.” In early October, Dollar General re-hired its former CEO who oversaw a highly successful multi-year period for the company and the stock rose nearly 10% on the day of this announcement.
Picking winners
SKAGEN Global’s AI-related holdings highlight that there are different ways to tap into the trends driving equity returns and that active management allows you to cherry pick the right companies at the right prices. Other attractive portfolio themes include emerging markets, consumer brands, family-owned businesses and those protected by high switching costs, with exposure gained via some of the world’s best and longest running companies.
Picking winners rather than backing the whole field is particularly important at a time when the market has become highly concentrated, as Gezelius explains: “The contribution of a small group of IT stocks to the overall market return isn’t sustainable. The record gap in valuations between the biggest companies in the index and the rest also spells higher risk – it has never been more important to resist the temptation of following the herd.”
The latest addition to the Global portfolio is RELX, an information-provider for professional and business customers. The UK-listed company originated from Reed Elsevier in 2015 and has since changed from a sleepy publisher to an innovation-driven data analytics business. Despite the transformation, Gezelius believes further upside lies ahead: “The market still underestimates RELX’s long-term equity story. Under one of Europe’s most prudent capital allocation management teams, it has an undervalued opportunity to deliver organic growth and rising profitability.”
Balance sheet strength
SKAGEN Global entered October with a portfolio of 31 companies having a weighted upside of 59%, which the portfolio managers believe can realistically be achieved over a two to three-year horizon. Importantly given the uncertainty over the economic outlook, the fund has been constructed to deliver attractive returns in a wide variety of macro and market scenarios.
The latest surveys suggest that the majority (64%) of investors expect a soft (or no) landing for the global economy despite half predicting weaker economic growth over the next 12 months[3]. With interest rates set to remain higher for longer in the face of stubborn inflation, debt could play an important role in determining company performance. SKAGEN Global’s holdings look well placed in this respect with lower credit risk and greater ability to service debt than the broader index (see chart)[4].
The uncertain macro outlook means that the dispersion of returns across the equity market is likely to remain high and volatility may increase further, creating further opportunities for active managers with broad mandates like SKAGEN Global. Gezelius concludes: “We aim to beat the market over time and help clients get rich slow. Patience is a quality shared by most successful long-term investors; outperformance is rarely a linear journey.”
NB: All information as at 30/09/23 unless stated otherwise.
[1] Source: SKAGEN. MSCI ACWI in EUR +10.9% as at 30/09/2023.
[2] Source: MSCI. MSCI ACWI as at 30/09/2023.
[3] Source: Bank of America Global Fund Manager Survey, October 2023.
[4] Source: SKAGEN. Based on median ratios.