Diary of a Fund Manager: Navigating through the coronavirus crisis

Start-up fund manager Abhinav Shah reveals how the Rosevine Capital Global Equity Fund has performed during the coronavirus crisis.

The first four months of 2020 have presented investors with unique challenges and opportunities as market participants attempt to assess the potential impact of COVID-19 on the future profitability and, in some cases, viability of companies around the globe. Since major equity indices reached a nadir on 23 March 2020, global equity markets have staged a recovery that has been almost as rapid as the decline that preceded it.

The speed with which global equity markets have recouped much of their earlier losses has surprised the vast majority of analysts and commentators from what I have read, with many seeming to be of the view that the recovery in global equity markets has come too far too quickly given the current uncertainty and the inherently wide distribution of outcomes from here.

To put some numbers on it, as of 30 April 2020, the FTSE 100 was down 23.59%, the S&P 500 was down 12.38% and the Nasdaq 100 was, by some miracle, down only 0.17% for the year. The significant variance in the returns of these three major indices is naturally a product of the constituents of each index, their relative weighting within each index and their individual returns for the year.

Unfortunately for investors in the FTSE 100, the significant weighting of financials and energy companies and under-weighting of technology companies in the FTSE 100 as compared to the S&P 500 and Nasdaq 100 has contributed markedly to the relative under-performance of the United Kingdom’s benchmark index.

Given the comparatively modest declines of the S&P 500 and Nasdaq 100 from the beginning of the year to 30 April 2020 (both indices have generated positive returns for investors in the month of May so far with the Nasdaq 100 now being firmly in positive territory for the year), it certainly feels as though the risk-reward is asymmetric at current levels with the likely direction of travel being downward rather than upward from here, although I would urge investors not to become anchored to the lows reached in late March.

Many investors will undoubtedly be kicking themselves that they didn’t deploy capital, to the extent that they had the capacity to do so, in late March and I suspect it’s these same investors who believe or hope that another sell off is just around the corner.

The reality is that the future is, by definition, unknowable although this does not discourage individuals from striving to predict it and benefit from those predictions. However, I prefer not to focus unduly on attempting to forecast the macro environment since I am just as likely to be wrong as I am to be right and if I do happen to be right, it’s just as likely to be down to luck rather than my ability to divine the future accurately.

Instead, my efforts are dedicated to identifying companies with enduring competitive advantages which I believe are attractively priced by the market and then diligently monitoring the evolution of the businesses in which the Rosevine Capital Global Equity Fund (the “Fund”) is invested against management’s and my own expectations. With that in mind, I will now turn to which companies in the Fund have performed well, how the Fund is positioned going forward and where they may be attractive investment opportunities in the future.

Technology leads the way

In broad terms, the share prices of the companies that have held up well during the pandemic have been those in the technology sector whilst the companies that have unsurprisingly seen some of the steepest declines are those operating in the consumer discretionary sector, e.g. hospitality, leisure, retail and travel businesses. As I survey the share price performance of individual companies held in the Fund, this narrative is broadly replicated with the consequence that the Fund has outperformed its peer group on a relative basis (10^th place out of 327 funds in the IA Global Sector in the period from 1 January 2020 to 30 April 2020) given the Fund’s holdings in the technology sector.

However, drilling down a little to examine the top five performers in the Fund on a percentage basis in the period from 1 January 2020 to 30 April 2020 reveals a more nuanced story. In order of magnitude of percentage gains in local currency from largest to smallest, the Fund’s top five performers in the period from 1 January 2020 to 30 April 2020 were MSCI, Amazon.com, Sea, T-Mobile US and Chr. Hansen. Technically speaking, they are all in different sectors albeit that most individuals would probably regard Amazon.com as a technology company at its core rather than a consumer discretionary company.

So, whilst the share prices of technology companies have undoubtedly outperformed in the first four months of the year, the Fund’s technology holdings only provide some of the explanation for the Fund’s strong showing over this period as illustrated by the diverse nature of the Fund’s top performers. All of these companies have now reported numbers for their most recent quarter, so I have provided a brief introduction to each company and a summary of their financial performance for the quarter below.

MSCI: resilience and growth

MSCI is grouped with other financials, although it has little in common with banks and insurance companies, and derives the bulk of its revenue from the license of recurring subscriptions for MSCI’s Index, Analytics, Environmental, Social and Governance and Real Estate products and services and fees from ETFs and other financial assets or contracts linked to or based on MSCI Indexes (MSCI pluralise the word “index” as “indexes”, so I have used it here although I prefer “indices”).

In the years 2015 to 2019, MSCI grew revenues at a 10% compound annual growth rate (“CAGR”), free cash flow at a 25% CAGR and adjusted earnings per share (“EPS”) at a 29% CAGR. During this period, MSCI’s operating margin also improved by almost 11% to 48.5% which illustrates the inherent operating leverage in the business, whilst recurring revenues from subscription and asset-based fees were ~97% annually with retention rates of >92% annually. As a customer of their services (the MSCI World Index is the Fund’s benchmark), I can personally testify to the necessity and stickiness of their products and services, which affords them considerable pricing power.

Despite the difficult economic environment in the first few months of the year, MSCI delivered organic revenue growth of 12%, an improvement in operating margin to just shy of 50% and an increase in adjusted EPS of 23% in Q1 2020 compared to Q1 2019. In addition, MSCI took advantage of weak share prices during Q1 2020 to repurchase 1.3 million shares at an average price of $248.65 per share, as compared to a share price of $333.58 at the close on 8 May 2020, leaving the company with $1.13 billion of share repurchase authorisation as at 31 March 2020 which represents ~3.9% of the company at prevailing market prices.

This robust financial performance, enhanced by opportunistic share repurchases, serves to demonstrate the resilience of the business and that the growth opportunities enjoyed by the company remain undimmed, even in a period marked by a significant drawdown in global equity markets.

Amazon: reinvesting during the downturn

As mentioned earlier, Amazon.com is grouped with other consumer discretionary companies but is probably regarded by most people as a technology company. As most individuals are also probably aware because they’ve used Amazon.com’s services at some stage, perhaps on an increasingly frequent basis since the onset of government imposed “lockdowns”, Amazon.com derives the majority of its revenue from the sale of myriad products and services to customers around the world. In addition, Amazon.com operates a division called Amazon Web Services (AWS) that provides cloud computing services to companies, large and small, and governments around the world.

Unsurprisingly, net sales grew an astonishing 26% to $75.5 billion in Q1 2020 as compared to Q1 2019 albeit that operating income and net income declined during the period as compared to Q1 2019 driven by meaningful cost increases as the company responded to heightened demand for their products and services.

In addition, the company announced that they expect to spend the entirety of their expected $4 billion operating profit in Q2 2020 on “COVID-related expenses”. This announcement led to some disappointment amongst investors causing the share price to decline from its all-time high the following day. Notwithstanding this small blip, Amazon.com’s sheer scale, robust business model, entrepreneurial mindset and willingness to reinvest in the business even during a downturn leave the company well placed to flourish in the years ahead.

Sea: uniquely positioned

Sea is a technology company founded in Singapore in 2009 that operates an e-commerce platform (Shopee), an online games developer and publisher (Garena) and a digital payments and financial services provider (SeaMoney). The company operates these businesses in Southeast Asia primarily, with the majority of revenue being generated in Indonesia, Taiwan, Vietnam and Thailand.

Between 2017 and 2019, Sea grew revenues at a CAGR of 129.2% from $414.2 million to $2,175.4 million, although net losses grew significantly during the period to $1,457.7 million in 2019 as a result of ongoing investment to expand the three businesses, with a particular focus on Shopee. In 2019, Sea derived 52.2% of its revenue from Garena, with the balance being derived from the operation of the Shopee platform in the main. In Q1 2020, total adjusted revenue increased 57.9% and gross profit increased 424.1% compared to Q1 2019, with the largest percentage increase in total adjusted revenue coming from e-commerce activities which serves to justify the increased investment the company is making in the Shopee platform.

Whilst Sea has not yet reached profitability, the company continues to benefit from the growing shift to online in the markets in which it operates and is uniquely positioned to benefit from this irreversible trend in the future.

T-Mobile: dialling into value

T-Mobile is America’s self-styled “Un-carrier”, delivering wireless services to 86 million postpaid, prepaid and wholesale customers. The company is now led by newly appointed President and CEO, Mike Sievert, who officially took over leadership of the company as of 1 April 2020 from the irrepressible John Legere who is rightly credited with an extraordinary turnaround of T-Mobile since his appointment as President and CEO in 2012, which culminated in the recent closing of the merger with Sprint which also took effect from 1 April 2020.

As has come to be expected of T-Mobile, service revenues and net income both increased 5% in Q1 2020 as compared to Q1 2019 and the company led the industry in “branded postpaid phone net customer additions” in Q1 2020, which represents the 25th consecutive quarter that T-Mobile has done so.

The investment case for T-Mobile going forward rests on a successful combination with Sprint, with management targeting ~$43 billion of synergies and an improved margin profile over the next three to four years and beyond. The execution risk associated with a merger of this size is not to be dismissed, but if T-Mobile can successfully replicate the playbook from their earlier acquisition of MetroPCS in 2013, after which they delivered 40% higher synergies than originally projected and one year ahead of plan, the opportunity for shareholder value creation is significant as the company delivers the targeted synergies and strong free cash flow generation enables a rapid deleveraging of the business.

Chr. Hansen: shrugging off COVID-19

Chr. Hansen is a Danish bioscience company within the materials sector that manufactures food cultures and enzymes, probiotics and natural colours for the food, nutritional, pharmaceutical and agricultural industries. Chr. Hansen generates 59% of its revenue from food cultures and enzymes with the balance almost equally split between the health and nutrition and natural colours segments.

In the most recent quarter to 29 February 2020, Chr. Hansen delivered organic revenue growth of 5% and maintained guidance for the year of 4-6% revenue growth with the company stating that COVID-19 “did not have a material impact” on the business in Q2 and that they expect to see both positive and negative impacts on the business during the rest of the year as countries attempt to manage the consequences of the pandemic. The necessity of Chr. Hansen’s products to their customers remains unaffected by the crisis and the long-term global trends such as population growth, more sustainable agricultural practices and reducing food waste that underpin the investment case remain very much intact.

Looking for bargains

The fact that the Fund’s top five performers during this challenging period operate in different industry sectors reinforces the importance of investing in companies with diverse and resilient business models that are unrelated in terms of their underlying activities and customer bases and also have the capacity to grow, almost irrespective of the prevailing economic environment.

In terms of how the Fund is positioned going forward, I have changed little in terms of the companies that the Fund owns. I have not engaged in any selling, but did buy into two new companies as the crisis began to unfold although I’ll admit that I was early in doing so because I had underestimated investor reaction to the perceived severity of the pandemic and the steps required to be taken by governments around the world to prevent the crisis from spiralling out of control.

The Fund has limited exposure to the sectors hardest hit by the pandemic, but the exposure it does have is to the best of breed businesses within their respective sectors. I anticipate that these businesses will have sufficient liquidity to survive any reasonable estimate as to the duration of the “lockdown” and are well placed to benefit from an eventual recovery, irrespective of the path that the recovery takes.

For those looking for bargains, opportunity is inevitably to be found amongst companies in sectors that have been hardest hit by the pandemic, e.g. airlines, aircraft manufacturers and their suppliers, financials, hotel chains, restaurant chains and retail. Some of these sectors are ones that I typically avoid due to cyclicality and lack of predictability, but there are some high quality businesses within these sectors that will generate attractive returns for the courageous investor, assuming that the world reverts to a pre-pandemic normal within a reasonable time frame, which is far from assured.

Whilst I am optimistic and am currently of the view that the pandemic will pass and that daily life will return to a normality that already feels quite distant, the distribution of outcomes for many businesses from here remains wide and highly uncertain. Accordingly, whilst I am spending time identifying and researching the best businesses in the sectors most affected by the pandemic, I am proceeding with caution and am currently in no rush to add additional exposure to these beaten down sectors.

About the author

Prior to founding Rosevine, Ab worked at Barclays for 13 years, where he was a Managing Director ultimately responsible for a proprietary investing, lending and trading business operating across both public and private equity and fixed income markets. Prior to joining Barclays, Ab worked at Société Générale. Ab began his career at Arthur Andersen where he qualified as a Chartered Accountant.