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Schroder GAIA Egerton Equity: Quarterly Fund Update
Schroder GAIA Egerton Equity: Quarterly Fund Update
Schroder GAIA Egerton Equity: Quarterly Fund Update
Fund benchmark* MSCI World TR Net (local currencies) Total net exposure 59.9
Options (delta-adjusted) 0.0
Fund size $1,298 million
Total gross exposure (delta-adjusted) 150.0
Ongoing charge** 1.67% Total net exposure (delta-adjusted) 59.9
Number of positions*
Performance fee 20% excess return above EONIA +
1% subject to a High Water Mark Long 38
Source: Schroders, as at 31 December 2018. Short 101
*Please note the fund is benchmark unconstrained; index returns are
provided for reporting purposes only. Source: Schroders as at 31 December 2018. Figures are on a delta-
**The ongoing charges figure is as at 31 December 2018 and may vary adjusted basis.*Excluding index options and government bonds.
from year to year for the C Acc EUR share class.
Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as
rise and investors may not get the amount originally invested.
The gradual slowdown in the European and Chinese economies seemed to accelerate and this fed through into a somewhat, but not
notably, weaker backdrop in the US. Even so, pessimism grew that the world’s largest economy could remain robust in a weaker
global context. America’s trade conflict with China was negative for US corporate confidence and for the Chinese economy, while
market participants grew quickly to fear that the Federal Reserve (Fed), by guiding to interest rate rises in the context of a global
slowdown, has trapped itself into a policy that ignores current data and, more importantly, a weaker outlook.
Markets fell sharply, led by the US, which has been the standout global equity performer over the last few years, as investors rushed
for the exit.
The fund dropped 10.7% in Q4, to end the year down 6.0%. We were disappointed by this given the fund’s strong start, although it fell
by less than global equities.
It ended the year with modest outperformance from both its longs and its shorts; i.e. the former dropped by less and the latter by
more than the market.
As we review our analytical mistakes of the last year, we feel our major, return-impacting errors of analysis (i.e. where we have
significantly misforecast earnings/cash-flows/balance sheets etc.) were dominated by the fund’s China-related names -Tencent,
Alibaba and Wynn Resorts. We believe our key errors were that we:
Underestimated the effect of the economic slowdown on their businesses and ended up cutting our forecasts on a number
of occasions;
Failed to cut positions aggressively enough; in the past we have felt that, while we make as many mistakes as anyone, we
are at least able to recognise our errors and dispassionately move on from them, and we were, and remain, seduced by the
long-term growth prospects of these businesses, and failed to walk away from a confluence of negatives.
The business is intrinsically very profitable, generating a mid-teens ROE with modest incremental capital needs from a fee-centric
model. Amex benefited for decades from the unique capabilities and insights stemming from its proprietary "closed-loop" business
model, and we believe that it has more potential than ever to exploit its holistic set of clean customer data, yielding it deeper insights
into spend and credit behaviour, while allowing its marketing dollars to be targeted more and more efficiently, year after year.
Still, we consider Amex to be a hitherto under-managed business which under its new CEO, Steve Squeri, should benefit from an
injection of focus and urgency.
In 2015 Amex suffered greatly from the loss of its key US co-brand partner, Costco, and struggled to execute on its “Enterprise Growth”
initiatives in areas like prepaid and financial technology; it had made various peripheral acquisitions, and seemed to be run as a holding
company under a CEO who had been in his role for a very long time.
Steve Squeri has a very hands-on approach, and has been responsible at Amex for the global commercial business, technology, and
corporate services, among other roles. He has pivoted the company to focus on its core strengths, and on accelerating spending and
lending. The company is applying its key learnings globally, and is now running its consumer and corporate operations as single,
integrated businesses, rather than as a series of regional entities. Our numerous recent meetings with several of the senior
management team have reflected a company that is more open, more focused, and much more clear about its key financial drivers
and objectives.
As a “closed-loop”, Amex differs from the larger card networks (Visa and MasterCard) in that it not only issues cards to customers, but
it also has a merchant-facing business whose role is to maintain and grow a formidable acceptance network. Amex was ‘under-accepted’
relative to the networks, and, on the basis that acceptance drives spend, has implemented a number of initiatives, such as its Opt Blue
programme (which works with third-party merchant acquirers to sign up smaller US businesses), to close this gap in the key US market
by 2019. It has adopted a more targeted approach elsewhere, with considerable success: in the UK, for example, its acceptance is very
strong in key cities and especially in travel/entertainment, but increasingly in everyday spend, which has helped it to grow volumes,
supported by its key co-brand partners (notably British Airways), by over 20%. Amex is now taking share in every one of its top 10
markets.
Amex is, on average, more expensive for merchants to accept than Visa and MasterCard (although not relative to their most expensive
cards). However, because it contracts directly with merchants, in advance, their costs are known, whereas the cost to a merchant of
accepting other cards can vary significantly. Further, in markets such as Europe, where network interchange fees have been cut
dramatically via regulation, Amex can promote its product as a premium rewards-driven product, since it is generally outside the scope
of such regulation. We believe that investors have begun to recognise that its average discount rate is much more of an outcome of
measures to drive acceptance and relevance to its customers, and thus spend and revenues, and that discount rate trends are relatively
stable. We are therefore unconcerned by the very modest decline in the company’s discount rate.
Amex recognises that, to drive spend, it must provide some of the best rewards/co-brand values, including not only points/miles but
ancillary benefits such as lounge access and insurance. The rejuvenated flagship Platinum product has been very successful, and Amex
has added new benefits such as Uber and dining credits to the package, in order to increase relevance to millennials and a younger
cohort. Revenue growth thus comes with modest discount rate erosion, and card member services spend which outpaces revenues.
We had been concerned that this trend was unsustainable, but now feel that the company has successfully reinvigorated its offering
and should be able to sustain decent revenue growth, while management is confident in sustaining cost control. Central costs have
barely risen since 2010, reflecting management de-layering, systems rationalisation and digitalisation, and general operating leverage,
while machine learning applied to data lowers the cost of acquiring customers. The firm admits that it has ‘years’ of improvements and
efficiencies ahead in key functions such as marketing.
We see Amex as growing revenues by 8-9% per annum, pre-provision profit by 11-14% and net income at 12%. The company has very
modest incremental capital needs, and so can buy back 2 to 3% of its share count annually, driving overall EPS growth in the 14% range.
Its prospects would be hit by the type of economic slowdown that would significantly impact spending volumes (Amex has a bias to
travel & expense or ‘T&E’spend) of either by individuals or corporates. In particular, it would be hurt by rising US unemployment, to the
extent this would worsen asset quality (we allow for a modest softening of asset quality in our numbers, but not a severe down-cycle).
We think the current valuation more than compensates for these risks.
Martin Marietta Materials, Inc. (MLM US) and Vulcan Materials Company (VMC US)
The fund recently invested in Martin Marietta Materials, Inc. (‘MLM’) and Vulcan Materials Company (‘VMC’), which are the two largest
US aggregates producers.
Quarried construction aggregates (which can be large blocks, crushed stone, gravel or screenings) are used as base layers for nearly
all construction sites (including housing), for concrete and paving asphalt, and are non-substitutable.
The main investment attraction of the industry is its excellent pricing power. Aggregates are a low-value product (normally selling for
considerably less than $20/t), which are expensive to transport relative to their value but which typically represent a very small (low
single digit percentage) of the value of a typical construction project. Planning permissions for new quarries are, meanwhile, near
impossible to obtain. Each quarry thus tends to be a local monopoly, and as industry leaders have bought smaller (typically family-
owned) entities, stable regional oligopolies have emerged. The supply of aggregates tends to be very well controlled, reflecting the
monopolistic characteristics of these local assets, and their highly variable, rather than fixed, cost structures allow their owners to cut
back output when demand is weaker, rather than maintain volumes and sell at lower prices.
Over the very long run, aggregate prices have risen by 3-4% per annum and in 2009 both MLM and VMC posted like-for-like price
improvements (of +2% and +3% respectively) despite sharp volume declines; indeed MLM’s prices increased by 2% per annum between
2008 and 2012 despite a 30% volume decline.
Operating costs at the major aggregate companies are typically well controlled. For example, since 2013, VMC’s unit costs have risen
by less than 1% per annum.
Demand for aggregates is driven by infrastructure projects (~45-50% of the market, new highways, bridges, tunnels), non-residential
construction (~25-30% of the market, offices, business parks, large new industrial projects, wind-farms, data centres), residential
construction (c~20% of the market) and for railroad ballast/other industrial applications.
MLM and VMC estimate overall demand to be running ~15% below mid-cycle levels.
Infrastructure is the most promising aggregate market near-term (and is running considerably below trend). We do not forecast a
major improvement in demand, but recent lettings (new project award) data from state Departments of Transportation (DoT) points to
an excellent outlook for spend from 2019-2021 in MLM/VMC’s key regions. State/local funding is more important than federal funding
for highways and other projects and so we believe growth will be strong even absent a new Federal Highway Bill.
US housing starts at around 1.2 million, are considerably below the long-term average of 1.5 million. Strong labour markets and rising
wages have bolstered demand, but tight supply and rising home prices have worsened affordability. Stable interest rates would help
demand, not least as millennials enter the market, while both MLM and VMC operate in states with growing populations.
Non-residential demand remains the most susceptible to an economic downturn. Forward indicators such as the ABI (Architectural
Billings Index) and Dodge Momentum suggest modest construction spending growth next year before a potential flattening trend in
2020.
Organic revenue growth of 7-10% over the next 2-3 years should have an outsized impact on earnings as incremental margins are likely
to be over 50% at this stage in the cycle. We forecast 25-30% earnings growth for both companies in 2019.
MLM and VMC’s shares were weak in 2018, dropping 19% and 21% respectively. We feel that these are assets with considerable long-
term earnings power on reasonable valuations (15-20% below their historic averages).
We believe that Europe remains set in its sluggish, low growth era, with little to spark a revival of animal spirits. To us, this is
little different from the environment of the last few years
Asia has clearly weakened, with China impacted by the trade war, and the cyclical nature of its economy; the tech hardware
sector is an area of particular weakness across Asia
Data remains reasonably strong – as indicated by the December employment statistics – albeit with exceptions (autos,
housing, tech hardware). However, sentiment/expectation/soft indicators have weakened because of a range of factors,
including trade wars, the nature of US political leadership, and the global backdrop
We have tried to build the fund’s long portfolio from advantaged companies that can grow above the averages. The fund has a
reasonable amount of cyclical/economy-sensitive exposure, via its positions in North American Railroads, MLM/VMC, and perhaps
Amex, but we feel that these companies have many attractive characteristics, while their businesses are far less volatile than is
commonly perceived. At present, we are unable to square the brutal price action of these stocks, or of the long portfolio overall in
October and December, with what we understand to be their fundamentals, and feel that good values remain on offer after the
recent sell-off (as they were before).
We realise that we are at risk of ‘arguing with the market’ in maintaining this stance. We will continue to monitor how economic
deterioration impacts the long portfolio to ensure that we do not fall into the trap of ‘thesis creep’, and to maintain a focus on
resilient, advantaged companies, which can grow in a world where positive revenue trends are scarce.
Risk Considerations
The capital is not guaranteed. The value of the fund will move similarly to the equity markets. Emerging equity markets may be more
volatile than equity markets of well established economies. The title of securities may be jeopardised through fraud, negligence or
mere oversight in some countries. However the access to such markets may provide a higher return to your investment in line with its
risk profile. The fund may hold indirect short exposure in anticipation of a decline of prices of these exposures or increase of interest
rate where relevant. The fund may be leveraged, which may increase the volatility of the fund. The fund may not hedge all of its market
risk in a down cycle. Investments into foreign currencies entail exchange risks. Investments in money market instruments and deposits
with financial institutions may be subject to price fluctuations or default of the issuer. Some of the invested and deposited amounts
may not be returned to the fund. The investments denominated in a foreign currency of the share-class may not be hedged back to
the currency denomination of the share-class. The share-class will be positively or negatively impacted by the market movements
between those currencies.
Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise
and investors may not get the amount originally invested.
2 France 13.8%
Information technology KR -0.8%
Germany 4.7%
3 Consumer discretionary CN -0.8%
Hong Kong 3.7%
4 Information technology JP -0.8%
Canada 3.4%
5 Consumer discretionary DE -0.8%
China 2.8%
Source: Schroders.
Luxembourg 0.9%
Sector allocation
Switzerland 0.5%
Italy 0.4%
Sector Net Weight
United Kingdom -0.2%
Industrials 24.1%
Israel -0.2%
Communication services 16.6%
Austria -0.3%
Financials 9.6%
Finland -0.4%
Information technology 9.4%
Taiwan -0.4%
Materials 7.7% Belgium -0.4%
Consumer discretionary 2.0% Denmark -0.7%
Total 59.9%
Total 59.9%
Source: Schroders. Analysis based on market exposure as a percentage
of total fund size excluding currency forward contracts.
The fund is currently closed for new subscriptions; however, to the extent that capacity becomes available new
subscriptions will be considered. To the extent you wish to subscribe in the fund, when there is available capacity, please
contact Schroder Investment Management (Europe) S.A. who can explain the process and your name can be added to
a waiting list which will be considered on a “first come first served” basis.
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