Optimism in European equity markets continued throughout the second quarter. The major stimulus plans announced, both in the US and Europe, are gradually becoming more tangible realities. It appears that lax monetary policies will not be overly tightened, despite inflation risks. In addition, expectations for the next earnings season are encouraging and vaccinations are accelerating at a rapid pace. In this context, EDM Strategy rose +9.8% in the second quarter, once again outperforming the +6.5% gains of the MSCI Europe NR. In YTD terms, it has appreciated +19.2% vs. +15.4% for the European index.
In the last few months of 2020 and the first quarter of 2021, we saw a notable shift in sector and style, from high-quality defensive and growth businesses to their more cyclical counterparts with significant declines in 2020, such as finance and energy. Many momentum-influenced investors sought opportunities in what are considered “value” businesses in the broad sense, more or less justified, depending on the case. In our view, there were indications in the second quarter that this rotation could be losing steam. Unlike previous quarters, it no longer seems sufficient for a given security to fit into a certain sector or valuation mould to guarantee good performance. We believe the market is refocusing its attention on earnings forecasts with a more “micro” approach that is less ostensibly centred on sector or category. In the last three months, we have seen winners in more sectors with a healthy return to the basic concept of our vision: quality understood as value creation throughout the economic cycle and sustained over the long term.
At EDM we invariably strive to avoid “growth” and “value” labels, which are more or less arbitrary self-imposed restrictions that hinder the search for good investment opportunities. We continue to focus on finding value for our clients by selecting quality companies, with excellent management teams that lead sectors with structural growth throughout the cycle, with healthy balance sheets, and elevated cash flows. We demand quality, but not at any price: it’s about finding good businesses, but not overpaying for them.
The second quarter of 2021 was clearly positive for EDM Strategy’s balanced, flexible portfolio. Successful stock picking has been pivotal and its merits are even more evident in an environment where the volatility triggered by sector turnover is less intense. The market continues to offer good opportunities for active management.
On one hand, the dichotomy between the “winners” and “losers” of the pandemic has been diluted, making it possible to find good opportunities, differentiating between those cases in which the rebound—fuelled by the return to normality—had perhaps gone too far (especially in more cyclical sectors, like certain segments of the travel industry) and those where the market continued to discount very pessimistic scenarios (defensive companies related to the health sector impacted by the delay in elective surgeries). On the other hand, we believe that some sectors are still in the process of readjusting their growth expectations upward in the post-pandemic world, probably to levels far above what could have been expected in 2019. These are companies whose structural trend was positive pre-pandemic, where the emergence of COVID delivered an additional boost to growth by accelerating long-term trends. Some examples include semiconductors, the shortage of which has become a suffocating bottleneck for the economy, or players in the development of global e-commerce, such as the most sophisticated providers of logistics services.
Three categories of shares served as the top contributors to EDM Strategy’s performance in the second quarter:
- Companies in the global logistics sector, such as DSV and Deutsche Post DHL. Despite the welcome news in recent months, we believe that the process of adjusting profit estimates upward is not yet over. Multiple structural factors compound the complications created by COVID-19 to bolster the position of global leaders emerging from the pandemic with growing market shares.
- Pharmaceutical and healthcare companies like Novo Nordisk, Fresenius, and Roche. The market perhaps exaggerated concerns about potential policy/regulatory changes in the US, as well as the duration of the pandemic’s negative impact on the normal activity of medical services companies. Moreover, this group was certainly not among those favoured by sector rotation toward cyclical, value securities in late 2020 and early 2021; as a result, relative valuations became considerably more attractive in our opinion. As usual, great investment opportunities arise when the sector is not “trending.”
- Companies in the luxury and consumer discretionary sector, like LVHM, Kering, and L’Oréal. Initial opening data in a world longing to return to normal show very positive figures that have led the market consensus to significantly improve earnings forecasts. We maintain a very positive structural opinion of the sector, which we believe will continue to grow at high rates, thanks primarily to the expanding middle class in China.
The success of EDM Strategy is not attributable to the extraordinary contribution of one or two securities that account for the portfolio’s profitability, but the favourable evolution of the majority of selected companies representing diverse sectors. In 2021, approximately two-thirds of the portfolio outperformed the European index, consistent with the fund’s results in the last three years.
Finally, we have always maintained that our management approach focuses on the long term. This in no way implies that we are insensitive to changes in valuation or circumstance. In Q2, we sold our positions in Assa Abloy and Air Liquide, and reduced positions in Michelin and Inditex. In all instances, the decision was the result of valuation considerations after the favourable performance of the shares; in none of these cases has our positive perception of the fundamental merits of the companies changed.
We believe that EDM Strategy is well poised to continue outperforming the market in the coming quarters. The fund has seen excellent profitability since the start of the year, though this is mainly attributable to upward revisions in earnings forecasts and not a rise in multipliers. We maintain a well-balanced portfolio of quality companies, leaders in attractive, long-term sectors with interesting valuations and all the ingredients to obtain good returns in the years to come.
José Francisco Ruiz and Beatriz López,
co-managers of the EDM Strategy fund