During the March 2024 quarter, the Polen Capital Global Growth Fund (the Fund) increased by 12.49 per cent in Australian dollars, while its benchmark, the MSCI ACWI Net Total Return Index, in Australian Dollars, returned 13.10 per cent. In many ways, the first quarter marked a continuation of the market dynamics already in place at the end of last year.
Markets staged a robust two-month rally into the end of the year on optimism that the Fed would achieve an elusive soft landing and taper interest rates in early 2024. This rally continued unabated into the first quarter, with much of the same high-momentum, highly cyclical leadership we saw last year. Consider some of the top-performing sectors: Information Technology, Financials, Industrials, and Energy. Even within Technology, it’s a story of a smaller subset of semiconductor companies benefitting from the growing frenzy around artificial intelligence (AI), with NVIDIA being the poster child.
A notable development in 2024 has been increasing dispersion and breadth of market leadership. This stands in sharp contrast with 2023’s concentrated leadership among a small grouping of the largest benchmark holdings, dubbed the “Magnificent 7.” This increased dispersion is none more evident than with NVIDIA and Meta Platforms being up 82 per cent and 37 per cent, respectively, during the first quarter, while Apple and Tesla were down -11 per cent and -30 per cent, respectively.
With our emphasis on sustainable, predictable growth, which in many cases is supported by secular tailwinds, this was not an environment particularly conducive to the way we invest. As such, we were pleased with how our the Fund performed in this heavily pro-cyclical market backdrop.
The latest earnings results reinforce the stability and resilience of the businesses we own, which by and large continue to meet— if not exceed—our earnings growth expectations.
Even in some segments, such as IT services and retail, where we have seen economic softening drive near-term weakness in fundamentals, we think it’s prudent of management teams to set conservative expectations reflective of an uncertain macro environment and with the long term in mind.
While extreme optimism seems to be the dominant feature in parts of the market of late, it does not influence our long-term approach to investing. Our approach centers on being long-term owners of some of the highest-quality businesses in the world, supported by durable competitive advantages, strong balance sheets, and secular growth tailwinds. In remaining disciplined in our process and research, we think our businesses are as well positioned as any to deliver above-average earnings growth with below-average risk in good times and bad.
Portfolio performance and attribution
The largest relative contributors to the Fund’s performance during the first quarter were SAP, Apple (not owned), and AmazoNot n. From an absolute perspective, the top contributors were Amazon, SAP, and Microsoft. The largest relative detractors to the Fund’s performance during the first quarter were NVIDIA (not owned), Adobe, and Workday. From an absolute perspective, the largest detractors during the quarter were Adobe, Globant, and L’Oréal.
SAP
After delivering a robust fourth quarter, SAP’s stock price again rose significantly in the first quarter of 2024 on solid 4Q23 earnings and full-year guidance that was revised modestly higher. Importantly, SAP’s transition to the cloud (a core part of our thesis on the business) continues at pace, and the company is seeing both strong cloud revenue growth and expanding cloud gross margins. Management is guiding cloud sales growth through 2025 in the mid-20 per cent range, which we view as reasonable and attractive. We view SAP as one of the more resilient software business models as it is an essential part of their customers’ day-to-day operations and cannot easily be turned off or scaled back. Additionally, we think CEO Christian Klein is honest, competent, and long-term minded – traits we value highly in leadership.
Apple
The zero weight to Apple was another notable relative contributor in the quarter. More recently, Apple has come under pressure from a confluence of issues ranging from a weak iPhone cycle, market share erosion in China, mounting regulatory pressure around App Store fees in Europe, and a lawsuit from the U.S. Justice Department accusing the company of anticompetitive practices in its iPhone business. All this has resulted in the stock being down 11 per cent year to date, underperforming the overall Index by 19 per cent – Apple’s worst relative performance quarter since 2013. It remains a great business and one we follow, but we’re content not owning it right now, given its growth prospects relative to its valuation.
Amazon
Amazon, which saw significant price appreciation throughout much of 2023, continued its strong performance on the back of a solid fourth quarter 2023 earnings report. After a long-awaited re-acceleration in AWS (Amazon Web Services) revenue growth, we saw it materialize during the period. Most importantly, the company’s margins and free cash flow have rebounded significantly off the 2022 lows. This rebound in margins and free cash flow at Amazon has been a key component of our shorter- term expectations for the business.
We expect the improvement to continue through 2024 and beyond (though perhaps not linearly) as the company optimizes costs and capital expenditures. Our longer-term thesis is that the business is dominant in its end markets, continues to have strong growth prospects with tailwinds, and rising margins should accompany growth to boot. Margins should rise as higher-margin business segments, namely AWS, advertising, and 3P, become a larger part of the mix over time. Our position in Amazon reflects our positive long-term expectations of their business, and it is currently our largest absolute weight in the portfolio.
NVIDIA
NVIDIA – a stock we do not own – was the largest relative detractor during the past quarter, having delivered an 87 per cent year-to-date return on the back of a 239 per cent return in 2023. The company continues to defy very elevated expectations as it plays a central role in building the infrastructure for AI in the years ahead. In our 2Q23 letter, we discussed at length our rationale for not owning NVIDIA and would point clients there for more detail. In short, however, our decision not to own NVIDIA comes down to questions about the sustainability and predictability of its growth. While we fully acknowledge this is a compelling business with a deep moat and skilled management team, the issue for us is that this is not a recurring revenue business. As we’ve seen through time, NVIDIA has proven susceptible to extreme cyclicality in its business, and with all of the fervent pull forward of demand over the past year alongside an elevated valuation, we prefer to remain on the sidelines until we can gain more conviction in the durability and predictability of earnings growth looking ahead.
Adobe
Adobe, the leader in cloud-based creative digital media, had been among the strongest-performing holdings over the past year. After some initial misgivings in early 2023 around generative AI’s impact, the market quickly embraced Adobe as an AI beneficiary following the rollout of its Firefly product, sending the stock up 84 per cent from mid-May through the end of January. Following its latest earnings release, the stock sold off on slightly weaker-than-expected 2Q 2024 guidance and some renewed scepticism around effectively monetizing AI within its creative suite. From our perspective, the recent share price moves are more reflective of changes in near-term expectations and sentiment than any fundamental change in Adobe’s business. We acknowledge that AI developments like OpenAI’s new text-to-video creation tool, Sora, might be seen as an emerging competitive threat. Still, we believe that Adobe is well-positioned to leverage new AI capabilities to its advantage, and we remain confident in the company’s position.
Workday
Finally, weakness in Workday during the quarter is likely more a function of the stock taking a breather than any adverse fundamental development. From the end of October through the end of February, the stock was up 40 per cent, buoyed by the company’s better-than-anticipated earnings in 3Q 2023, and management raised revenue guidance for their fiscal 2024. In 1Q 2024, the stock sold off on results and guidance that did not exceed the elevated expectations some investors anticipated. We believe Workday has ample room to continue taking share in a nicely growing $100 billion + global human capital management (“HCM”) market and remain confident in the company’s ability to generate 20 per cent + annualised free cash flow per share growth over the next three to five years.
Outlook
While market sentiment has markedly improved in recent months, consensus now expects a soft landing and stabilisation of the interest rate environment. Only a few months ago, the consensus called for rates to remain “higher for longer,” and expectations for imminent recession were not uncommon. Regardless of the near- term direction of the global economy, our research indicates that the Fund’s holdings are performing well, and we expect them to continue to perform well through the cycle. We believe the Fund’s valuation is currently fair for what we consider to be a collection of some of the best companies in the world.
The Polen Capital Global Growth Fund owns shares in SAP, Amazon, Microsoft, Adobe, Globant, L’Oréal and Workday. This blog was prepared 18 April 2024 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade SAP, Amazon, Microsoft, Adobe, Globant, L’Oréal or Workday, you should seek financial advice.
If you would like to learn more about the Polen Capital Global Growth Fund, please visit the fund’s web page to learn more: Polen Capital Global Growth Fund
Past performance is not an indicator of future performance. Returns are not guaranteed and so the value of an investment may rise or fall.
This report has been prepared for the purpose of providing general information, without taking into account your particular objectives, financial circumstances or needs. The issuer of units in the Polen Capital Global Growth Fund (ARSN: 647 518 723) is the Fund’s responsible entity Fundhost Limited (ABN 69 092 517 087) (AFSL: 233045). The Product Disclosure Statement (PDS) contains all of the details of the offer. Copies of the PDS and Target Market Definition (TMD) are available from Montgomery Investment Management, contactable on (02) 8046 5000 or at www.montinvest.com and at https:// fundhost.com.au/ An investment in the Fund must be through a valid paper or online application form accompanying the PDS. Before making any decision to make or hold any investment in the Fund you should consider the PDS and TMD in full. The information provided is general in nature and does not take into account your investment objectives, financial situation or particular needs. You should consider your own investment objectives, financial situation and particular needs before acting upon this information and consider seeking advice from a licensed financial advisor if necessary. You should not base an investment decision simply on past performance. The investment returns of the Fund are not guaranteed, and so the value of an investment may rise or fall.