The Thomas Report
This is the last Thomas Report, as after nearly forty years in the securities industry, it is now time to retire, soon after my sixty fourth birthday in March 2019.
There have been many changes to this industry since I started, just before Maggie Thatcher was elected in 1979. The removal of exchange controls was probably one of the first notable events, soon followed by the de-nationalisation of the myriad state owned companies and the general reduction of taxes – personal and corporate. You never stop learning in this industry, whether through the gloom of the crash of 1987 or the credit crunch of 2007/8, or the euphoria of the tech bubble in 1999/2000. Self-regulation, then regulation and the most recent malodorous outcome that is MIFID 2.
“Our dilemma is that we hate change and love it at the same time; what we really want is for things to remain the same, but get better.” Sydney J Harris, US Columnist
The new rules of data capitalism are still being written. Jeff Bezos, Founder and CEO of Amazon, believes you must obsess about customers, invest for the long term, exploit your network of customers to grow further, and focus on delivering the best customer experience at the lowest price via an online platform. In the past, we have written that the platform must be backed up by robust logistics and distribution centres.
Where data capitalism is embraced in data-rich markets, such as the UK, traditional companies are challenged and have to adapt or become obsolete. It is one of the functions of the investment manager to establish which they are, and avoid the ‘dinosaurs’. It should come as no surprise that Woolworths and British Home Stores no longer exist. However, looking at the list of consumer companies that are, or have been, in administration or Company Voluntary Arrangements (CVAs) is perhaps an indication that the Amazon effect is taking its toll – Homebase, Mothercare, House of Fraser, Maplin, New Look, Carpetright, Toys R US, Poundworld and, more recently, Coast. This influence of online platforms is not restricted to retail, and extends to other industries such as property, automobiles, travel and hotel accommodation. Within the AXA Framlington UK Select Opportunities Fund, we own Rightmove, Autotrader and also Worldpay, who facilitate transactions in the digital world. It took Airbnb three years to enter 89 countries, and took the Hilton Group 72 years to enter 69 countries. In 2007, CEO of Microsoft, Steve Ballmer, pronounced that “there is no chance the iPhone is going to get significant market share”. By neglecting the steady and continuous advancement in computing power and mobile technology, Microsoft missed the smartphone phenomenon.
Disruptive innovation is also manifesting itself in many ways. Professor Hayek, the Austrian liberal economist foresaw that “markets are essentially an ordering mechanism, growing up without anybody wholly understanding it, that enables us to utilise widely dispersed information about the significance of circumstances of which we are mostly ignorant”. Some disruption will continue to arise from advances in battery and storage technologies, and smart voice–activated assistants, 5G communication and autonomous vehicles.
“The secret of change is to focus all your energy not on fighting the old, but on building the new”. Socrates
Citigroup estimated that the average company lifespan on the S&P 500 Index has dropped from 61 years to 18 years. Those dinosaur companies fighting the old are not coping with behavioural changes, technological changes and industry and/or sector changes. One company in which we are increasing our exposure and that we perceive is coping well with change, is Coats Group. Established in the 1750s by James and Patrick Clark in Paisley, Scotland, it became a listed company in 1890. It was one of the world’s largest companies by market capitalisation in 1912, following its merger with the Coats family company. Through decline, de-listing and rebirth via private equity, it re-listed on the London Stock Exchange in 2015.
Coats is the world’s leading industrial thread manufacturer with a 20% market share. It is also a major player in American textile crafts. Their threads keep your jeans and trainers together. Customers include Uniqlo, Nike, Adidas, Under Armour, Next and GAP. In their performance materials division, including super tensile and fire retardant threads, end use includes car tyres, where Michelin is a customer.
It is in Coats’ operations where they have embraced new and digital strategies. More than 90% of thread sampling by customers is digitally enabled, with the relaunch of www.coats.com. More than 20% of performance material sales come from new products1, developed in three innovation centres, increasingly interacting with start-up companies and universities. They have put in programmes to reduce energy and water and invest in more efficient equipment, which has led to a 26% decline in water usage and a 20% decline in energy over five years. In 2017, 29% of energy used was from renewable sources; for example, solar, while 75% of waste is reused or recycled.
Where corporates find it difficult to enable these types of strategies across silos or individual business units, some more radical solutions are adopted. One we particularly favour is de-merger, where significant value can accrue. One of the most successful de-mergers in my investment career, which occurred in 1993, involved ICI, which was split into pharmaceuticals, paints, fertilisers, agrichemicals, seeds and specialist chemicals. Parts of ICI are now owned by AstraZeneca, Norsk Hydro, Syngenta, Akzo Nobel and Victrex. The de-merger of Great Universal Stores (GUS) also created great value to shareholders, becoming Experian, Burberry and Home Retail Group (Argos and Homebase).
One of our holdings is going through this process at the moment. In March 2018, Prudential (founded in 1848) announced the de-merger of M&G Prudential and Prudential plc. Upon completion, there will be two listed companies with different investment characteristics and opportunities: M&G Prudential, with £341 billion in assets under management, and Prudential plc, which comprises their US variable annuities business, Jackson National Life and the fast-growing Prudential Corporation Asia2.
During the year, we received a takeover bid for GKN from Melrose, and subsequent to the bid succeeding, the resultant holding in Melrose was sold. The final tranche of Vodafone was sold and Paddy Power Betfair was sold as betting taxes rose in Australia and weaker trading on the Betfair exchange was witnessed. Other holdings reduced included Rightmove, RPC, BTG and Essentra. Coats Group was purchased for the reasons above and holdings added to included Breedon, Weir and Applegreen. A new holding of Creo Medical was purchased. Creo is a manufacturer and pioneer of new products in electrosurgical endoscopy, using new technologies in gastrointestinal procedures.
With respect to the wider economy, in which all our companies have to operate, amber lights are flashing. In the US, there are several indications of a very strong economy: US earnings per share growth for 2018 is expected to be at least 20%; the first half of 2018 has seen economic growth of 4-5%; the introduction of a Trump tax stimulus of $1.5 trillion, which has added fuel to fire; record share buybacks; a 3.8% rate of unemployment; consumer confidence has been very high; housing starts back at peaks; operating margins at all-time highs; high utilisation rates; auto sales peaking; and truck orders at two times the previous forecasts for 2018. It is no surprise that US Federal Reserve (Fed) Chairman Powell stated “we are far from neutral”. Barclays’ Adviser, Richard Fischer, commented that his friend, Jay Powell, “will hike rates as fast as he can, taking no notice of how much markets might squeal”. Following the period-end, US Treasury 10-year bonds have declined in price to yield 3.2%. Equity prices do not like rising interest rates, and are reacting. The withdrawal of quantitative easing, and replacement with quantitative tightening, will now shrink the Fed and Bank of England balance sheets. This will likely result in less liquidity, which has previously driven many asset prices. Combined with slower growth in China and trade issues with the US, Brexit, Corbyn and the ECB being less accommodative, and a strong US dollar in emerging markets - things are looking more uncertain.
We continue to advocate our investment mantra that “things will not necessarily get better or worse, but will become different”. As you have seen above, it is at the core of our investment style, but can be blown off course in the short term by global events in the interest rate and business cycle. Equities are long duration assets and we are comforted that the long-term compounding of reinvested dividends is compounding in your favour, not against you.
“The time to relax is when you don’t have time for it”. Sydney J Harris
Through all this change, the enjoyable part has been finding good companies and management teams that can genuinely enhance shareholder value over the long term. Whatever the politicians are capable of, they must let Adam Smith’s invisible hand operate in our economies, so that equities can compound over the long term. I am still intrigued by the creation of wealth through incorporation and the businesses and characters it creates. No company has a God-given right to succeed or for that matter turn into a dinosaur!! As the third act of my life beckons, I will continue to enjoy following trends and stocks and hopefully find a few successful compounders along the way.
I know that I leave the AXA Framlington UK Select Opportunities Fund in very capable hands, with long-standing deputy manager, Chris St. John, taking over full management responsibility in January 2019. Chris and I have worked alongside each other for many years and I know he will continue to manage the Fund in the best interests of unitholders.
A final thank you to the people who have helped and supported me and especially those that have informed me, all too many to mention.
1 Coats Group plc 31st July 2018.
2 Prudential plc – updated to 27th July 2018 £351billion.
Why is this Fund in this category?
The capital of the Fund is not guaranteed. The Fund is invested in financial markets and uses techniques and instruments which are subject to some level of variation which may result in gains or losses.
Liquidity Risk: some investments may trade infrequently and in small volumes. As a result the Fund manager may not be able to sell at a preferred time or volume or at a price close to the last quoted valuation. The Fund manager may be forced to sell a number of such investments as a result of a large redemption of units in the Fund. Depending on market conditions, this could lead to a significant drop in the Fund’s value and in extreme circumstances lead the Fund to be unable to meet its redemptions. Further explanation of the risks associated with an investment in this Fund can be found in the prospectus.
Before making an investment, investors should read the relevant Prospectus and the Key Investor Information Document, which provide full product details including investment charges and risks. The information contained herein is not a substitute for those documents.
If you are unsure about any of the information provided please speak to a financial advisor. If you do not have an adviser you can find one at www.unbiased.co.uk.The source of all information in this document is as at 30 September 2018, unless stated otherwise. This document does not constitute an offer to buy or sell any AXA Investment Managers group of companies’ (‘the Group’) product or service and should not be regarded as a solicitation, invitation or recommendation to enter into any investment transaction or any other form of planning. It is provided to you for information purposes only. The views expressed do not constitute investment advice, do not necessarily represent the views of any company within the Group and may be subject to change without notice. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Past performance is not a guide to future performance. The value of investments, and the income from them, can fall as well as rise and investors may not get back the amount originally invested. Due to this, an investment is not usually suitable as a short term holding. Framlington Equities is an expertise of AXA Investment Managers UK Limited. Issued by AXA Investment Managers UK Limited which is authorised and regulated by the Financial Conduct Authority in the UK. Registered in England and Wales No: 01431068. Registered Office: 7 Newgate Street, London EC1A 7NX. Telephone calls may be recorded for quality assurance purposes.