Welcome to Inside Active, a podcast about active managers that goes beyond sound bites and headlines and looks deeper into their processes, challenges and philosophies and security selection. I'm David Cohne, i lead Mutual fund and active Research at Bloomberg Intelligence. Today my cost is Laurent Dulier, Senior equity strategist at Bloomberg Intelligence. Laurent, thanks for joining me today.
Welcome.
So last week you published a note on Q one earnings in Europe based on earnings calls, what was the sentiment like with respect to the different sectors.
Yeah, so, just for our listener, in terms of context, we do track quarterly earnings results for the past five years and what is new is that over the past twelfth to eighteen month in Europe we have introduced AI model which tracks the frequency and the sentiment towards specific investment themes. And what is quite interesting in the last
reporting season is two big trends. The first one we have seen a fivefold increase in the frequency for tariff related commons and also the collapse in sentiment compared to the previous two quarters. And now in terms of sentiment, we are towards the level of twenty eighteen in the midst of the first US China trade war. And the second signal that we saw is we have seen a significant plunge in the sentiment around capital expenditures in the
energy and industrial sector in Europe. We are really at the lowest since twenty eighteen as well, and I think it shows that the uncertainty and the stop and go policy of Donald Trump on tariff do really an impact on the actwards spending of companies. So in conclusion, we still think that the European equity market may be too complacent following its recentrality, and that it may be overlooking some of the risks associated to the trade war.
Great speaking of European markets and the international markets in general, I think it's a great time to bring on our guests. Danielle Menechela is a portfolio manager and senior research analyst at Scance Capital, including the Scance Capital International Growth Strategy and subadvisor to the Touchstone Scance Capital International Growth Equity Fund. Danielle, thank you so much for joining us.
Thank you for having me. It's great to meet.
You, and more this morning before we dive into your strategy. We'd love to hear your thoughts on you know, what you kind of learned through Q one earnings in Europe? Were you seeing you know, similar sentiment at first.
Sure, we've seen and we've heard a lot more certainty as it relates to tariffs, as it relates to sentiment, continued uncertainty as it relates to China and geopolitical aspects. But I would just point out that the European market in a broad sense, may have a lot of exposure to businesses that are cyclical like this and that could be impacted by this uncertainty. But there are pockets of businesses and pockets of areas of growth that aren't seeing
as much of that uncertainty. So I would just say that this is a time in particular when we need to be extra focused on choosing the best businesses, the ones that that have things like competitive modes and the ability to grow in our innovative regardless of what's happening in the rest of the world.
Great, So let's talk about SANS Capital. Is there a firm wide investment philosophy?
Yes, So at SANS Capital we do one thing. We invest in leading growth businesses globally our firm was founded over thirty years ago in nineteen ninety two. Our approach is simply described as having a business owner's mindset to.
Public equity invest in investing.
We do not want to be thought of as stock traders, but we do want to be thought of as business owners.
And how do we do that.
We do bottom up investing by applying deep, fundamental business focused research with an aim to identify and select businesses with the capacity to generate sustainable, above average earnings growth that beat our investment criteria. And then we own those businesses and concentrated conviction weighted portfolios over a.
Long time horizon.
And we start with growth because it's been our observation that over the long run, earning's growth is the dominant driver of stock market returns. And while valuation shifts create volatility like what we were talking about earlier, and also could be paid for in the short term, they tend
to have a limited impact over the long term. We also believe that markets systematically underappreciate the compounding impact of both nonlinear and long duration growth businesses, and this differentiation, I would say of our investment philosophy enables investors to benefit from the compounding of that growth, that multiplier effect over a longer time period than others consider. And I mentioned growth already. But at SANDS, we choose businesses to
own by rigorously applying our sixth investment criteria. It's the same criteria that we've used since Sam's was founded and the same that we use across all of our public strategies. So growth is our first criteria. We look for businesses that have sustainable, above average earnings growth. The companies also need to meet the other five criteria. So Number two leadership position in a promising business space, so if a
space with under lying attractive economics. And this is because the disproportionate amount of the reward of any industry accrues to the leaders. But that only matters if the leaders can achieve attractive returns. Number three significant competitive advantage deep motes allow sustainable leadership and growth. Number four clear mission, strong management, team, value added focus. Number five financial strength of healthy balance sheets, and number six rational valuation relative
to the market and business prospects. Great.
So we went through the philosophy. Can you if we kind of zero in on the international growth strategy, can you walk us through the process of stock selection sure sure.
So International growth is led by a three person portfolio management team that includes pms from our two flagship global strategies. The portfolio owns about thirty to thirty five businesses. The recommendations for what we own comes from our investment team of about twenty analysts across industries, and our top ten weights comprise about forty five percent of the portfolio, so
on average, our holding size is about three percent. And what we're doing in this portfolio is we're looking to have a balance of higher growth, higher valuation businesses, so businesses with a greater cone of outcomes but potentially higher upside, and then offset that with a more mature group of
classic growers. So while you'll notice exposure to some large secular trends within our portfolio, we're also cognizant of having too much exposure to any singular trend and therefore aim to get a diversity of earnings drivers across those thirty to thirty five names. So, for example, you'll see names that include things as diverse as semiconductor equipment, e commerce, extremely high end luxury, discounted consumer retail, live and stream
music and events, and emerging market banks. And that's just to name a few of the things we have exposure to. So the result is that we build a high conviction, highly concentrated portfolio that looks meaningfully different from the benchmark. And I think that's really important when you're investing internationally international indices, especially developed ones. They're large, they're broad, and perception, perhaps rightfully so, is that they're filled with mediocre, slow
growing or even declining companies. And for the most part, that may be true, but we would argue if you're patient, if you go deep, you know where to look. In these markets, you can find a top tier of businesses that are every bit as high quality and innovative as anywhere in the world, and we aim to build a portfolio of those gems.
Makes sense if we go back to the philosophy a little bit at the end, you mentioned rational valuation. What measures you know, a particular are you looking at.
Yeah, I'm glad you coned in on the rational valuation because that's what it really is. It's we're not looking to find great value, or we're not looking to get a great deal because a company may or may not continue to exist.
What we're looking for is rational valuation based on.
How large we believe the business can be over a five year period, so how much can it grow in that time. And this begins with the strict adherence to the six criteria, so quantitative qualitative assessments, consideration of the market, the competitive landscape, management, long term strategy, potential, ability to cause disruption or to be disrupted.
And then risks.
So it's really a combination of analytical rigor and creative thinking. And then we discuss and we debate. We have a really collaborative research process at SANDS. We have a team that has a lot of years of different kinds of experiences, you know, different markets, different different sectors, different countries, exposures, and so we put all of those people together to pride ourselves on a culture of meaningful discourse, you know, high trust, share context. And so when we think about
a rational valuation we're having these debates. We want to think about terms. We want to think about it in terms of both absolute and relative terms. We want to bring in the shared experiences of the team. When it comes to risk. We want to focus on the long term, what that valuation could be in five years time, and what the is the growth rate that would support that valuation.
And you know, don't get me wrong, I keep saying five years, but our analysts and our PM teams are really thinking more about in terms.
Of ten or more years.
But the actual quantitative valuation is based on fibers.
Okay, DANIELI, And now I'm going to switch gear a little bit and ask you some questions on some of the specific sectors where potentially you can find those growth opportunities. So the first one, your strategy is massively overweight TMT. So is it really a bet on the rollout of AI or is it just a coincidence of many growth opportunities existing and being concentrated in both sectors.
Okay, So I'm going to show my age here because when you say TMT, I want to say what no, because it comes to mind as like cell phone plans and fixed line service providers and dial up internet companies. But I understand what you're asking, and you're right in
terms of waiting. As of March thirty first, approximately twenty percent of our portfolio businesses or classes by it is it versus twelve percent for the benchmark, which is the ms AQUI XUS index, by the way, and approximately eighteen percent are classified as communications services versus the BENCHMARKT six percent. So yes, large overweight, but I wouldn't call that a
bet on their rollout of AI per se. I mean, we're strong believers in AI and the demand for more and greater compute, but this portfolio is not built with That is the only factor. I keep saying diversity of earnings drivers, and you have many different factors driving the growth in IT and communications. So thinking of the businesses that we own the fall into TMT, they actually benefit from quite different secular changes. For example, the retail revolution
that is e commerce. The pandemic turbocharged e commerce adoption, but it still accounts for less than thirty percent of total global retail sales. So we own several of the global leaders in the e commerce space in different regions. We also own one of the key providers of border and digital payment services. Another trend would be legacy process improvements. So growth investors seek to benefit from change across industries.
Digitalization and new technologies are upending legacy processes with products and services that are better, cheaper, faster than the status quo. Factory automation and robotics, computer aided design, digital twins are examples of this. We own several businesses in Japan and Europe that do that. And then we have the future
of computing, perhaps the most obvious for AI. Demand for computing powers accelerating far faster than most appreciate in our view, with new use cases created, this demand's going to require new and more efficient ways to access, store, manipulate, process data and enabling technologies becoming increasingly complex require higher manufacturing intensity, this resulting in pricing power for select businesses positioned a key choke points in the semiconductor value chain, so we
own a view of those, and then probably worth calling out the truly diverse businesses in what we classify as as our communications holdings. One of them is a large e commerce slash gaining business, but we also have exposure to the rights for one of the fastest growing viewerships and sports with strong potential for modernization. And we have some businesses exposed to streaming and watching live music and other live events.
Okay, so it may be more media oriented rather than telecom oriented. One of also, when I look at your strategy, it seems to be underweight elsecare, which is often viewed as a growth sector and now it is different at a reasonable valuation. Do you think that there are reasons to be conscious or underweight this sector at this point in time, or do you think that the policy of the Trump administration, which seems to be quite a stein towards the sector, may be an impediment to invest in it.
Yeah, I think there are reasons why we are underweight. Ten to fifteen years ago, healthcare sector was a rich opportunity set for finding growth businesses that matter criteria, but this really hasn't been the case in recent years. Although we do have some exposure. We own a CDMO business, a glass tools company that sells to pharmaceutical companies. We've recently purchased an innovative software hardware razor razor plate model
for radiologists. So it is possible to find special businesses within healthcare, but we don't expect this to be a material sector for us going forward. And part of this is due to the fact that most of the value creation, especially within the innovative areas of therapeutics and diagnostics, is
occurring while the businesses are still private. Additionally, healthcare businesses tend to be less capable of what we say in our jargon making their own weather than we'd like to see for our businesses.
So this is.
Largely due to the outsized influence that regulation, reimbursement rates, even political whims can have on these businesses, which can materially affect their earnings power and their valuation. And they're largely outside of the businesses control. And then the last thing I would point out is that healthcare traditionally has been thought of as a more defensive sector that provides
ballast to an overall portfolio. And this is not what we observed in recent years, especially going through COVID and coming out of it. There's been more volatility and less of the diversification benefit than in the past.
Interesting, And I mean, when we look at the ottest theme in Europe, it's definitely defense investing in defense companies. You seem to have no investment in this theme. I mean, do you think it is because it is massively overplayed and so the rational valuation does not exist in this industry or is it because you do not want to invest in defense stocks?
In defense stocks? Is that what you said?
Yeah?
Yeah, defense?
Yeah, So defense companies the other button topic. So European and Asian defense companies are an area of active research focus for US. We should also note that Scance Capital does own some defense related businesses US our strategies like our private equity strategies, but we've not invested in any international growth and that's partially because historically we've found these businesses to be more controversial from the client perspective.
But the overwhelming reason.
We haven't invested in defense names for the portfolio is we haven't completed research that suggests these businesses meet our six criteria. So business spaces that tend to be cyclical, where companies cannot create their own demand, they tend to be unattractive to US, and defense companies tend to be beholden to government wins. So additionally, a lot of these companies are large, with many different divisions and segments, which tends to cloud the growth and dampen the overall overall
top line. For sure, you could make money in this space, and people definitely have been doing that recently while you're p and defense businesses have garnered headlines in recent in recent months. At this point, we're comfortable with our lack of representation, especially considering what valuations have done, and that I would classify these these businesses in general as being lower growth opportunities.
Now we've talked about the types of companies you're looking for. You know, is there an average length of how long you hold them or is it you know, I imagine it's dependent on the company, but you know, is there like a number that's typical.
Yeah, we try to own businesses on average for five years. We've owned some for ten, some even for fifteen, but on average are holding periods five years, which gives us a turnover of about twenty percent.
I mean, regarding tarifs, do you think we have past maximum uncertainty and market relativity or are we currently just a bear markets run.
The infamous tariff question.
We've had a lot of that over the past few months, and unfortunately, I don't think I have an answer that you want, Like, it's a great question, but I can't answer it with any certainty. But it does get at the heart of what we think about investing at scance Capital.
The short answers.
We don't pretend to have a crystal ball on macro variables or tariffs, volatility, the market's next move.
What we do know is that uncertainty is a constant in markets.
So whether it's tariffs today, interest rates tomorrow, geopolitical tensions next year. There's always something that investors in the short term, and for sure tariffs have done that. But when you only have to own a handful of businesses and you choose ones with strong competitive modes that are growing in
attractive business spaces, they have market leadership. That's the definition of competitive advantage, the ability to pass on prices, to withstand demand disruption, the ability to continue to invest and win market share. So we believe that's our best protection
against uncertainty. So rather than trying to time the market, call the top, call the bottom, we stay focused on identifying those businesses, yes, understanding the risks, but also being able to stay focused and maintain conviction during these difficult emotional times. And that's what they are, they're emotional times. So are we in a bear market rally maybe, or maybe we're at the beginning of a new bull cycle.
What matters more to us is whether the businesses we own are continuing to innovate, gain market share, reinvest intelligently. And so we have we passed max uncertainty in my opinion, yes.
For a short time, but probably not overall.
However, for disciplined, business focused investors, Enduring uncertainty is part of the job, and that's part of the opportunity as well.
As a follow up, when you discuss with the management of the companies you owned, have you noticed a change in the tone on how they speak about their market, their positioning because of tariffs.
You know, I think there's been a lot of writing on the wall in terms of a potential uncertainty that could come out of terrifs for a while. I mean, I don't think this was new, something new that happened three months ago, and so a lot of the businesses that we owed it, they, first of all, I have, you know, sort of limited exposure to to these things
that really are impacted. But they've been thinking about it, and so they have been diversifying their supply chains, and they have been building factories in new places, and they've been doing things to try to minimize the impact of terriffs. But overall, these are companies that have such leadership and have sell things or services that people need and that they're going to pay, and there really is an elastic demand for it, so they can pass on the prices
pretty easily. But certainly everyone who speaks to these management teams when you're in investor groups, they're asking about tariffs and the impact of tariffs, and the.
Companies are being thoughtful about it. They're being honest.
They're saying, we don't really know what ultimately will happen, but we have been trying to position ourselves to be flexible and to maneuver quickly.
And then there's some.
Businesses that we own that actually could benefit from tariffs.
You know, these automation companies that we own in Japan.
These are companies that will allow companies to build manufacturing facilities and lines that use less labor, that are you know, lower costs, that are more efficient, that have less waste, and so.
They will improve.
So not only are they benefiting from building out these new lines that are closer to home, but they're also benefiting from trying to bring down prices, whereas otherwise they would be going up.
Now, your strategy is pretty concentrated, and so I was just wondering if there are any part of your process that looks at risk, you know, just the risk that could come from a concentrated strategy or just risk in general.
So let me first say that although some investors assert that a concentrated strategy poses greater risk in terms of higher short term volatility. We believe that a portfolio diluted with a large number of holdings could introduce the risk of not knowing each of those businesses well enough, or having to choose businesses that don't really need our criteria,
like you can't just own the market leader. The more companies you own, the more likely it is you're also going to own the number two or the one that's not as good. So on average, and also on average, our analysts cover a single digit number of businesses and they cover them for years, so our pms go deep in that ongoing research with analysts, and we assert that we own our businesses more than we know our businesses.
More than most.
However, to address to your questions specifically, we implement risk mitigation tools that help us understand the volatility profile of our businesses throughout the cycle, as well as how correlated our businesses are to each other. I mentioned earlier that we look to have a diversity of earnings drivers or businesses geared to different end markets and different trends.
So these tools help us see.
Those correlations in a more objective way than our internal thought process.
Okay, And in terms of selling securities, you know we've talked about what you look for, but what would have you triggered? What would trigger selling the portfolio? Could it be you know, valuations, poor fundamentals, or just better ideas?
Yes, all three of those things.
I mean, in theory, it's an easy answer, right it fails to meet one of our six investment criteria, but in practice it's a bit more nuanced. You know, we need to evaluate whether the business is dealing with a transitory issue or if there's real business impairment. So, for instance, in twenty twenty two, we had several businesses that saw growth impaired because demand pulled forward during COVID, so then revenue subsequently slowed.
But at the same time, these businesses continue to.
Spend and invest in their customers to win more market share, and that further pressure EPs. So on a growth basis, didn't look so great. But those businesses were going through a temporary hiccup that actually allow aut.
Them to emerge even stronger with less competition.
So that's an example of a transitory issue, not permanent impairment. And we would have been wrong if we sold those companies during that time. So sometimes something happens that changes the investment thesis due to regulatory shift. Sometimes valuation just has gotten too high for the growth expected. I think the key point on what triggers to sell is that these are highly concentrated portfolios, so oftentime, to buy a new business, we have to sell an existing one, and
I call that attrition due to better opportunity. We have a saying that we don't want to be rearranging deck chairs, but when we sell something to buy a new company, we need a good reason for it. So maybe it brings a new growth driver to the portfolio, maybe it cuts down exposure to a secular trend that has been overly appreciated recently, or maybe the new company is just a stronger criteria fit.
I have a question on Japan, because many investors see or think that the country is undergoing structural shifts in terms of the economy, in terms of corporate governance. Do you think it gives a good new growth opportunities which have not been the case for Japan for the past two decades, or do you think that this is something which is most of the growth opportunities are already priced in after the rally of the past two to three years.
I do.
I think Japan is a very interesting place right now. I've been to Japan about six times in the last eighteen months, So Japan is experiencing a resurgence, and I would say it's driven by demand for industrial automation, but also those corporate governance reforms increase tourism, a re energized consumer class, and then you have the macro economic factors such as wage growth, inflation normalization, some global supply chain shifts, Japan's neutrality proximity to the rest of Asia.
These can all help create a favorable backdrop for investment.
So we've found opportunities investing in the country's more innovative companies that are blending tradition with cutting edge technology to redefine their industries and also expand across geographies. Interestingly, we own a century old consumer stables business that used to that's used this knowledge and expertise to expand outside of food and seasonings and become a monopoly provider of a key semiconductor input as well as a growing player in
biopharmer services. So that's one example of the kinds of things that we're finding there in terms of valuation the Japanese market, it's important to acknowledge historically has been considered normal for growth for Japanese businesses. It was like mid mid single digits, maybe high single digits.
So when businesses have above.
Earnings growth rates in Japan, they deserve to trade at a premium, and that premium becomes more justified given the improving macro backdrop than further justified when we're seeing these Japanese management teams all of a sudden starts to be really invest your friendly. Focusing on corporate governance reforms. These are reforms that encourage the use of large cash balances that many of these companies have sat on for years, some even decades, and in many cases these piles are
quite large. So the useful and careful deployment of such cash can bring faster growth opportunities, whether it's organic or inorganic, higher dividends, more share repurchases, is all of this generating higher ros and more investor friendly interactions. So these are all things that shoul drive returns and should justify the valuations.
Okay, I mean regarding Europe, I mean European equities have outperformed the US quite significantly here to date. Do you think that this still offers some good value at the current multiple or do you think that most of the growth of opportunities which you have identified are quite well priced at the time being.
So, yes, the European equities have done really well here to date, and for propably like that, like we run, it really inspires us. The European equities have staged a historic comeback relative to US equities here today.
But I note a few things.
First, if you look at MSCI Europe at about fourteen times currently versus SMP at twenty one, so there's still a significant discount there, and especially when you consider that the average over the past fifteen years was only three points. So Europe went up, but there's still more room for it to go up. And the second thing I'd say is as fundamental business focused investors or not choosing markets to invest in instead, we're seeking to just own the
best growth businesses that made our criteria. And with that perspective, we continue to believe that there are attractive businesses domiciled in Europe that we believe are under appreciated.
Most.
And then the third thing is most and probably the most important. We would argue, and we have argued that as a whole, Europe's not that attractive of an opportunity set. The economic and the market underpinnings, including the greater representation of cyclical and value oriented stocks, make it a more shallow.
Opportunity set for growth equity investors.
And it was this opportunity set whose stocks have performed well recently. But this is all what really gets me excited. There are a select group of high quality growth businesses domiciled in Europe. They are innovative, they're growing, they're good stewards of capital, they meet our investment criteria, and these may continue to get lost in equity index returns, but they're not going to be lost by us or an
active manager. We only need to uncover thirty five of those businesses across all international markets and hold them in a low turnover, longtime horizon, high conviction international growth portfolio.
Well, thank you, Danielle, this was great. Thank you again for joining us.
Thank you so much for having me.
It's been great to chat with you and hear your perspectives on Europe and Japan and defense companies.
And Lauran, thank you for joining me as my co host today. Thank you until our next episode. This is David Cohne with Inside Active