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From the desk of the Mackenzie Global Equity & Income Team Q2, 2024
Mackenzie Global Dividend Fund
Highlights:
- Global indices rose 3.75% in Q2 2024, driven (again) by a narrow set of US-based companies in Information Technology and Communication Services. Japan was the worst performing major market.
- In the context of the number of significant elections taking place worldwide in 2024, market reactions seem to be more focused on perceived stability of the incumbent or incoming regime rather than political leanings.
- Our portfolio is constructed to be resilient to political shifts by diversifying across geographies and industries as well as focusing on companies less reliant on national support.
Global markets rose 3.75% (in CAD) in the second quarter and our portfolio slightly exceeded that gain and was up 4%. Sounding like a broken record, it’s what we didn’t own that impacted relative performance. Nvidia accounted for almost 40% of the global market’s return this quarter, and despite its absence in the portfolio we were able to generate strong absolute and relative returns. This was driven by stock selection in the other technology companies we own across semiconductors and our consumer platform franchises in communication services.
From a factor standpoint, shares of faster growing and higher quality companies outperformed this quarter. Given the size of the Magnificent Seven in our benchmarks, they really skew the style factors that drive performance in any one quarter. Taking the Magnificent Seven out of the benchmark returns would still show that quality and growth factors drove returns, but not nearly to the same degree. For better or for worse, the concentration effect of the largest companies in the index continues to be a significant driver of performance.
Powered by the Information Technology and Communications Services sectors, the US was among the best performing regions in Q2. Japan was the worst performing major region, driven by a weakening Yen. The Japanese Yen in fact breached 160 ¥/$ for the first time since 1986. From a sector standpoint, IT (+12.6%), Communication Services (+9.2%) and Utilities (+4.3%) were the only sectors to outperform the benchmark’s 3.75% return in Q2. Materials (-2.4%) and Real Estate (-2.2%) were the worst performing sectors. Worries about weakening demand for raw materials and commodities weighed on the former sector, and investors grappled with the potential for interest rates to remain “higher for longer” on yield sensitive Real Estate companies. And while strong stock selection in our IT and Communication Services investments helped returns, our relative underweight versus the benchmark combined with our overweight in Materials put a lid on our relative and absolute outperformance.
Although we try to keep our commentary focused on the investments in the portfolio (along with the odd macro-observation) given the recent events of the past few weeks we would be remiss if we didn’t revisit how we think about global geopolitics and how it impacts portfolio decisions. We bring this up because 2024 is lining up to be a very active year on the election front. We count no less than 50 national elections in 2024, many of which are significant. Taiwan kicked things off by holding elections in January, followed by India in May and Mexico in June. Voters in the UK and France went to the polls this past month. And of course, we have the US Presidential election in November.
Our observations on these matters are straight forward. We don’t necessarily buy into the consensus view that a left-leaning party being elected is “bad for markets” and a conservative result is “good”. It usually comes down to how the market views the relative stability of the incumbent party and/or its leader i.e. did the governing party get a majority or not?
The divergence in market outcomes seems to be not left versus right, but competence and stability versus incompetence and potential chaotic change. For instance, the prospect of a far-right National Rally party victory under Marine Le Pen led to French markets selling off, only to recover after the left-wing New Popular Front emerged as the second-largest bloc as investors viewed policy gridlock as a more palatable outcome than a dramatic shift in economic policy. That being said, the French market still has not recovered to the level it was at before President Emmanual Macron’s decision to dissolve parliament and announce a snap election on June 9. The strong performance of both the far-right and the left-wing coalition signals a clear shift away from centrist politics and towards more polarized ideologies. Contrast this to the UK, where the clear victory for Keir Starmer’s more centrist Labour Party resulted in a benign market reaction.
The US elections present a particular challenge given how the ground seems to shift on a weekly basis. Since the end of May, the following events have happened: Donald Trump was convicted of 34 felonies related to falsifying business records; Robert F. Kennedy Jr. emerged as a third party candidate, polling higher than any independent since Ross Perot in 1992; the presidential debate on June 27 was an unmitigated disaster for Joe Biden, which resulted in calls from his own party that he remove himself from the presidential ballot; on July 13 Trump survived an assassination attempt at a campaign rally in Pennsylvania; on July 21 Joe Biden officially withdraws from the race, marking the first time since 1968 that an eligible incumbent president has chosen not to seek re-election; Vice President Kamala Harris launched her presidential campaign on the same day as Biden’s withdrawal.
Given all these moving and unpredictable parts, how do we go about making actual investment decisions? As we have said before, we try to build portfolios that are resilient to political changes and own companies that have experience navigating different scenarios. How do we do that? Firstly, we diversify both by geography and industry – this has been a central tenant of our portfolio construction process since Day 1. We generally own companies that are global in nature and not dependent on any one country or region for their ability to succeed. And with few exceptions, they are less reliant on national largesse for their ability to grow. Investors could point to utilities as an exception to this rule, but our investments are somewhat insulated based on their diversification (Veolia operates across multiple end markets and geographic jurisdictions) and, in North Carolina-based Duke Energy’s case, regional stability. Another exception are Financials, and specifically banks. It is hard to avoid exposure to political change because banks are primarily domestic companies, they are heavily regulated, and are frequently unpopular and thus easy political targets. We own three, all with quite different risk exposures. JP Morgan is the biggest and among the most diversified financial institutions in the world: if regulators were to enact policies that significantly impacted the company, the rest of the industry – and the economy – would feel it much more acutely. DBS Bank is based in Singapore and operates in a highly stable financial regime, given that its political system is heavily tilted in favor of the ruling party. We just had a real-time test case for India-based HDFC Bank, as the general election results announced in early June surprised the market in that sitting Prime Minister Narendra Modi’s BJP did not win a majority. HDFC Bank sold off initially but has since recovered, as the market has taken the more measured view that a country operating under more constitutional constraints and having to account for other minority views is not necessarily a negative thing. So, despite being more susceptible to short-term political destabilization, all three investments are a direct result of our long-term fundamental views on the underlying businesses. This will not change in the coming months as election results continue to roll on.
What contributed positively to performance?
Perhaps unsurprisingly, semiconductor, software and hardware companies benefitting from artificial intelligence were top performers in Q2. Broadcom was a standout performer for the quarter, appreciating by 21% on the back of another guidance increase for 2024 aided by the 280% year over year growth in AI related revenue. TSMC also had a strong quarter thanks to its dominance in AI and high-performance chip manufacturing. While TSMC has always been highly customer centric we are interested to watch TSMC’s approach on pricing given the value they have created for key customers. Alphabet was another company that benefitted from the artificial intelligence exposure, demonstrated through recent results that generative AI spending is positive for Search queries, drives increased advertising spend and lowers internal operating expenses. The icing on the cake was the announcement of a $70bn share repurchase program and dividend initiation. We continue to be optimistic on the prospects for these companies but are prudently managing our exposure levels.
AstraZeneca returned 17% in Q2. The company’s Q1 fundamentals drove the share price, which mostly moved following the results. Strong business momentum in the first quarter, including 19% sales growth and the Oncology business accelerating to 26%, indicated 2024 full year performance would come at the high end of company guidance, and well above sell side consensus estimates. Analysts raised their estimates and began to anticipate the company raising full -year guidance at the company’s May Capital Markets Day during H2 results. AstraZeneca is well positioned with many late-stage drugs with strong commercial potential in its pipeline, including several important readouts in 2024 and 2025. The company’s Capital Markets Day engaged on 2030 targets, raised from $70B to $80B, with broader and stronger growth than expected and robust margins that would support teens EPS CAGR through the rest of the decade.
HDFC Bank returned 19% in the second quarter. HDFC Bank merged with HDFC Ltd on March 28, 2024; effectively a $57B acquisition by the former of the latter. The transaction will create significant corporate value over time but in the short term there is noise. The company guided then missed. While there were very modest integration issues, this was principally due to the change in the macro environment between when the deal was announced (April 2022) and when it was consumed in 2024. Mainly, higher interest rates led to slower loan growth. Market participants speculated that Net Interest Margin, or the profitability on loans, would decline and additionally higher provisions would be taken. Loan growth did slow, but the other anticipated negative developments did not occur. This supported the share price. The path to higher shareholder value remains clear: improving RoAs (Return on Assets) through higher loan yields, lower costs of funds via recycling of HDFC Ltd’s funding/liability base, all enhanced by favorable operating leverage. The stock is historically cheap from a P/B and P/E while long term growth and returns are robust and very attractive.
What detracted from performance?
CRH, a leading building materials supplier for North America and Europe, was down -12% in the quarter. Poor performance was the result of multiple contraction, as investors began to worry about the sustainability of volume growth and pricing in aggregates. We remain confident in our thesis, with 70%+ of EBITDA exposed to the United States where government spending (Department of Transportation/Infrastructure & Jobs Act) directly supports growth. Further, aggregates & cement are essentially local monopolies, with low supply supporting pricing growth in all historical periods ex the GFC.
After appreciating by 52% in 2023 and an additional 13% in Q1 of 2024, Ferguson took a breather in Q2 and was a detractor for the quarter. Ferguson battled two forces in Q2: deflationary pricing pressure and the concern regarding the strength of their end markets due to “higher for longer” interest rates. These temporary market forces are masking the material outperformance of Ferguson against its end markets and the underappreciated transition to a standalone industrial distributor following the divestiture of its European manufacturing business. Ferguson continues to trade at a 50% lower valuation to industrial distributor peer, Watsco, despite having similar free cash margins, similar returns on invested capital and a superior through the cycle revenue growth algorithm. We believe this valuation gap will close when market conditions normalize.
Two of our financial exchange investments had a rough go of it this quarter. As a loose proxy for the Nikkei combined with the weak Yen, Japan Exchange was down over -12% in CAD. CME Group was down over -7%, impacted by both the prospect of inflation coming under control as well as noise surrounding potentially new competition coming together in an attempt to make dent in their interest rates futures franchise, which is considered to be among the best financial services profits pools in the world. We continue to keep our positions in these companies – along with Deutsche Borse, HK Exchange and the London Stock Exchange – as they still provide among the highest quality exposure to the growth in capital markets along with their defensive characteristics during market dislocations.
What changes have we made to the Mackenzie Global Dividend Fund?
We sold out of the insurance broker Aon, following poor relative performance in its commercial risk segment, which represents 50% of sales. To bolster its commercial business, Aon acquired a leading mid-market brokerage, NFP, for $17B. While we view the acquisition as positive for the long term, they paid up for this business and integration concerns heighten the risk profile in Aon over the next year or two.
Following the sale of Aon, we re-initiated a modest position in the world’s largest alternative asset manager Blackstone, a company we have owned in the past. With over 70% of fees generated from its #1 real estate and #4 private equity business, we believe Blackstone is well suited to benefit from a potential return in private market transactions, which are currently at depressed levels. Historically Blackstone has generated fee related income growth and margins above its peers, leveraging its industry leading brand. We expect this cycle to lead to similar returns, bolstered by a durable 2.5% dividend yield.
The fund initiated a position in Assa Abloy, a Swedish industrial focused on locks and access. It is the global leader in a very attractive category and one of the highest quality industrials in the world; and was available at a discount to intrinsic value. The discount reflects higher interest rates slowing residential housing builds in both Europe and North America. Assa Abloy earns a significant portion of its profits from aftermarket business rather than new builds and also enjoys meaningful barriers to entry. Its growth is underpinned by an accretive mix shift to electronic locks and entrance systems. Lastly, Assa has achieved a very impressive M&A records, which is systematized through decentralized operating groups. Assa has a long runway to continue allocating capital at attractive incremental returns on investment. The company’s presence in North America and Europe is very strong – but it is ‘behind the scenes.’ As an aside Assa Abloy provides the entrance systems and locks for our office building in Toronto.
UK-based RELX is a provider of commercial information, and information-based analytics and decision tools. It focuses on Risk and insurance information, Scientific, Technical and Medical information, Legal information, and Exhibitions. We have owned RELX in the past and have long been investors in its closest rival, Wolters Kluwer. Both companies focused the last decade on transitioning from print to electronic publishing. That transition means today’s product suite allows for more integrated workflow solutions and more product innovation. The change supports higher barriers to entry and scope for more growth. For example, in its Risk business, its fastest growing business, product introductions are driving overall performance well ahead of market growth.
We sold out of industrial conglomerate Honeywell. While we remain confident in Honeywell’s leading aerospace business, issues remain for its short-cycle businesses, including industrial automation, energy and sensing solutions segments. Each of these segments operates on varying cycles with different backlogs and end customer profiles, but all experienced slowdowns into an uncertain macro environment. We are always looking for opportunities to upgrade the quality of our holdings and decided to exit our position in Honeywell, and initiate a position in Cleveland-based Parker-Hannifin, a long-time Dream Team company. Parker-Hannifin is a global leader in motion and control technologies that are used throughout a variety of industrial end markets, including aerospace. The company has been transitioning from a high-quality cyclical to a long cycle compounder with the industrial aftermarket and aerospace businesses expected to make up 85% of revenues by 2027. A large part of this is due to the 2022 acquisition of Meggitt, a London-based aerospace supplier that had a highly complementary portfolio to Parker’s existing business with limited overlap. Most importantly, we are impressed with the strong core engineering capabilities and company culture of Parker.
We sold out of the analog chip manufacturer Texas Instruments, following a long history of owning the business. Management has embarked on an ambitious capital plan to grow manufacturing capacity, which we believe to be the correct long-term decision but comes with medium-term execution risk. Currently however, analog chip end markets remain in a drawdown. This has negatively impacted the economics of the business, with decreasing visibility to a return to normal. At this time, we’ve decided to sit on the sidelines and added to our position in Analog Devices, TXN’s largest competitor. ADI uses more contract manufacturing and is therefore more capital light, while diversifying its footprint from key geopolitical risk areas. We expect ADI to benefit from the cycle upturn in analog without the associated capital intensity.
We sold out of defense contractor Northrup Gruman, as higher interest rates continue to crowd out budget spending for the US defense sector. Despite our positive long-term view on Northrup’s leading space business, the US Department of Defense is hardly receiving funding to cover the rate of cost inflation – this issue is likely to continue without changes to congressional caps or larger defense reforms. In its place we have added to our position in UK-based BAE, Europe’s largest defense company. This provides us leading exposure to higher defense spending internationally, without US budget risk. It also operates in aerospace and security solutions. The company develops, and manufactures systems for the military, for national security, and for securing critical information and infrastructure. These include combat and training aircraft; land combat vehicles; surface naval ships and submarines; ammunition; and cyber security and intelligence capabilities. The ramp up in European defense spending underpins long term growth. The company has reorganized with better processes, better management systems, and is well positioned to engage on the growth opportunity profitably. Further, BAE operates as a partner to NATO’s in extending capabilities to its emerging market allies.
We made the difficult decision to sell out of Equifax this quarter. The crown jewel of Equifax, Workforce Solutions, is dealing with challenging market conditions in Mortgage and Talent which make up almost 30% of overall revenues. While we believe Equifax will outperform their end markets due to record growth, new product launches, and pricing, we don’t think the valuation properly reflects the structural headwinds in their slower growing markets. We still respect and admire the work of CEO Mark Begor and will look to reinitiate a position if we are presented with a more attractive entry point.
Portfolio Management Team
Darren McKiernan, Head of Team, Senior Vice President, Portfolio Manager, Investment Management, Mackenzie Investments
Ome Saidi, Vice President, Portfolio Manager, Investment Management, Mackenzie Investments
Katherine Owen, Vice President, Portfolio Manager, Investment Management, Mackenzie Investments
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On July 26, 2013 the Mackenzie Global Dividend Fund changed its mandate from investing in equity and fixed income securities of companies that operate primarily in infrastructure related businesses to investing primarily in equity securities of companies anywhere in the world that pay or are expected to pay dividends. The past performance before this date was achieved under the previous objectives.
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