Q2 2024 CIO Investor Update

The funds struggles during the quarter were by no means unique, as benchmarks powered forward driven by just a handful of stocks. The quality/moat stock space in which TOLL operates also struggled as rising rates during the quarter hurt performance.
 
We have shifted the strategy of TOLL to focus more on the US market. In doing so we have maintained our existing benchmark as we still look at global businesses in the US and select non-US investments. At the end of the quarter 88% of the fund was invested in North America up from 70% at the start of the quarter.
 
Encouragingly the transition was smooth and the two of the quarters top performers were new US positions we bought. First, Teradyne, the chip testing business, which was a new addition to our semiconductor equipment sub-theme. Second, Tyler Technologies, which has a monopoly in software provided at the local government and institutional level.
 
In terms of losers a big detractor was Airbus, a position we halved at the start of the quarter taking profits after a strong Q1. Airbus warned the market that it would not meet delivery targets set at the start of the year. This was disappointing as supply chains were improving. We took another prudent move and halved the position again, taking the view that the risk of further downgrades became elevated. Ultimately we think the Airbus production ramp will eventually happen but the timing is uncertain. We retain a small position and will look to get back in once we have done deeper work on the current situation that we thought had inflected. 
 
One feature of moat investing is that though the outputs are quantitative, such as return on invested capital, the inputs require qualitative analysis. You can’t screen for the type of companies in TOLL – each source of competitive advantage requires deep fundamental analysis. Encouragingly for investors the qualitative insights are much less efficiently priced by the market creating a source of potential alpha for those prepared to do the work.

For a full list of holdings, please visit the TOLL fund page.

A top contributor was L’Occitane which received a take private offer from its founder that is being financed by Blackstone. We took the decision to exit the shares as they traded up at or near the offer price, making the position the top contributor to the fund since inception. This is a great example of the kind of “outside the box” ideas we conceive, analyze and size accordingly for portfolios. 

The other top contributor was a Viking Holdings, the luxury cruise operator, that we purchased right after their IPO. The shares benefitted from broker initiations as they came out of the post IPO blackout. These highlighted what our analysis identified – a strong luxury focused business with very high future bookings coverage. 

In terms of detractors we saw weakness in luxury bellwethers Hermes and LVMH, reversing gains following Q1 results. We think the weakness was tied to continued challenges in the key Chinese market. Although LVMH remains a core holding we took the decision to halve the position in the face of data points suggesting promotional discounting in China, which puts the earnings trajectory near term at risk. For both stocks there was also a spike in the risk premium in French shares following a surprise election call by president Macron. 

We continued to increase the luxury consumer staples bet within the fund, adding to for example Campari in spirits. We see a compelling investment opportunity as the valuation of these stocks, especially the European ones, struggles as US 10 year yields rise. Today spirits and cosmetics are the biggest overweight in the fund relative to its benchmark, respectively.

For a full list of holdings, please visit the LUX fund page.

Part of this underperformance relates to a dearth of M&A activity after a very busy previous six months, a topic we covered here. We did have one deal – Deciphera being acquired by ONO for $2.4bn - which was a top contributor to the fund. The fund also benefited from good data at Agios Pharmaceuticals, followed by a well-received financing event. Guardant Health also contributed positively as the FDA advisory panel voted to approve their cancer screening offering.

Several oncology diagnostics positions occupied the top detractors list. Exact Sciences continues to struggle due to concerns about competition. Illumina shares were weak due to uncertainty surrounding the divestiture of GRAIL. 10x Genomics detracted due to lingering concerns about its revenue outlook. We continue to like this space and one of our main takeaways from attending ASCO was how often genomic profiling of tumors was mentioned across recurrence monitoring and treatment selection. You can read our other takeaways here.

Despite oncology not capturing the market’s attention companies we own continued to make fundamental progress. We have been adding to AstraZeneca, which had very positive updates across several products at a recent medical conference, and Intellia, where we bought weakness as the firm continues to progress their gene editing platform. We also started a new position in Amgen, as we feel the market is underappreciating their position in T-cell engagers to fight cancer.

Oncology is a vast domain with a range of themes and modalities. One theme that we see gaining more prominence in the next few years is the ongoing efforts to develop therapies for cancers driven by the RAS/MAPK signaling pathway. Mutations in the Ras signaling pathway are a leading cause of cancer, as demonstrated below.

For a full list of holdings, please visit the CANC fund page.
1) Estimated using tumor mutation frequencies from Foundation Medicine Insights March 2022 and scaled to estimated patient numbers using cancer incidence from ACS Cancer Facts and Figure 2023. NSCLC=non-small cell lung cancer; CRC=colorectal cancer; PDAC=pancreatic ductal adenocarcinoma. RAS refers to a family of genes (KRAS, NRAS, HRAS) whose mutations are associated with the development and progression of various cancers due to their role in regulating cell growth and division. MAPK (Mitogen-Activated Protein Kinase) refers to a signaling pathway that regulates cell growth, division, and survival, with dysregulation often contributing to cancer development. 

Top contributors to the fund were dominated by under the radar reshoring companies. SPX Technologies, which makes industrial cooling applications, continues to see sustained demand, which led it to raise 2024 guidance. Clean Harbors (CLH), a waste management company, reiterated confidence in continued strong volume and pricing growth. We added materially to the position especially as the company is adding new capacity in Q4. There is also potential for acquisitions to boost growth, as many peers are subscale with rising costs. Although not part of our core reshoring thesis, the market is realizing CLH has one of the only solutions to the rising problem of forever chemicals (PFAS), a problem that could rival asbestos in its cost. 

In terms of detractors, Lincoln Electric gave a negative pre-announcement and is now seeing decline in revenues whereas growth was previously forecast. We made the decision to exit this position as we saw risks of further cuts and a downgrade cycle. Herc was also a name that struggled in the quarter as persistent concerns about higher for longer rates hurt the stock. We reduced our weight as conviction around near-term earnings trajectory of equipment rental reduced. Longer-term the trend for renting rather than owning equipment remains hence we have continued to own the stock. 

We continued our theme of adding non-manufacturing reliant businesses by making Ingersoll Rand a top position, after their entry into the medical equipment adjacency with the acquisition of ILC-Dover. This opens a significant growth opportunity and diversifies the business. 

We also bought a new position in Primoris Services due to its focus on designing and developing the current large backlog of commercial grade solar and grid upgrade projects. Valuation on the stock is relatively cheap compared to the Engineering Procurement Construction (EPC) sector and we believe it should close due to management focusing more on these two verticals and de-emphasizing less profitable verticals such as refinery and chemical plants.  

Is the reshoring story over? Though higher interest rates might delay some projects, we firmly believe reshoring is just getting started. Take this slide from Eaton, the bellwether in reshoring markets, who point out “only 16% of these projects have started construction”. We are particularly excited about automation and companies like Emerson and Rockwell. Automation is a core engine of the US manufacturing boom and is attractively valued as near term destocking is over.

Source: Eaton, 2024. For a full list of holdings, please visit the RSHO fund page.

Performance was helped once again by Eli Lilly, which had a positive FDA advisory panel ruling for its lead Alzheimer’s drug. Other contributors included Alnylam, which had a positive data read out, and Vertex, where the market started to increasingly price in their efforts in developing the first ever effective non-opioid pain treatment.
 
In terms of detractors, Scholar Rock saw competitive concerns emerge which impacted the market outlook for its pipeline. Quanterix struggled similarly due to competitive concerns impacting the neurodiagnostic end market in which it operates.   
 
We recently initiated a position in Dyne Therapeutics, an emerging leader in RNA-based therapies for orphan neuromuscular disease. It is our conviction that many of these terrible diseases can only be treated with genetic modalities where innovation continues to accelerate.
 
Alzheimer’s/dementia is an area we are also particularly excited about near term. There are significant catalysts on the horizon that should capture the market’s attention. This starts with, at the time of writing, the approval of Eli Lilly’s Donanemab, the second disease modifying agent ever on the US market. 55 million people worldwide live with dementia that until recently had no treatment options. Many pipeline attempts have failed. We are monitoring closely the launch of Biogen's and Eisai's Leqembi, whose sales outperformed consensus last quarter, though it is still early days. In addition to these two high profile launches, Biogen and Eisai are attempting to gain approval of a subcutaneous version of Leqembi, which could potentially accelerate market adoption.

Source: Cummings; M de la Fleur, PhD, Illustrator. For a full list of holdings, please visit the MNTL fund page.