217. Making money from an economy in structural decline

Darius McDermott (DM):

I’m Darius McDermott from FundCalibre and this is the ‘Investing on the Go’ podcast. Today, I’m joined by Alexander Darwall, manager of the European Opportunities Trust. Alexander, good morning. 

Alexander Darwall (AD):

Good morning, Darius. It’s good to be with you again.

(DM):

Thank you for your time. Look, it’s crazy out there. It’s not just European equities, UK equities, US equities, [the] bond market. It’s all very, very volatile. So how does Europe look from your perspective? You’re [a] very experienced investor and seen several market cycles where we’ve had ups and downs. What’s your view of what’s going on in Europe, and how the central bank[s] are doing and the energy crisis; what does it mean for your type of companies?

(AD):

Well, I look at it in two ways. One is we’re very consistent about how we go about this job and what we do. And the first thing I’d say is, that we’ve never been excited about Europe as an economy. We’ve always been excited about great European companies, competing on the world stage. And this matters now, more than ever. So, we think our mentality of global winners that happen to be European-listed, is the right thing to do.

Our companies have as much exposure to faster-growing Asian economies and as much exposure to the faster-performing and better-performing American economy, as we do in Europe. So, I think we’re very well set in that respect.

And the second thing is coming to your specific question about what’s going on in Europe. Europe has been in structural decline for a long time. I think the European energy policies and the lack of rigor on inflation, probably accelerates that relative decline. So, we’re no more excited about Europe than we have been, but we’re still very excited about some great European companies.

No, I think Europe has profound problems. The socialist model, or social democrat model of Europe, and I include the UK in that, is programmed for decline. And the energy policies have been a profound mistake by the entire political class. So, that’s going to be expensive.

Our companies, which compete and succeed on the world stage, tend to be much lower users of energy than the average, and have much less debt than the average, and [are] more global in their sales. And that’s the right way to be, because energy costs cannot be suppressed by governments long-term. The markets will always come through. That’s one thing. And I think they have been slow … Christine Lagarde [President of the European Central Bank], the French politician, who knows nothing about economics, has been consistently weak on inflation. So, I don’t, that’s at the IMF level and I think the ECB [European Central Bank] too has been politicized – as all central banks are very political now – so they’ve been slow to deal with inflation, and I think that’s going to be a long haul. But again, if we’re in the right companies, we can mitigate those problems. So, we work very hard to be in the right companies.

(DM):

So, let’s have a few words then on the actual European Opportunities Trust itself. How do you, and I think I know the answer because you’ve already started, but how do you view the portfolio and what can investors expect over the medium-to longer-term? 

(AD):

What we offer is a collection of, what I call, special companies. These are companies that do something, provide goods and services, which are valued, highly valued, by their customers. And so, the sequence that we like, is a company that has advantages either through the structural market or technologies where they can deliver products and services better than other people, and to customers who not only value them and are prepared to pay but are able to pay.

And that means that we have a lot more intellectual property and less capital intensity. It means that we have not just companies that do something special – and I’ll tell you in a second what that might be – throughout all our companies, but also they’re selling to people who’ve got the money to pay. So, if I just take briefly, just one example of that; Novo Nordisk, our biggest holding, I had mentioned it because it’s our biggest holding, is, along with Eli Lilly of America, the world leader in the treatment of diabetes and obesity.

And what I like about this is, they, along with Eli Lilly, have [a] truly differentiated product. It’s measurable in its benefit, and it’s monetisable because healthcare authorities in America, but also in other parts of the world, recognise the value they bring, and they want to pay for it. And then the last, the critical piece of that is, can those health authorities pay? And the answer is, yes, they can. So, this is very different from a consumer, retail-facing business, where a consumer squeeze means people can’t pay.

People, governments, healthcare authorities, corporates, private insurers will pay for these terrific pharmaceutical products because the alternatives are much, much worse. You better keep taking insulin or GLP-1, or your diabetes will have very unpleasant consequences and you die. So, we think we have differentiated product there, valued by customers and a customer, in its many guises, [who] can pay. So, that’s a pattern we look for across all our portfolio. But it is a series of single company, uncorrelated risk. That’s to say, we have a huge amount of diversity, not just geographic, but also in terms of activity, with a relatively small number of holdings; a concentrated portfolio. But we don’t have doubling up ideas, they’re all single company ideas. So yes, there’s healthcare, but there’s also tech, and there’s also agriculture and aquaculture, and there’s also some special financial services, so, there’s a lot of digital. We’ve got a lot of variety and diversity, but always with, what I call, these special companies.

(DM):

So, you’ve already mentioned healthcare then with Novo Nordisk, but also as a sector I see, and I appreciate they’re a group of special companies, but four of your top 10 are healthcare names. Another manager I spoke to last week, really did like US healthcare in this stagnation potential environment that we may find ourselves in, in the coming years. Do you view the European healthcare sector in that same way? And is there the same choice in Europe, as there might be in the US, in broad healthcare names?

(AD):

We’re very specific in what we select. And if we take the biggest one, Novo Nordisk as I mentioned before, I don’t get excited about it because it’s in a healthcare sector or a pharmaceutical, I get excited about it because of the specifics of their industry.

I can’t think of another massive therapeutic area – diabetes – which is addressed by two dominant leaders, which is Eli Lilly, Novo Nordisk. Sanofi is a distant third because they don’t do the GLP-1 drug. And, in fact, they’re not just addressing one massive therapeutic area as a quasi-duopoly, they’re also addressing the new obesity opportunity.

These are global opportunities coming from, really, two companies. This is an extraordinary situation. So, this is a world away from a healthcare, a pharmaceutical company which might have a bunch of drugs that are about to go off patent and don’t have any follow on.

So, we are very specific about what we do, [and] very specific about the opportunities of each company. Just again, I’ll keep on Novo [as an example]. The pricing threat to pharmaceutical companies in America, is there for Novo, but it is not there to the same extent, because they’ve not been raising prices as much as one or two, say [for example], oncology companies have been doing in the past. So, they are going slightly below, not so much below the radar [but] they’re on the radar, but they’re not one of the bad boys that the American authorities are trying to deal with who’ve been overly greedy on pricing. So, let’s look at the specifics. We don’t invest in pharmaceutical; we invest in specific companies that happen to be classed as pharmaceutical. It’s a very different mindset.

(DM):

Would you do me a favour? Because you’ve mentioned GLP-1 and the obesity angle with Novo Nordisk. My understanding, in layman’s terms, is that that was an accidental byproduct of the diabetes drug, but clearly opens up a huge opportunity in obesity. Is that something that the management of Novo Nordisk are now aggressively looking to diversify into?

(AD):

I like the way you put it. I think it was a happy incidence of the semaglutide molecule, but it is now well documented, accepted, signed off by the FDA. The FDA recognised that the GLP-1 molecule, semaglutide, or tirzepatide in the case of Eli Lilly, it is a massive breakthrough in the treatment of obesity, and, at present, what the GLP-1 is doing, is reducing body mass by about 17% for people at the BMI of over a hundred.

There are a hundred million people in America classified as obese, with BMIs over 130. And these people were just scratching the surface of what that can do. But there is no doubt, that it is getting enormous attention in the US, the payors [the authorities] are very keen. Because the benefits of reducing people’s body mass by 17% – and indeed, the next iteration of this drug, is going to be nearer 25% loss in body mass – the benefits for the comorbidities are very significant. That’s to say, if you don’t have diabetes, but you can reduce your weight before the onset, you make the onset of diabetes much less likely. You have fewer cardiovascular problems, you get fewer problems of glaucoma. There are many healthcare benefits of reducing weight, which I think are sort of fairly straightforward, and the authorities are prepared to pay for that, because they understand the pharmaco- economic benefits of it.

To your question, is Novo Nordisk as a company, pursuing this opportunity? You bet they are. They are absolutely pursuing it, and I think it’ll take years for the full benefits to be rolled out across the world. But we’re in the foothills of a very significant opportunity. 

(DM):

Really interesting. As I say, I’ve heard a number of people talk about Novo Nordisk and this drug, and the opportunity set. So, thank you for giving us more detail on that. Let’s talk about a couple of other holdings, if we may. Deutsche Boerse being one. This is another company; how does it benefit from sort of the market volatility that we are – I’ll say ‘enjoying’, but maybe that’s a bit too optimistic – that we are experiencing at the moment?

(AD):

So, Deutsche Boerse is one where I have to admit, I bought too soon. We bought it at the outset of covid, or increased our position at the outset of covid, because I had grave concerns about the political reaction to the covid pandemic. I thought that QE would lead to enormous problems down the track. And I thought we could see significant, inflationary worries and a consumer squeeze. I was wrong. For two years, or two and a half years, the irresponsible covid enthusiasm, carried all before it, and QE led to rising asset inflation. Now that asset inflation has seeped out into the real world, and we have real cost inflation. And now is the time for Deutsche Boerse. So I was early, but now we’re right!

Deutsche Boerse, as an exchange, benefits from various trends. One is, in volatile times and in times where you don’t necessarily trust your counterparty’s financial strength, you want to go on exchange because the exchange will protect you from a counterparty defaulting. So, tougher, economic times drives people onto exchanges, and away from the over the counter [market]. We are seeing that trend.

Another big trend we’re seeing, is that Deutsche Boerse benefits directly from uncertainty with volatility because it does a lot of futures [trading] – it’s an exchange for futures trading on interest rates – and because of their huge custody business, they benefit directly from higher interest rates, because they make money from holding funds in custody, and they get a clip on an interest rate on that. Well, when an interest rate’s at zero, the clip on zero is very little, but a clip on 3% interest rates is very significant. So, they are a beneficiary of uncertainty, of volatility, and higher interest rates.

(DM):

Thank you. Another interesting sector is cyber security and, again [you are] well placed, you have a stock there, Dark Trace. Maybe you could tell us a little bit about that, and their increasing opportunity set.

(AD):

Well, the cyber security threat is a well-known one and, I would think, for virtually every board in Europe or indeed in America, the number one concern for a board, I should think, probably is cyber security. It can put a company out of business, very quickly.

There are many people offering cyber security products. What Dark Trace is doing, is a bit special and a bit different. And it is for that reason, an exciting company. What it is doing, is using AI – artificial intelligence – to monitor the cybersecurity threat, by monitoring within a company any change of behaviour, any patterns that look disrupted, any strange behaviour. So, this is very different from a firewall, which other people do. It’s more looking at internal behaviours, to see if there’s anything which can give you an alert.

The facts are that, since it was quoted, this company has produced good results. We saw it as a terrific opportunity because it came with a health warning, which we felt was unwarranted – because of its association with Mike Lynch, we think that’s a completely irrelevant point – so, we got it at a good value. We’re very pleased with how the management’s delivering. It’s an exciting company, but not yet a good or a great company.

And I look at Novo Nordisk as a great company, because it’s so strong, and any threatened disruption to their business will come with lots of warning. The nature of clinical trials means you can’t easily get disrupted on technology very rapidly in the pharmaceutical world, because you’ve got to go through stages of clinical trials. So, any disruptor coming in, we would see them coming. The same is not true in cyber security. It can happen quickly, which is why this is an exciting opportunity, and will have a commensurately small weighting, because it’s not yet what we look for, to be a good or a great company, very well embedded and barriers to entry, which means they can’t get disrupted. This company could get disrupted, but I have to pay credit to the management, they’re doing a great job. We’ll stick with this investment until, unless there’s any reason to cut it. But for now, we’re very happy with what they’re doing.

(DM):

Alexander, thank you very much for running us through some of those really interesting special companies. I think it’s fantastic for our listeners to actually hear managers talk about stock and companies themselves, and that unique characteristic or goods or service that they offer. So, I really do appreciate your time this morning and I thought that was a thoroughly interesting run through.

 If you would like further information on the European Opportunities Trust, please do visit FundCalibre.com and please do subscribe to the ‘Investing on the Go’ podcast.

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.