Weekly Market Commentary By H.E.R.O. (12 to 16 Oct 2020)
The Portfolio of Dividend-Yielding Global H.E.R.O. Innovators rose for the sixth consecutive week during the week ended 16 October 2020, vs MSCI ACWI All World index -0.5%, Topix -1.8%, DAX -1.1%, Euro Stoxx -0.8%, Gold (physical spot in USD) -1.6%, maintaining her overall absolute positive and relative outperformance against major world indexes since her recent inception on 28 August 2020, during which MSCI ACWI All World index declined -0.5%, S&P 500 -0.7%, Stoxx -0.4%, and Greater China stocks slumped with Hang Seng index -4.1%, Shanghai Composite index -2%, CSI 300 index -1.1% and HSCEI -3.9%, and Gold (physical spot in USD) -3.3%.
The separate equity portfolios of H.E.R.O. Innovators of our clients rose between +1.3% to +2.2% during the week to another new record high with +52% in average returns since the H.E.R.O. research methodology was provided for and implemented in March 2020.
- Nordic, Swiss, Australia and Japan stocks were key contributors during the week, led by: (1) “Sweden’s Twilio” & Emerging Global Cloud Software Leader in Communication Platform as a Service (CPaaS) (+21%); (2) Japan’s #1 Cloud Software Leader in Groupware for Mail Sharing & Expense Settlement (+15.3%); (3) Denmark’s #1 Cloud Software in Process Transformation for the Public Sector (+12.5%); (4) Japan’s #1 SaaS Cloud Leader in Integrated Real Estate and Facilities Management Software (+10.1%); (5) Nordic Global #1 Technology Leader in Weather, Environmental, and Industrial Measurement (+9.4%); (6) Australian Global SaaS Cloud Medical Diagnostics Imaging Visualization Software Innovator (+9.1%); (7) Finland's #1 Market Leader in Specialized Cloud-Based ERP & Accounting Software Solutions for Construction, Building Services Engineering, and Manufacturing Companies (+9%); (8) Nordic Global Leader in Pet Health & Nutrition (+7.4%); (9) Lonza, “The TSMC in Biotech” & Swiss Global #1 CDMO (Contract Development & Manufacturing Organization) Leader (+7.3%); (10) Nordic Global Medtech Leader in Glaucoma & Ophthalmic Diseases (+7.1%).
- The K-shaped recovery divergence, coupled with the worsening U.S.-China relationship, points towards the new world order in the post-pandemic future that marks the ascent of the quiet Nordic powerhouse region – comprising of Sweden, Denmark, Norway, Finland and Iceland with a combined GDP of over US$1.6 trillion, combined population of around 27.3 million people, and the highest regional GDP per capita in the world at over US$62,000 – where they are a Winter War kind of country: innovation happens when things are tough, not when they’re easy and comfortable.
Markets were entangled in the spiderweb of news in vaccine halts, lack of (and also hope for) stimulus deals, and the pre-winter spike in COVID cases during the week that continue to entrap whipsawed traders speculating in Cyclicals and Value Traps and chasing loss-making Growth Imitators which were caught out and crashed in the earnings season updates. Traders are torn apart in trying to puzzle out the correct positioning, whether it’s a Trump or a Biden win, a spike in Covid cases or a successful treatment, or a slowdown in the economy versus an acceleration towards a V-shaped recovery. At the same time, the deafening market noise continue to provide quiet opportunities for the long-term investor riding on quality disruptive innovators with highly-profitable, cashflow generative and scalable business models with multi-year recurring revenue streams who are able jump out of the lethal spiderweb due to their strong earnings growth and clear outlook.
Two vaccine trials by J&J and Eli Lily were paused for patient safety reasons after unexplained illness in the study participants. Meanwhile, as the number of trial halts involving experimental vaccines and therapeutics grows, Bill Gates warned that the “world won’t return to normal” until "a lot of people" take a second-generation "super-effective" coronavirus vaccine that could be years away. On Thursday, WHO poured cold water in questioning the effectiveness of Gilead’s Remdesivir, AbbVie's lopinavir/ritonavir and interferon, and hydroxychloroquine, after conducting a clinical trial that showed that the group of drugs being used to treat COVID patients had “little or no effect” on 28-day mortality rates. Meanwhile, a second wave of COVID cases in Europe is tearing into countries that escaped the first and straining hospitals and health systems.
The case on Lonza, one of our portfolio stocks, is instructive: On Friday, “The TSMC in Biotech & Life Sciences” & Swiss global #1 CDMO (Contract Development & Manufacturing Organization) leader rose +5.1% after the company announced details of its new structural design, culture and external reporting, as well as guidance of double-digit sales growth, CORE EBITDA margin of 33%-35% and double-digit ROIC. The troubling trial halts of experimental vaccines and therapeutics highlight the critical importance of having a reliable partner like Lonza with deep expertise in bringing lab processes to commercial, industrial scale processes in order to bring the medicines safely to market.
On Thursday night, after hesitating to make the commitment for weeks, Trump said he would accept a peaceful transfer of power if he loses the election. But he continued to cast doubt on the election results. Stocks trim losses and U.S. markets edged up for the week, led by financials, on fresh hopes for stimulus after House Speaker Pelosi told Democrats that a Covid-19 relief package won’t wait until January as she was scheduled to have another call with Treasury Secretary Mnuchin, while President Donald Trump said he’d go over $1.8 trillion in stimulus. Equities slumped earlier as Europe’s biggest cities clamped down to curb the virus, adding to concern that further restrictions could cause more damage to the global economy. On Friday, there was an unexpected surge in U.S. jobless claims to the highest since August, a troubling sign for a labor market whose recovery from the pandemic was already slowing.
On Friday, Robinhood warned users about an increase in "margin maintenance requirements for several widely-held stocks". Other popular online brokerages, such as Interactive Brokers, recently raised its initial and maintenance margins by a whopping 35%. These could exacerbate near-term volatility of popular widely-held stocks and Big Tech. Interestingly, the VIX curve, which was sloped upwards back in February, has been downwards-sloping or heavily kinked over the past eight months, meaning market participants are paying more for near-term volatility protection. The VIX curve, which shows the price of VIX futures contracts of different maturities, is generally upward sloping, meaning market participants were generally willing to pay more for volatility protection over the long term than in the short term. The big market selloff in March flipped VIX into what's known as backwardation. S&P points out that backwardation of this magnitude has happened only four or five times since 2005, usually coinciding with periods of intense uncertainty like the 2008 financial crisis or when the U.S. lost its triple-A credit rating in 2011. The upshot of a backwardated VIX curve is that it means markets are generally so well-hedged over the next couple of months in demanding insurance for the possibility of multiplying tail risks that it would be difficult to generate an unexpected spike in volatility even if something weird were to happen in, say, the U.S. election or the unfurling of the coronavirus crisis.
In Asia, China markets stalled after President Xi’s much-anticipated speech delivered in Shenzhen, following a quick run up from the optimism and hype surrounding hope for developing the tech powerhouse of Shenzhen, . Xi did a copycat move of his predecessor Deng Xiaoping, the late paramount leader who embarked upon the historic Southern Tour 南巡 to Shenzhen, which was designated as a Special Economic Zone (SEZ) as early as 1978. After 3 years of economic stagnation following the 1989 Tiananmen Square incident and the resultant governance crackdown, the trip by Deng, then 88 years old, on 18 January 1992, was the tipping point for entrepreneurship, reversing stalled economic reforms and setting China to become the world’s second largest economy. In the end, markets pulled back after Xi’s 50-minute-long address lacked specifics. Meanwhile, the U.S. Department of Defense submitted a proposal to the Trump administration to add Alibaba’s Ant Group, which is slated to dual-list in HK and Shanghai STAR market, to a trade blacklist. There is also concern that the Trump administration could decide to impose even tougher sanctions on Ant, in the form of an executive order barring it from doing business with any U.S. individual or company. In Japan, Bloomberg reminded everyone in an article during the week that shares in two of the five sōgō shōsha, or the commodity-centric Japanese trading conglomerates, are now trading at or below levels before Buffett’s Berkshire Hathaway announced its stake purchase in August.
While the short-term day-to-day price movement can be volatile, what continues to be crystal clear is that the quiet structural growth H.E.R.O. innovators remain the most visible and vibrant pathway in a foggy, volatile, whipsawing, uncertain market to deliver sustained outperformance with their healthy fundamentals results.
|The H.E.R.O. Investment Framework
The H.E.R.O. framework, methodology and strategy are powering equity portfolio asset for our clients. The Portfolio of Dividend-Yielding Global H.E.R.O. Innovators is the only equities strategy in the market that focuses on both dividend yield and innovation-driven capital gains to enhance total shareholders’ returns. It is also the only dividend-yielding equities strategy in the market that is entirely not dependent on and with zero exposure to: (1) cyclicals (concentrated in economically-sensitive and rate-sensitive sectors such as financials, property & construction, energy & materials) that may not be resilient in economic downturns, and (2) cheap-gets-cheaper yield- and value traps. It also applies the proprietary forward-looking fact-based accounting fraud detection system that was pioneered and taught at the Singapore Management University, ranked top five in the world accounting rankings, and presented to the top management team of Singapore’s top financial regulator Monetary Authority of Singapore (MAS), to mitigate downside risks which escape detection by typical western-based forensic tools.I. Strategic Focus on Quiet Innovators & The H.E.R.O. Investment Framework
Our investment strategies distinguish from those of all other tech- and innovation-themed funds with its singular focus on quiet innovators, which present structurally mispriced opportunities and avoid overcrowded misopportunities that stem from the human tendencies to equate flashy popularity with excellence, and have an active ratio of over 95% (vs the MSCI World Index). The portfolio companies are exceptional innovators and focused market leaders in their respective fields with unique, scalable, recurring-revenue and high-profitability business models delivering innovative products and services indispensable to our well-being in daily life and run by high-integrity, honorable and far-sighted entrepreneurs with a higher Purpose in solving high-value problems for their customers and society whom we call H.E.R.O. – Honorable. Exponential. Resilient. Organization.
H.E.R.O. is operationalized into a systematic 4-step investment process and investment framework powered by sustainability & ESG principles to identify the winners, to distinguish between the true innovators and the swarming imitators, between the devoted missionaries forging a greater Purpose and the mercenaries.
We use the framework and positive criteria of the United Nations Sustainable Development Goals (SDGs) to integrate environmental, social, and governance (ESG) considerations into the research and investment process in selecting companies that generate sales in products and services that contribute to the achievement of the UN SDGs. The central focus of our impact investing is on innovators who contribute to the UN SDG Goal 9: Industry, Innovation, and Infrastructure — “Build resilient infrastructure, promote inclusive and sustainable industrialization, and foster innovation”.
H.E.R.O. is unique in eliminating the downside risks from accounting tunneling fraud and misgovernance through unusual related-party transactions, consolidation accounting craftiness (opportunistic shifting of expenses and debt into unconsolidated entities), and hidden balance sheet liabilities at the wider pyramidal business group level etc., which escape detection by western-based forensic tools through a proprietary forward-looking fact-based accounting fraud detection system developed by KB, and taught at the Singapore Management University, ranked top five in the world accounting rankings, and presented to the top management team of Singapore’s top financial regulator Monetary Authority of Singapore (MAS). For instance, prevalent across Asian companies, previously Big-4 audited “cash” in the balance sheet are often misclassified “cash equivalents” disguised from improper short-term related party loans employed by the insiders to expropriate or tunnel out cash from the company after initially propping up financial numbers artificially to create false positive signals to lure in funds.
|II. Be Stronger, Wiser & Kinder By Participating in the Quiet Innovators' Quest to Purpose
“Innovators” are companies that generate sales in technologically enabled new products and services that potentially transforms the way the world works. We seek to identify companies capitalizing on innovation in offering faster, cheaper, more productive, more cost effective, more compelling products and services, or that are enabling the further development of an innovation theme in the markets in which they operate.Not only do the H.E.R.O. innovators generate high profitability at the inflection point of their exponential growth trajectory, more importantly, they are governed by a greater purpose in their pursuit to contribute to the welfare of people and guided by an inner compass in choosing and focusing on what they are willing to struggle for and what pains they are willing to endure, in continuing to do their quiet inner innovation work, persevering day in and day out.
|II. Quiet Innovators Thrive in Stormy Times
Prepare and position a winning portfolio for a post-pandemic world with innovators who thrive in stormy times and transform crises and trauma into opportunities for the future. The coronavirus crisis has helped accelerate innovation and enhanced the leadership of innovators. Market positions are not redistributed during sunny and calm times, but during times of crisis. The pandemic crisis has changed the behavior of both consumers and businesses. Companies offering faster, cheaper, more productive, more cost effective, more compelling and innovative products and services are gaining significant share.Market leadership and resilient winners in stormy market environment and in the post-pandemic future will be much less about the overcrowded popular trades in mega-cap tech and loss-making tech/biotech, as defined by FAANGT-STAMP (U.S.: Facebook, Apple, Amazon, Netflix, Google, Tesla; Asia/China: SEA, Tencent, Alibaba, Meituan-Dianping, Pinduoduo), who also do not pay any dividends (with the exception of Apple and Tencent), and will be led more by highly-profitable quiet innovators, including dividend-yielding cloud Software-as-a-Service (SaaS) companies.
Notably, of the 90+ cloud software companies listed in the U.S., nearly all (>95%) do not pay any dividends, with many still looped in a negative free cashflow position, while the 20 global SaaS portfolio companies in the Portfolio of Dividend-Yielding Global H.E.R.O. Innovators are unique in being exceptional market leaders in their respective field with ample internal cashflow generative capacity to reinvest for higher-margin growth and still consistently produce rising dividend yield to reward shareholders.