Good morning, and thank you very much for joining us today as we talk about what we think is going on in stock markets, and most specifically within the European region.

And I wanted to start off by saying that we believe that the last 40 years or so, equity markets have moved to a particular rhythm, and that rhythm has been set by the economic cycle. As a consequence of that, investors have reacted by playing different sectors and stocks in the context of the economic cycle, riding the cycle out, protecting themselves when the cycle falls.

But the economic cycle has not been the primary actor, we don’t think, for a little while. That is a problem because many of the opinions in the investment fraternity and much of the intellectual architecture of the industry is built on the idea that the economic cycle is the primary actor. So what has happened to change things? Well, first of all, there’s been this remarkable emergence of the tech sector on this incredible structural growth. It’s led the US market, and we think is one of the reasons why the US market has been better than other markets on a global basis. My colleague, Freddie Fuller, will go into greater detail about this.

The second thing that’s happened is that there’s been a step away from aggressive application of antitrust rules. And we think this has led to concentration in a number of industries, whether it be telecommunications or airlines. And again, it’s something that is probably most acute within the US market. And this means that margins have gone up, have become more stable, and corporate profits as a percentage of GDP are at all-time highs. So what happens in this sort of environment is that the winners pull away. They consistently do well. The economics of the businesses continue to improve. And the losers continue to suffer. They’re undermined because of technological disruption or because they don’t have the scale to compete with larger businesses.

Now if we’re right about this, it folds into the debate about growth in value. There isn’t very much that we can add to this debate and it’s become a bit strident, but we do believe it’s true to say that value needs reversion to the mean to work effectively. So those companies that have done very well need to be brought back down by the economic cycle turning or by competitors, and those fallen angels that have needed to restructure are not in a position whereby they can’t get back to what they were before. Neither of these things is working at the moment.

There’s a UK-based portfolio manager, a leading fund manager who’s done very well over the last 20 years or so, who’s written in the British press recently that the job of equity markets is to allocate capital to new and growing areas. And we think he’s correct in saying that. He’s suggesting, though, that the level of adaption has been fairly slow, and he thinks that the reason for this is that everybody follows a Warren Buffet style of investing whereby value is the key determinant.

Sometimes new industries don’t display value in a traditional sense because they’re on very high structural growth rates. We don’t think the latter part of this completely holds water.

Other people have said, within the British, press that the reason why the adaption of stock markets to what’s happening in Main Street has taken some time and it isn’t complete is because of the tyranny of numbers, the obsession with metrics that exists everywhere these days.

The idea is that if a corporate management team is obsessed with its return on invested capital, it will lose the will to be entrepreneurial. It will negate their desire to take risks. Again, we don’t think this argument completely holds water because this doesn’t seem to have affected Elon Musk or Jeff Bezos, both of whom have raised capital and grown businesses from the ground up.

We think it’s more likely that this is about investors being obsessed with reversion to mean, being attached to the idea that it’s the economic cycle that’s the primary actor. And we think that this has been exacerbated by the drawing up of categories within the stock market. Categories were developed in order to simplify the stock market, and in many respects they have been successful, but sometimes categories obscure as much as they reveal.

And one of the categories, value, has something akin to a golden rule attached to it. The idea is that value always outperforms. Now when a golden rule exists, we would observe that it tends to be the enemy of thought. It’s the enemy of critical analysis as to why value, a value approach should work and when it should work.

So these are just concepts that I’m throwing out here and, therefore, we need to test them by looking at the evidence, by being empirical. And I’ve taken a few companies within Europe and I’ve used them as proxies for sectors. I’ve got a proxy for the telecommunications industry. And what I can see is that since 2012, the gross cash flow of this company has declined by 25 percent. Telecommunications in Europe is a highly competitive industry without great moats, with great protections against competitors, and has been disrupted by new forms of technological delivery of content.

Another sector that has done poorly is the bank sector. And again, I’ve chosen a proxy. And gross earnings, cash earnings for this proxy have declined by a quarter since 2012, so very similar. Banking has been affected by the fact that interest rates are low and the regulatory regime has changed. But also by, again, aggressive technological disruption through the fintech industry. The other side of the coin is, I’ve chosen a technology company as a proxy for technology. It’s a company that has very strong intellectual property in semiconductors and it has grown its gross cash flow by 183 percent since 2012.

I’ve also chosen a pharmaceutical company, again, for a proxy for pharmaceuticals. The sector’s fairly heterogeneous so I think that that’s acceptable. And it has grown its gross cash flow by 73 percent. And this is because it has great intellectual property and huge barriers to entry and is on a secular growth trend. So we tend to focus on the second group of companies, companies that have very high levels of profitability, low levels of capital intensity, great moats built around them, and that have secular trends of growth. So if we return now to the idea of whether the market has adapted effectively to the changes that we see in Main Street, you have to ask the question, is it Buffet’s fault or is it The Quants. And I’m fairly convinced that it’s neither in entirety. This is much more to do with opinions.

And in order to demonstrate that point, I’m going to look back at history. In the early 19th century, the canal industry was created and saw tremendous growth in tonnage for a long period of time, as it became the mode of transport for goods across networks of countries. But it faced a remarkable form of disruption when the railways arrived. So there were many people who were dismissive of the railways. There were people who worried if passengers would asphyxiate because of the speed at which trains traveled. And more prosaically, there were many operators of canal systems that had to be committed to their business plans and, therefore, continue to invest. And the upshot is that it took 40 years or so for the canal industry to ultimately become financially redundant and commercially redundant.

So this is what happens in paradigm shifts. They’re always painful, and they always take a considerable amount of time, and they’re always built on opinions changing too slowly.

So we believe that the index will adapt to the changes that we’re seeing, predominantly within the technology sector. And we’ve seen this to a great extent within the US market. But the job of the portfolio manager at this stage is to step ahead of indices and to imagine the shape of the economy in the future.

Now I’m going to pass over to my colleague, Freddie Fuller, to take you through the technology element that I talked about before.

Thanks, Dominic. I’m going to start by looking in a little more detail at Dominic’s point that he made about how technology has been that primary driver of US stock markets.

The slide you can see on your screen demonstrates the percentage of the market capitalization of the S&P 500 made up by the FAANGM stock. Now this being the traditional FAANGM [indiscernible] of Facebook, Amazon, Netflix, and Google, with Apple and Microsoft thrown in almost for good measure.

As some people who have noted recently, a huge proportion of what has been driving US markets has not been the US economy itself, as one might believe, but it is in fact at least partly down to the US index’s strength in technology stocks.

Now to narrow these numbers down even further, it’s interesting to note that both Apple and Microsoft make up over 5 percent of the S&P 500 each. And therefore, looking sectorally, each of these stocks on their own has a higher weighting than each of the energy, utilities, real estate, and material sectors individually.

And importantly, it isn’t just market share, but performance has been dominated by technology. Over the last 10 years, and by that we mean to January of 2020, the S&P 500 rose 251 percent. And of this, 76 percent was the technology sector, which is more than double the next highest-performing sector, which was health care. Thirty-one percent was down to just Apple, Microsoft, and Amazon.

Now clearly, this is an extremely narrow band of market participants. We thought it would be interesting to compare this with Europe and analyze how the two regions have differed, both historically as well as how things might look in the future.

Europe, rather unlike the US, has historically been far more value-orientated by virtue of having a far heavier weighting to sectors such as financials and industrials. So to Dominic’s point earlier, traditionally, investors may have been looking to exploit this fact by, say, investing in Europe when GDP growth was picking up and more value-orientated sectors might theoretically outperform.

But this technological disruption that has occurred over the last 10 to 15 years is not strictly limited to the US. Europe may not have the leviathan tech companies of the US West Coast, but European indices are no longer as heavily weighted to financials as they once were.

And as this slide shows, technology companies have recently outweighed banks within European indices for the first time in history. Clearly, the increased weighting of technology is not just due to the ongoing expansion of the technology sector, but also, the ongoing disruption in the banking sector itself. As Dominic noted, low interest rates are longer, post-GFC regulation increased capital requirements, as well as ongoing disintermediation have all proved fairly formidable headwinds for the profitability of the banking sector. But it should be noted that, again, technology has played its part as digital disruption and things such as fintech start-ups continue to produce fairly appetizing alternatives for traditional banking customers.

It is, of course, very difficult to know whether this change in dominance between the two sectors will continue in perpetuity. But given the astonishing disruption that technology is having on companies, there seems at least to be the opportunity for this to progress further.

So having seen this divergence between the two regions, we can see that, effectively, index composition has by proxy served as a hindrance within Europe. Most of the big sectors, and by this we mean sectors such as oil and banking or chemicals, are very much the growth stories of the last century, not the growth stories of the 21st century.

In this regard, then, much of the relative underperformance of, say, the FTSE 100 over the last decade or so, particularly compared with the US, is less to do with the domestic [upheaval], or for that matter, actually, even socioeconomic upheaval such as Brexit. But instead, it’s the index itself suffering from its very own composition.

So the question this leads us to is, how should we approach investment in Europe given this underlying disruption and the apparent changing of the guard with regard to sectors?

Well, we believe that Europe has two key sustainable advantages. The first comes down to Europe’s particularly robust regulation in accounting laws. Now this may not sound like the most exciting or enticing reason. But we think that it’s particularly important because of another aspect, which is that—and one that is rather overlooked, we think—which is that Europe has this inherent emerging market exposure, given the kinds of companies that exist in Europe. Now some of these companies are several hundred years old and have a remarkable relationship with emerging market countries, even at a cultural level. This exposure to emerging market growth and the resulting middle-class expansion that comes with it, coupled with the overlay of extremely robust accounting and governance, we think creates a compelling investment case for the right companies and industries in Europe.

And in fact, when you dig down into the data, European companies derive 31 percent of their revenues from emerging markets, while domestic revenues, and by that we mean revenues from Europe itself, are 47 percent. Compare this with North America which derives over 70 percent of its revenues domestically and the divergence becomes very clear. And in a world where technology is disrupting at the rate that it is, the ability to diversify revenue sources we don’t believe should be dismissed out of hand.

The second sustainable advantage is the fact that Europe is proving to be very much the epicentre of an ongoing transformation in the culture of business. Even before the global COVID-19 pandemic, we were witnessing what really felt like a potentially transformative reckoning with regards to how business not only views itself but fits within the socioeconomic landscape. By this I mean rather existential questions, such as what role should business play in society or should shareholders take precedence over other stakeholders such as customers or employees. Very much the Milton Friedman question over the last 18 months to 2 years.

Although still fairly early days, it would appear that the pandemic is not going to derail this self-reflection of business, if you like, and indeed has produced a number of examples of how companies may be regarded in the future, such as how companies’ treatment to employees during lockdowns or any even recessions might be analyzed, or perhaps how they have made efforts to contribute to wider society during turbulent times.

In perhaps a sort of chicken-and-egg situation, Europe has also become the market leader in ESG investing, not only in terms of the companies’ investors themselves, but also with regard to forward-looking regulation and policy. As this slide shows, in terms of sustainability data, measuring the Environmental, Social, and Governance credentials of individual companies, Europe remains the highest-scoring in the world, with countries such as the Netherlands, Finland, and Sweden scoring particularly high.

Now we recognize that these metrics are by no means the be all and end all, but it is at least indicative of how Europe continues to push the boundaries with regards to the sustainability of business. From a policy perspective, the European Green Deal, which is a series of initiatives undertaken by the EU to create a more sustainable economy as well as become climate-neutral by 2050, is due to be joined by the EU Taxonomy. And this is something that we believe is a genuine attempt to focus what is an intensely complex and wide-ranging topic and narrow it down to assist investors.

So where does this lead us? Well, we think that to try and navigate the disruption that technology is really wrecking on traditional styles of investing and the underlying companies within, we should be searching for those sectors and companies that display great characteristics and strong defenses against competition. But perhaps most importantly, it’s those business models that can rapidly adapt to the disruption that we’re witnessing. Going back to Dominic’s point, the form of Adam Smith, creative destruction in Europe means many future developments are potentially going to come from here. So Sweden is fast becoming an interesting heartland for small, young tech start-ups. Denmark now leads the world in microbes, enzymes, and diabetes care. And France and Italy, perhaps unsurprisingly to many, lead globally in fashion and high-end goods.

We think this will lead to many very interesting opportunities for future growth. It will not necessarily conform to what historical norms may have inferred, especially with regards to our areas of the market that may outperform in the long run. And as fund managers, this will mean being agile as well as different from the index and ready to harness those companies and sectors that are ready to emerge on top in the future.

So I’m going to leave it there. But before we finish, we wanted to respond to some of the questions we’ve received in advance of this recording, which Dominic has kindly said he will respond to.

So, Dominic, the first asked for our thoughts on how bottom-up Europe equity managers should be approaching investing in companies operating out of different countries that may be taking different approaches to handling the pandemic. So I suppose, said differently, if a bottom-up manager finds a great company that happens to be based in a country that right now perhaps has difficult policies with regards to the pandemic, should a manager be investing in that company? Or does a top-down view become the primary factor?

Well, it’s an interesting question, and I guess it must have been provoked by the fact that there is a genuine outlier within Europe, and that’s been Sweden. Sweden has had a different approach, much less lockdown, especially relative to its Scandinavian peers. But for us, I think it’s a moot point because the vast majority of companies that we invest in are highly international. And there are variations on a global basis but they’re not something that we can model, to be honest, and I think they’ll offset each other ultimately. And again, to repeat a point that you made only a couple of minutes ago, we’re looking for the secular trends, the emerging trends, actually, are being fortified by, unfortunately, by the pandemic. So I don’t think it’s a consideration for us, but an interesting question.

Second one and final one that we have is really angled to that ESG side of things that I’ve touched on. And we often try to educate investors on being careful not to think of ESG as being synonymous with environmental activist investing. However, do you envision the pandemic and reduced global transportation demand right now to have any longer-term catalytic effect on increasing renewable energy usage? Or on the other hand, do you have concerns companies will put the whole question of ESG and environmental responsibility on the back burner in order eke out profits in any way necessary to avoid financial losses?

Again, another interesting question. It’s difficult to improve upon the explanation that you provided slightly earlier. It’s possible that in the short term, if companies are suffering from a financial perspective, that they will throw some of the environmental concerns out of the window. But I think that will be reined in really quite quickly. And this is ultimately all about consumers, and consumers’ mindset, I think, is very directed towards the environment.

So I don’t think that the long-term trends will be disrupted. I think, in fact, ultimately, they will be accelerated.

Right. Well, thanks very much, Dominic. And thank you very much to everyone for the questions you’ve sent in, and thank you very much for joining us this afternoon.

Thank you.