The Polen Capital Global Growth ETF (Fund) gained 7.70% at NAV during the first quarter of 2024, trailing the MSCI ACWI Index (Index), which was up 8.20%. The Morningstar Global Large Cap Growth Fund peer group returned 9.00% in the quarter.
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Quarterly Portfolio Manager Commentary
In many ways, the first quarter marked a continuation of the market dynamics already in place at the end of last year. Markets staged a robust two-month rally into the end of the year on optimism that the Fed would achieve an elusive soft landing and taper interest rates in early 2024. This rally continued unabated into the first quarter, with much of the same high-momentum, highly cyclical leadership we saw last year. Consider some of the top-performing sectors: Information Technology, Financials, Industrials, and Energy. Even within Technology, it’s a story of a smaller subset of semiconductor companies benefitting from the growing frenzy around Al, with NVIDIA being the poster child.
A notable development in 2024 has been increasing dispersion and breadth of market leadership. This stands in sharp contrast with 2023’s concentrated leadership among a small grouping of the largest benchmark holdings, dubbed the “Magnificent 7.” This increased dispersion is none more evident than with NVIDIA and Meta Platforms being up 82% and 37%, respectively, during the first quarter, while Apple and Tesla were down -11% and -30%, respectively.
With our emphasis on sustainable, predictable growth, which in many cases is supported by secular tailwinds, this was not an environment particularly conducive to the way we invest. As such, we were pleased with how the Fund performed in this heavily pro-cyclical market backdrop.
Even in some segments, such as IT services and retail, where we have seen economic softening drive near-term weakness in fundamentals, we think it’s prudent of management teams to set conservative expectations reflective of an uncertain macro environment and with the long term in mind.
While extreme optimism seems to be the dominant feature in parts of the market of late, it does not influence our long-term approach to investing. Our approach centers on being long-term owners of some of the highest-quality businesses in the world, supported by durable competitive advantages, strong balance sheets, and secular growth tailwinds. In remaining disciplined in our process and research, we think our businesses are as well positioned as any to deliver above-average earnings growth with below-average risk in good times and bad.
As we look ahead, we expect underlying earnings per share (EPS) for the Fund to grow in the mid-teens over the next five years. If our portfolio holdings can deliver on that, we would expect returns to roughly follow as we have observed over the long term.
Portfolio Performance & Attribution
The largest relative contributors to the Fund’s performance during the first quarter were SAP, Apple (not owned), and Amazon. From an absolute perspective, the top contributors were Amazon, SAP, and Microsoft. The largest relative detractors to the Fund’s performance during the first quarter were NVIDIA (not owned), Adobe, and Workday. From an absolute perspective, the largest detractors during the quarter were Adobe, Globant, and L’Oreal.
After delivering a robust fourth quarter, SAP’s stock price again rose significantly in the first quarter of 2024 on solid 4Q23 earnings and full-year guidance that was revised modestly higher. Importantly, SAP’s transition to the cloud (a core part of our thesis on the business) continues at pace, and the company is seeing both strong cloud revenue growth and expanding cloud gross margins. Management is guiding cloud sales growth through 2025 in the mid-20% range, which we view as reasonable and attractive. We view SAP as one of the more resilient software business models as it is an essential part of their customers’ day-to-day operations and cannot easily be turned off or scaled back. Additionally, we think CEO Christian Klein is honest, competent, and long-term minded traits we value highly in leadership.
The zero weight to Apple was another notable relative contributor in the quarter. More recently, Apple has come under pressure from a confluence of issues ranging from a weak iPhone cycle, market share erosion in China, mounting regulatory pressure around App Store fees in Europe, and a lawsuit from the U.S. Justice Department accusing the company of anticompetitive practices in its iPhone business. All this has resulted in the stock down -11% year to date, underperforming the overall Index by -19%—Apple’s worst relative performance quarter since 2013. It remains a great business and one we follow, but we’re content not owning it right now, given its growth prospects relative to its valuation.
Amazon, which saw significant price appreciation throughout much of 2023, continued its strong performance on the back of a solid fourth quarter 2023 earnings report. After a long-awaited re-acceleration in AWS (Amazon Web Services) revenue growth, we saw it materialize during the period. Most importantly, the company’s margins and free cash flow have rebounded significantly off the 2022 lows. This rebound in margins and free cash flow at Amazon has been a key component of our shorter-term expectations for the business.
We expect the improvement to continue through 2024 and beyond (though perhaps not linearly) as the company optimizes costs and capital expenditures. Our longer-term thesis is that the business is dominant in its end markets, continues to have strong growth prospects with tailwinds, and rising margins should accompany growth to boot. Margins should rise as higher-margin business segments, namely AWS, advertising, and 3P, become a larger part of the mix over time. Our position in Amazon reflects our positive long-term expectations of their business, and it is currently our largest absolute weight in the portfolio.
NVIDIA—a stock we do not own—was the largest relative detractor during the past quarter, having delivered an 87% year-to-date return on the back of a +239% return in 2023. The company continues to defy very elevated expectations as it plays a central role in building the infrastructure for Al in the years ahead. In our 2Q23 letter, we discussed at length our rationale for not owning NVIDIA and would point clients there for more detail. In short, however, our decision not to own NVIDIA comes down to questions about the sustainability and predictability of its growth. While we fully acknowledge this is a compelling business with a deep moat and skilled management team, the issue for us is that this is not a recurring revenue business. As we’ve seen through time, NVIDIA has proven susceptible to extreme cyclicality in its business, and with all of the fervent pull forward of demand over the past year alongside an elevated valuation, we prefer to remain on the sidelines until we can gain more conviction in the durability and predictability of earnings growth looking ahead.
Adobe, the leader in cloud-based creative digital media, had been among the strongest-performing holdings over the past year. After some initial misgivings in early 2023 around generative Al’s impact, the market quickly embraced Adobe as an Al beneficiary following the rollout of its Firefly product, sending the stock up 84% from mid-May through the end of January. Following its latest earnings release, the stock sold off on slightly weaker-than-expected 2Q 2024 guidance and some renewed skepticism around effectively monetizing Al within its creative suite. From our perspective, the recent share price moves are more reflective of changes in near-term expectations and sentiment than any fundamental change in Adobe’s business. We acknowledge that Al developments like OpenAl’s new text-to-video creation tool, Sora, might be seen as an emerging competitive threat. Still, we believe that Adobe is well-positioned to leverage new Al capabilities to its advantage, and we remain confident in the company’s position.
Finally, weakness in Workday during the quarter is likely more a function of the stock taking a breather than any adverse fundamental development.
From the end of October through the end of February, the stock was up 40%, buoyed by the company’s better-than-anticipated earnings in 3Q 2023, and management raised revenue guidance for their fiscal 2024. In 1Q 2024, the stock sold off on results and guidance that did not exceed the elevated expectations some investors anticipated. We believe Workday has ample room to continue taking share in a nicely growing $100 Billion+ global human capital management (“HCM”) market and remain confident in the company’s ability to generate 20%+ annualized free cash flow per share growth over the next three to five years.
Fund Activity
During the quarter, we initiated new positions in Sage Group and Airbnb and added to our existing position in Globant. We were also in the process of adding a new position in Paycom, which was completed shortly after the end of the quarter. By contrast, we eliminated our position in Nestle and trimmed our existing position in Accenture.
Sage Group is an accounting and financial software provider focused on small-medium businesses (SMBs). We’ve covered Sage for many years. Sage occupies a leading position as a scaled provider of mission-critical software for SMB customers across Europe and North America. We have been impressed with management’s ability to transition the business to the cloud and re-focus its efforts on the core business through the divestiture of non-core segments with the proceeds reinvested into R&D. This has driven accelerating revenue growth, improving margins, and highly recurring revenue, and we think the business continues to have a long runway ahead of sustainable mid-teens earnings growth.
Airbnb is a great business model, according to our research, due to its two-sided global network effects. For several reasons, Airbnb has a better mousetrap with its supply growth engine, with its hosts having a far lower cost of capital and more flexibility than hotels. We think private rentals should continue to grow their share of overall accommodation stays, potentially up to 30% of lodging or higher over the long term, letting the private rental gross booking value grow at a low double-digit rate. We also think Airbnb should continue to gain share within the private rental market as its global network effects strengthen, allowing for mid-teens revenue growth. With flat to rising margins over time, significant free cash flow generation, and a management team that has demonstrated its owner orientation, this should result in high-teens EPS growth over time. While the path there will not be linear, and it is a more discretionary spending-tied business, we think the long-term secular growth opportunity is very compelling.
Paycom is a leading cloud-native payroll and human capital management (HCM) software provider. We think it’s a well-run, high-quality business operating in an excellent sector with many winners. We know the payroll and HCM software sector well, having owned ADP for many years and, more recently, Workday. While a recent go-to-market SNAFU with their new Beti product and some macro weakness has led to a deceleration in their near-term growth, we think the long-term picture remains—it is a leader in an attractive industry, providing mission-critical software with highly recurring revenue, 90%+ retention rates, and high returns on capital. We think Paycom has a leading product and should be able to continue to grow foster than the market and succeed in moving up-market. It has gained market share since its founding in 1998 and IPO in 2014, and we expect this to continue after the short-term clouds dissipate. We believe it will return to a normalized long-term revenue growth rate in the mid-teens or better over time and that the valuation reflects near-term concerns, presenting a positive risk-reward.
Finally, we added to our existing position in Globant with the proceeds from trimming back our Accenture position. We think this is prudent because Globant’s valuation isn’t much higher than Accenture’s, but it should be able to grow EPS faster at ~20%+ over the next five years. We see both as excellent businesses benefiting from similar tailwinds behind the increasing need for trusted third-party IT services providers and continue to feel good about holding both companies for the long term.
On the other hand, we eliminated our position in Nestle after trimming it last quarter. Nestle has served as a solid “safety” holding for many years in the Portfolio. Over the past several years, the company has effectively pruned its product portfolio of low-growth, low-margin, capital-intensive businesses and reinvested the proceeds in more attractive companies to drive margin expansion. At this point, we feel there isn’t much of an opportunity to drive further margin expansion, and the competition is significant for potential acquisition candidates who meet these criteria. As a result, we believe that Nestle’s ability to achieve our hurdle of low double-digit returns going forward will be more challenging, and we used the proceeds as a source of funds to add to businesses with a higher probability of delivering on our demanded returns.
Outlook
While market sentiment has markedly improved in recent months, consensus now expects a soft landing and stabilization of the interest rate environment. Only a few months ago, the consensus called for rates to remain “higher for longer,” and expectations for imminent recession were not uncommon. Regardless of the near-term direction of the global economy, our research indicates that our portfolio companies are performing well, and we expect them to continue to perform well through the cycle. We believe the Fund’s valuation is currently fair for what we consider to be a collection of some of the best companies in the world. We believe these companies are well-positioned to deliver mid-teens underlying EPS growth, in the aggregate, for many years.
Portfolio Asset Allocation as of March 31, 2024
| By Sector | By Region | ||
| Finance | 14.9% | Europe | 32.6% |
| Consumer Discretionary | 15.4% | North America | 65.6% |
| Information Technology | 34.5% | Asia ex-Japan | 0.0% |
| Communication Services | 7.2% | Japan | 0.0% |
| Health Care & Pharmaceuticals | 18.9% | Latin America | 0.0% |
| Industrials | 5.2% | Africa | 0.0% |
| Consumer Staples | 3.0% | Australia/New Zealand | 1.8% |
| Real Estate | 0.0% | Middle East | 0.0% |
| Utilities | 0.0% | Other Countries | 0.0% |
| Energy | 0.0% | *Cash is excluded from calculation. | |
| Materials | 0.0% | ||
| Cash | 1.0% |