Global equity markets delivered solid gains in the second quarter despite intra-quarter swings influenced by shifting dynamics in the trade dispute between the U.S. and China and indications that the U.S. Federal Reserve may move to a more accommodative monetary policy. For the second quarter, BBH Global Core Select Composite (“Global Core Select” or “the Strategy”) appreciated by 5.46% bringing the year-to-date gain to 19.57% while the MSCI World index gained 4.00% in the quarter and 16.98% year-to-date.
Our best performing investments in the second quarter were Copart Inc. and FleetCor Technologies Inc. Copart gained 23% in the quarter and 56% year-to-date as the shares continue to respond favorably to strong business performance. As the market leader in the salvage auto auction market with a strong technology platform, Copart is benefitting from the favorable industry trends of i) increasing salvage vehicle volume and rising vehicle inventory, driven by increases in accident frequency, and ii) strong pricing driven by increases in vehicle complexity and rising buyer demand as more international buyers enter the market. Copart also is continuing to build out infrastructure in its German operations and has grown volume rapidly in that market, offering a potential additional leg of growth going forward. We expect Copart will continue to generate shareholder value and to benefit from industry tailwinds, maintain its industry leading position in the U.S., and expand its footprint globally.
FleetCor’s shares appreciated 14% in the quarter, continuing the strength we saw in the first quarter and bringing the year-to-date gain to 51%. FleetCor reported strong operating results during the quarter, with double-digit revenue growth across key operating segments demonstrating the Company’s excellent execution. Importantly, Management’s strategy of expanding the addressable markets of FleetCor’s most mature business, fuel cards, is exhibiting signs of success as growth in the segment accelerates. Fuel cards are basically “control cards” issued by fleet owners to employees that limit the types of purchases that cardholders can make. As allowable purchases are expanded beyond fuel, FleetCor expands the number of transactions on which it earns fees, in turn increasing per-client revenue. FleetCor is generating strong free cash flow which is partially being deployed towards acquisitions, most recently the tuck-in acquisition of a software business that expands its presence in the attractive electronic corporate payments industry. We remain very constructive on our investment in FleetCor; however given the very strong share price performance and a new investment that we initiated during the quarter in the payments industry, we modestly trimmed our position.
Alphabet Inc., Google’s parent company, and Lloyds Banking Group plc were the most significant detractors from performance during the second quarter. Alphabet declined 8% in the quarter bringing the year-to-date return to +4%. Alphabet’s shares were pressured by a slowdown in revenue growth reported during the quarter, compounded by concerns regarding potential regulatory pressures on large U.S. technology companies, including Alphabet. While revenue growth reported during the quarter was below expectations, this was largely a function of Company-initiated product changes, as well as currency headwinds. Management had discussed implementing these changes in Fiscal 2019 with the goal of improving user and advertiser experiences at the expense of near-term revenue growth. Our view is that Alphabet is performing well and believe Management is making appropriate changes to improve the health of its platform and user experience. Management continues to invest in cloud, hardware, machine learning, and augmented/virtual reality, all of which enrich its core business and the broader Google ecosystem and supports multiple avenues of potential future growth. With respect to regulatory concerns, media reports of pending antitrust investigations into Alphabet, Facebook, Amazon, and Apple surfaced during the quarter and triggered negative investor sentiment. Antitrust lawsuits can often take years to decide and regulators would need to prove that Alphabet has gained or maintained a monopoly through unlawful practices or that a past merger substantially decreased competition. We will closely monitor this development and incorporate new facts into our analysis as they emerge. Regardless of potential regulatory outcomes, we believe Alphabet is well positioned to continue to achieve strong revenue and cash flow growth from search advertising, and increasingly cloud, hardware, and apps, driven by the secular shift of advertising and enterprise spending online. We took advantage of the share price weakness to add to our position during the quarter.
Lloyds’ shares have retraced a portion of their gains from the first quarter and declined by 8% in the second quarter, though on a year-to-date basis the shares have returned nearly 13%. Uncertainty regarding Brexit and the potential impact on the UK economy have weighed on the shares, as well as the British Pound. Additionally, the Company reported mixed results during the quarter with soft revenue offset by lower costs and loan losses. However, Management maintained its guidance for the year and, with one-off charges expected to decline and a recent reduction in capital requirements, we believe Lloyds is positioned to generate strong returns on tangible equity. With respect to Brexit, Management consistently highlights multiple cost-control levers it can pull to protect profitability in the event of a hard Brexit. Funding costs would also fall in a hard Brexit scenario, as Lloyds would likely benefit from inflows of low-cost deposits as it did in the aftermath of the Brexit vote in 2016. We believe the market continues to underestimate the resilience of Lloyds’ margins and the continued convergence of statutory and underlying earnings. Lloyds is trading at a very attractive valuation and has the potential to distribute nearly a third of its market cap over the next few years through dividends and buybacks.
We added three new investments to the Fund during the first quarter: Fairfax Financial Holdings Limited, Mastercard Inc., and Henry Schein Inc. Led by investor Prem Watsa since 1985, Fairfax is a Canada-based global insurance conglomerate with leading positions in commercial property and casualty (P&C), specialty insurance, and reinsurance. Fairfax’s insurance operations were built up over decades through acquisitions and organic growth and are run in a decentralized manner by incumbent management teams
while the float and broader investment portfolio are managed centrally by Watsa and his team. Fairfax has five established insurance companies and two established international reinsurance and specialty companies led by strong management teams focused on underwriting profit. Watsa’s investment team manages a $39 billion portfolio – including $22 billion in insurance float – and has a proven track record over the long term. Fairfax is committed to growing book value per share by 15% annually over the long term and has exceeded this objective with 18.7% compounded annual growth in book value per share since 1985. Returns have faltered in recent years due to a highly conservative investment allocation and a soft insurance market. Recently, Fairfax has found more investment opportunities that meet its criteria, boosting interest and dividend income. Supported by growing insurance profits and better expected investment returns, we believe the Company is on track to resume double-digit book value per share growth in the future.
Mastercard is a technology company that enables transactions through its electronic payment networks and connects tens of millions of merchants to billions of credit and debit card accounts. The Company operates in a de facto duopoly with Visa to enable open-loop, multiparty payment networks, and both companies focus their respective strategies on replacing cash and checks with card transactions rather than competing on price. We believe the barriers to building a payments network at scale are formidable for a new entrant and that the durability of digital payments growth is underappreciated by the market. We expect Mastercard to benefit from the tailwinds of growth in global spending, increasing card market share, e-commerce, and corporate payments opportunities. Mastercard is a strong fit with our investment criteria given its number two position in an attractive industry with strong network effects and scale economies, high customer retention due to the switching costs to a card issuer of changing card networks, and very attractive returns on invested capital and cash flow generation. While Mastercard is a well-known business upon which many investors look favorably, our differing perspective is our view that the persistence of the growth opportunity and durability of the business model are not fully reflected in the share price. Continued penetration of consumer transactions remains a robust opportunity as cards currently account for less than 45% of global personal consumption expenditure (PCE). Additionally, we see Mastercard’s potential to benefit from commercial payments transactions – a very large market where cash and checks still represent 50% of volume – as being underappreciated. Combined, we believe these factors support attractive compounding of growth of revenue and commensurate growth Mastercard’s intrinsic value1 over time.
Spun off from Novartis during the quarter, Alcon Inc. is a new position in which we retained our distributed shares and subsequently increased our investment. Alcon is the largest eye care device company globally, operating in two segments: i) Surgical, which includes products and services for the surgical ophthalmology market (cataract surgery, vitreoretinal surgery, LASIK/refractive surgery, and glaucoma, and ii) Vision Care, which includes contact lenses and ocular health products. Alcon was acquired by Novartis in 2011; however following a strategic review, Novartis concluded it was not the optimal owner of Alcon and decided to spin the business to shareholders, completing the transaction in April. Alcon represents a strong fit with our investment criteria given the essential nature of its products; a growing patient population; its strong leadership position in a segment of healthcare that is relatively less exposed to managed care given a higher skew towards cash pay; high customer loyalty supported by customer service, training, and support; and an equipment footprint that drives recurring consumable sales. We believe significant opportunities exist to generate stronger financial performance of the business, as the franchise was not optimally managed as part of Novartis, with underinvestment resulting in share losses and margin degradation. New management began its tenure prior to the spin and is executing a turnaround focused on increased investments in supply chain, sales, marketing and service, and research and development, initiatives that are all supportive of improving and sustaining the business’s operating performance.
Henry Schein is the largest dental distributor globally, leveraging broad logistics capabilities to serve dental practitioners, dental laboratories, and physician practices as well as government, institutional health care clinics, and other alternate care clinics. Core competencies that support Schein and distinguish it from competitors include deep and loyal customer relationships, a broad product and service offering at competitive prices, favorable demographic trends, mergers and acquisitions (M&A) built into its operating model, a deep infrastructure, and a successful and stable management team. Currently, Management is working to optimize its cost structure and business processes by driving lean and streamlined operations. Continued market share gains, attractive end-market characteristics, consolidation opportunities, geographic expansion, and advancing technology solutions (including practice management) should continue to generate sustained organic growth supplemented by M&A. We maintain a high opinion of the management team for its consistent execution and forward-thinking strategy.
Early in the quarter, we sold our remaining positions in three media investments, Discovery Inc., Liberty Global plc, and Qurate Retail Inc. While we respect all three businesses and regard the respective management teams as strong capital allocators, we believe that structural challenges in segments of the media industry are escalating. In our view, the range of potential outcomes in these companies’ respective industries is widening as the fragmentation of consumption has increased competitive threats. Ultimately, we determined that those changes may compromise the strengths we see in each Company and we chose to exit our positions. With respect to additional portfolio changes, we added to our positions in Alphabet, Unilever NV, Alcon, Linde plc, and Celanese Corporation during the quarter, and we trimmed our positions in PayPal Holdings, FleetCor, and Sanofi.
We ended the quarter with 33 portfolio companies and 48% of the portfolio in the top 10 positions and a cash position of 2.8%.
We had a change to the investment team during the quarter as Marla Sims, an analyst on the Global Core Select team, left Brown Brothers Harriman at the end of June. We are grateful to Marla for her many years of service and we wish her well. Marla’s responsibilities within the Media and Consumer sectors have been absorbed by other members of the Global Core Select team.
On behalf of our entire investment team, we would like to thank you for being an investor with us in Global Core Select. Please feel free to contact us with any questions or suggestions.
Regina Lombardi, CFA
Holdings are subject to change. Totals may not sum due to rounding.
Price/Earnings (P/E) ratio is a company’s current share price divided by earnings per-share.
Turnover ratio is the rate of trading in a portfolio; higher values imply more frequent trading.
Opinions, forecasts, and discussions about investment strategies represent the author’s views as of the date of this commentary and are subject to change without notice. References to specific securities, asset classes, and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations.
Purchase and sale information provided should not be considered as a recommendation to purchase or sell a particular security and that there is no assurance, as of the date of publication, that the securities purchased remain in a fund's portfolio or that securities sold have not been repurchased.
International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.
The strategy is 'non-diversified' and may assume large positions in a small number of issuers which can increase the potential for greater price fluctuation. Investors should be able to withstand short-term fluctuations in the equity markets in return for potentially higher returns over the long term. The value of portfolios changes every day and can be affected by changes in interest rates, general market conditions and other political, social and economic developments.
Data presented is that of a single representative account ("Representative Account") that invests in the strategy. It is the account whose investment guidelines allow the greatest flexibility to express active management positions. It is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the proposed investment strategy.
For purpose of complying with the GIPS® standards, the firm is defined as Brown Brothers Harriman Investment Management ("IM"). IM is a division of Brown Brothers Harriman & Co. ("BBH"). IM claims compliance with the Global Investment Performance Standards (GIPS®). To receive a list of composite descriptions of IM and/or a presentation that complies with the GIPS standards, contact Craig Schwalb at (212) 493-7217, or via email at email@example.com.
Gross of fee Gross of fee performance results for this composite do not reflect the deduction of investment advisory fees. Actual returns will be reduced by such fees. "Net" of fees performance results reflect the deduction of the maximum investment advisory fees. Performance calculated in U.S. dollars.
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1BBH’s estimate of the present value of the cash that a business can generate and distribute to shareholders over its remaining life.