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07 March 2024

Redmayne Bentley Publications Podcast February 2024

We are pleased to present the audio version of our February 2024 edition of Market Insight.



In this issue, we explore the continued momentum of US technology sector and the Magnificent 7, delving into the drivers of meta platforms recent share price resurgence.
We also look into the one of the often-missed factors of importance within the active verses passive debate and ask where next for the battery storage sector?

TRANSCRIPT

Welcome to the audible version of Redmayne Bentley’s Market Insight Publication. Our February 2024 edition of Market Insight explores the continued momentum of US technology sector and the Magnificent 7, delves into the drivers of Meta Platforms recent share price resurgence, comments on one of often missed factors of importance within the active verses passive debate and touches on the recent development with the UK’s battery storage sector.

Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. There is an extra risk of losing money when shares are bought in some smaller companies. Redmayne Bentley has taken steps to ensure the accuracy of the information provided. Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.

Tech winter momentum shows no signs of cooling 
Konrad Pietka | Investment Research Team Member

This year was billed as an important one with more than forty elections globally, most notably in the US, India and Taiwan. It has been a mixed start, with Pakistan experiencing a hung parliament and the Taiwanese election seemingly highlighting discontent with China. In equity markets, the march of the Magnificent Seven persists and shows signs of continued momentum. Nvidia, Meta, Tesla, Amazon, Alphabet, Microsoft, and Apple delivered returns of between 50% to 240% in 2023, driving the performance of the S&P500. Excitement around the development of Artificial Intelligence (AI), as well as hints of interest rate cuts later in the year, were the tailwinds driving performance. Even as the valuations of those tech giants reach historical highs, the appetite for US tech stocks appears to be far from satisfied. Nvidia shares have enjoyed a blistering start to 2024, rising 46% at the time of writing, followed by Meta and Microsoft with 32% and 12% respectively.

Meta, the parent company of social media platform Facebook, comes under the microscope in our Stock Focus article. The company’s share price suffered a significant decline from the highs of 2021 as concerns around declining advertising revenue and huge levels of investment within the reality labs division, which develops technologies like virtual reality headsets, weighed heavy. Fortunes have seemingly turned for the company though, with 2023 labelled a year of efficiency, seeing aggressive cost-cutting measures deployed. The market has reacted favourably, with Meta’s share price rallying from just below the US$100 mark towards US$470 where it currently trades, buoyed further by the recent announcement of a significant buyback program worth nearly US$50bn and a quarterly dividend.

While technology firms are initiating dividends, an important sector within the UK’s transition to net zero is unfortunately experiencing some difficulty paying theirs. The battery storage sector has drawn investor attention in recent years, providing the opportunity to generate attractive levels of income while participating in the growth of renewable energy. The UK has quietly become a world leader in offshore wind, and renewables continue to be an important part of our energy security. But with renewables comes the issue of an intermittent power supply onto the electricity grid. With electricity supply and demand fluctuating, batteries have become an important tool in keeping the two forces at equilibrium, within the national grid. While the importance of battery assets in the long-term is clear, the three listed investment companies focusing on the sector have experienced short-term difficulties. Declining battery revenues have hit the sector hard as electricity prices declined faster than expected, causing dividends to be suspended and share prices to head south.

We finish the edition with insight into one of the benefits of active management, risk control. Passive funds, those replicating a benchmark, have experienced significant growth in recent decades and triggered one of the hottest debates in the industry over whether active is better than passive. With recent momentum in the US, those in the passive camp are likely to be quoting statistics around the percentage of actively managed funds failing to outperform the index. In a momentum market, which we would argue the US is clearly in, how much risk needs to be taken to outperform the benchmark? We explore this question with a current example, hopefully adding credence to the notion that there are more reasons to use active management than just outperformance.
 
Stock Focus: Meta Platforms Inc
Oscar Sheen | Investment Executive

If you asked a hundred investment professionals what the biggest surprise of the last two years has been, you would probably get almost as many answers. Markets can be difficult to predict at the best of times and recent events have thrown more than a couple of spanners in the works. However, I would imagine that the fall and then meteoric rise of Meta Platforms Inc, the company formerly known as Facebook, would be picked by more than one person in this hypothetical survey. Prior to the rebrand in 2021, Facebook was riding high with a share price of US$378.69. Following on from this the company saw its share price drop to a low of US$90.79 in late 2022, a decrease of more than 75%. From this point the share price has surged to a new high of US$477.11 at the time of writing, an increase of over 400%. In this month’s stock focus we examine what lies behind this change in fortunes and what it could mean for the company’s future.

Markets do have a tendency to overexaggerate both good and bad news. If you want a more striking example of this, I will point you towards the recent fanfare surrounding the potential for interest rate cuts this year. At the end of 2023 we saw a disproportionate drop in bond yields as people started to predict more and more interest rate cuts despite central bankers indicating rates were likely to remain high. Following Facebook’s rebranding to Meta, it was potentially a victim of this same effect. It came to be seen as a binary bet on the future of virtual reality and AI (Artificial Intelligence). Concerns about this coupled with the poor press surrounding the Cambridge Analytica scandal, where data from millions of Facebook users was collected without consent and used for political advertising, led to a serious decline in Meta’s share price. At the time, it was all too easy to get swept up in this narrative. However, Instagram and Facebook were still very cash generative, and despite increasing competition in the digital advertising market from the likes of TikTok, Meta’s flagship platforms were still key players in the space. In fact, despite a massive increase in capital expenditure the company still reported positive free cash flow throughout 2022 and 2023. The increased investment undeniably presented a risk, in fact it still does, but the company was still generating a profit, had a war chest of over US$15bn, and boasted one of the largest customer bases in the world. This is all easy to identify in retrospect, but despite all this the fear surrounding the company’s future was palpable at the time.

Fast forward to today and the picture has changed drastically. AI is Wall Steet’s new favourite buzzword, and Meta’s investment in the space has certainly paid dividends. For the first time in its history Meta has announced that it will start paying a 50 cent per share dividend every quarter. At current prices this gives it a yield of around 0.43% and signals that management clearly has confidence in the company’s long-term prospects. AI has given its advertising revenue a real lift by allowing for more targeted, more user-relevant content to be pushed forward to people using its platforms. The future of Meta Founder Mark Zukerberg’s ‘metaverse’ and the potential success of virtual reality over the short to midterm, remains uncertain. That said, the investment in AI certainly appears to have been prudent. Such has been the growth in the market that Meta has actually announced further investment in the area with a particular focus on generative AI and integrating new technology with its metaverse project in order to make it more appealing for investors and customers. All of this has resulted in the company’s share price climbing to new heights, with it now fast approaching US$500.

Ultimately, the effects of AI on both the economy and individuals are difficult to predict. The World Economic Forum has suggested that it will replace some 85 million jobs globally by 2025. While we remain a long way off people being displaced en mass by robots and computer programs, the shift is underway. What this transition means for the regulatory landscape that current industry leaders, such as Meta, will have to operate in is also unclear. On top of this, new technology has been historically difficult for markets to value. If we take the late 1990s and early 2000s as an example, companies such as Qualcomm Inc, which produce a large amount of the hard and software that enables wireless technology, saw its share prices rocket before the infamous dotcom bubble burst and prices came crashing back down. Despite the company consistently succeeding by almost any other metric, it took around 20 years for its share price to recover to the levels first reached in the early 2000s. I am not suggesting that history is repeating itself, companies such as Meta are in a much stronger fundamental position and are already exceptionally cash generative, but this is something we must be aware of when assessing if Meta is worthy of investing our hard-earned cash in. While there is enormous potential here, there are also a lot of unknowns.
 
Insight article: The tech momentum
Greg Lodge | Performance & Risk Analyst

Technology stocks have performed strongly in recent times. Buoyed by investor confidence and the opportunities Artificial Intelligence (AI) may present, the so-called ‘Magnificent Seven’ - Microsoft, Apple, Amazon, Alphabet, Meta, Tesla and Nvidia - accounted for a large portion of market growth last year. As we make headway into 2024, this tech momentum shows little sign of stopping any time soon. With tech stocks dominating the financial news, let us look at why these companies are generating so many gains and headlines.

One star of 2023 that continues to burn brightly is Nvidia, a designer of chips for industries such as robotics, video gaming and car manufacturers. It has now taken a prime spot in the AI space, having provided the hardware behind OpenAI’s ChatGPT. With such hype around generative AI and the extent to which it could change the way we live and work, it has transformed from a company that perhaps most people hadn’t heard of until relatively recently, to being close to becoming the third most valuable tech company in the world, in the realms of Apple and Alphabet. Within just over a year, its share price increased five times over, and has climbed a further 45% within 2024 alone. While Nvidia looks to have taken an early lead in the AI race, there are uncertainties ahead. Some of its biggest customers, Microsoft and Amazon, have been developing chips of their own. It is still early days for generative AI. Where and how it will be adopted, and how profitably, remains to be seen.

Of the Magnificent Seven, it is electric car manufacturer Tesla that has had the roughest ride lately. After doubling its share price in 2023, this year has seen a steep fall after reporting slower revenue growth for the final quarter of 2023. While the company was the first household name in electric cars, it now faces increasing competition. One of its main rivals is Chinese company BYD, which overtook Tesla in electric vehicle (EV) sales last year. A record 1.2m EVs were sold in the US in 2023, which was lower than expected, possibly due to the high initial purchase price at a time of higher interest rates.

It is not only US tech companies that have enjoyed substantial gains recently. While the UK market is fairly light on tech, there have been some home-grown success stories. Chip designer Arm is based in Cambridge but listed on the tech-heavy Nasdaq last September. Similarly, to Nvidia, its chips have seen increasing demand for AI applications, particularly the V9 chip, which is being used by Microsoft and Amazon to power their large language models (predictive machine-learning systems). Initially floated on the exchange with a market capitalisation of US$65bn, it was the largest US listing for almost two years. Shares have increased by almost 50% in February after the company posted revenue of US$824m in the last quarter of 2023, exceeding analyst’s expectations.

With chip manufacturers seeing such prominence in the market currently, how is the rest of the supply chain faring? Perhaps unsurprisingly, pretty well. The Dutch company, ASML, builds the advanced lithography machines used to create microprocessors and has a near-monopoly on this extremely complex and specialised business. Being the only maker of chip machines means the company has had to contend with issues of diplomacy. US policy has sought to limit China’s access to the most advanced chips. China in turn has been getting around these restrictions by buying older machines for making simpler chips and still accounted for 39% of ASML’s fourth quarter sales. The company took record €9.2bn orders last quarter, suggesting that a chip boom could be on the horizon. Consequently, its share price has increased by around 30% so far this year.

The story for iPhone maker, Apple, is very typical of the Magnificent Seven. The company returned to growth at the end of 2023, on the back of strong iPhone sales and its services division, which includes Apple TV. Shares are up by around 28% over the last 12 months and with a market cap of around US$3tn, it remains the world’s most valuable company. To continue a theme that seems almost inescapable now, the company has been investing in its own AI technology. To this end, it has acquired 21 AI start-ups since 2017, far more than its peers Meta and Alphabet. Often protective of its technology, Apple has so far been secretive about its plans for AI. It is expected that more will be revealed at the Worldwide Developers Conference this summer.

As tech stocks continue to surge ahead, the excitement and expectations surrounding generative AI grow too. Are we on the cusp of a tech revolution? No doubt many companies will be considering what AI could do for their business. How long will the tech momentum last? Will working life as we know it be unrecognisable in a few years? Many questions remain, not least for investors.
 
Active Management, Controlling Risk
Konrad Pietka | Investment Research Team Member


The close of 2023 marked the first time that the scale of assets within passively managed funds exceeded those in actively managed funds. Advocates of both passive and active investing continue to argue passionately about the subject, with performance often the focal point. In this article, we explore one of the often-missed positives of active management, the ability to better control risk.

What is the difference between active and passive managed funds?
Actively managed funds are those in which a fund manager or team of fund managers invest the fund’s assets to meet a stated performance objective. This objective can vary, from growing the client’s capital to generating a required level of income. One thing that does remain constant however, is the desire for the fund manager to outperform their fund’s stated benchmark. A passive fund on the other hand, aims to replicate a specific benchmark and provide performance as close as possible to the benchmarks with minimal deviation.
Investors in an active fund will generally believe in the ability of fund managers to outperform their benchmark and generate excess returns over time, while passive fund investors are seeking the benchmark return and in doing so removing both the potential for outperformance and underperformance from an active manager.

The great debate: active vs passive
The merits of active versus passive investing continue to be fiercely debated. The most frequently cited evidence against active management is the proportion of active funds underperforming their benchmarks. The point of this article isn’t to answer, or even reflect on this debate, but to explore a fundamental positive for active management, risk control.

Why is risk control key?
Risk control is a key issue in investing, understanding the risks being carried and their magnitude are fundamental to portfolio management. To explain risk control, we’ll use the magnified example of an extremely popular UK-listed investment fund, Polar Capital Technology Trust (PCT). The fund invests in a portfolio of technology companies globally, historically producing attractive returns for shareholders. At the end of December, the 10-year return for holding PCT shares was 427.44%. The fund’s benchmark, the Dow Jones Global Technology Index, however, returned 531.34%.  Underperformance in this case is notable and may lead to some questioning the use of a higher fee active fund over a low-cost passive fund.

We recommend looking deeper and asking some key questions such as what is the fund invested in? What is the make-up of the index? At the end of December, PCT’s top two positions were Microsoft and Apple at weights of 10.3% and 8.3% respectively. The benchmark index also shows these two companies as top constituents, but with weights of 16% each. We would expect investors to be nervous seeing an index with such high weightings to few names. It also raises the question of how big the fund’s holdings in these two companies might need to be to outperform the index, positions potentially closer to the 20% mark, would almost certainly cause concern.

So how is risk being controlled here? 
The simple answer lies in the prevention of over exposure. If constituents holding weighty positions in the index begin to falter, then risk is magnified and performance decline is much sharper than potentially may occur within the actively managed fund, hence protecting some capital. The second benefit of active management in this case is the ability to liquidate a position quickly, removing exposure to a company experiencing stress, something the index cannot do given its composition is dictated by a defined mathematical methodology.
During periods of momentum in financial markets, risk control can be perceived to reduce in importance as investors chase participation in returns. Nowhere was this potentially harder hitting than in the bond market in recent years. Some of the strategies posting the best returns in a low return world were running significant amounts of risk in doing so, leading to material underperformance against peers when markets declined at the onset of inflation and interest rate hikes in 2022.

In conclusion
The active vs passive debate shows no signs of slowing down and with recent momentum in equity markets, notably the US, the scale of passive funds overtaking their active counterparts would suggest that voting is in favour of passive. While relative performance is important, risk management remains crucial for continued compounding of returns and loss prevention.
 
Battery Storage – A short-term wobble?
Samantha Cory | Investment Research Team

The UK’s transition to clean energy has been underway for some time, with Government net zero pledges and new energy security strategies released in recent years. Once a country where energy independence was driven by the thriving coal and North Sea oil and gas industries, the UK has quietly transitioned into one of the global leaders in offshore wind power. One issue arises with a focus on renewable energy sources however: their intermittency. As we all know, the wind doesn’t always blow and the sun isn’t always shining, making their energy supply to the national grid volatile.

A transition to renewable energy generation leads to further reliance on another technology, battery storage. The intermittent nature of renewables means the national grid is at risk of having either too much or too little electricity. The importance of battery storage lays in the balancing of electricity by either storing excess electricity supply or releasing electricity into the grid during periods of high demand.

The importance of this technology has been continually highlighted and its status noted with the November 2023 release of the Government’s UK Battery Strategy, within which the vision for the UK having a globally competitive battery supply chain by 2030 was outlined. Significant Government investment is earmarked, but corporates have also been directing money into the space. 

Three notable active participants in the battery storage sector come from the UK-listed investment companies’ space: Gore Street Energy Storage, Gresham House Energy Storage and Harmony Energy Income Trust. All three are still in the build-out phase of their portfolios, with their operational capacities set to double in 2024 based on the projected completion of assets currently under construction. While these companies operate in a growth industry and provide much required services, their share prices have been disappointing of late, with all three down between 20% and 30% since the start of the year, following a challenging 2023. 

At the core of the issues faced is lower than expected power prices and a faster than expected decline in battery revenues. Modo Energy, a provider of battery revenue benchmarks, highlights the fall in revenues for one-hour battery assets from a peak of £265,000 per mega-watt per year in June 2022 to just £19,400 in January of this year. Declining revenues have led to some concerns around cash generation and dividend coverage for the three investment companies, leading to both Gresham House Energy Storage and Harmony Energy Income Trust suspending dividends in recent trading updates. The board of directors for the more internationally focused, Gore Street Energy Storage, on the other hand reaffirmed the intention to pay out a dividend.

Alongside declining battery revenues lays the issue of skipping, where assets or technology types are skipped in the balancing mechanism, the activity the national grid undertakes to align supply and demand levels. It operates on an auction basis, with bids and offers taken for different durations of capacity required. In theory, if the bid or offer is cheaper than the most expensive action, then it should be taken. Modo Energy highlights the skipping issue with only a small amount of battery capacity being accepted, despite being cheaper than the most expensive action. Clearly, if assets are being skipped despite viable bids and offers, then revenues are impeded, potentially magnifying the issue of declining battery revenues.

While disconcerting for some investors in the short-term, discussion remains focused on the longer-term outlook for these assets. In December, the national grid launched a new Open Balancing Platform aimed at increasing the actions taken with smaller battery storage sites while speeding up the balancing process and reducing costs. While early days, the outlook is positive but dependent on how the new platform is used by the national grid. It may take some time to see the effect of the change on battery revenues. Aside from the new platform, the pipeline of new operational assets coming online remains a significant positive for companies focusing on battery technology. For those funds with large volumes of assets under construction, increasing the operational proportion of the portfolio should result in greater cash generation and a more stable dividend, potentially calming income focused investors who have been drawn to the sector.

If there is one issue common in the renewable energy and battery storage sectors, it is timely grid connection of completed projects. Bottlenecks in the connection line are frustrating for portfolio buildouts but beneficial for portfolios with a large proportion of operational assets. Throw into the mix the significant share price discounts to net asset values these funds currently trade at, and takeover bids become a reality for other entrants to the market looking for a ready-to-go portfolio.

The battery storage sector is a highly technical area and one which has seen disappointing share price performance for the three vehicles at private investors’ disposal. The future can be considered bright for the technology and it is clearly important for the net zero transition, but whether it turns out to be an area of the market where returns are reaped remains to be seen.

 
Redmayne Bentley Publications Podcast February 2024

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