General Investment

Range by David Epstein – Cerno Capital Book of the Year 2019

By |2019-07-18T10:40:39+00:00July 17th, 2019|Cerno Capital Posts, Cerno Global Leaders, General Investment|

We have been reading the newly published book, Range, by David Epstein. The central argument of the book is a refutation of a well circulated theory that expertise in most fields can be attained by 10,000 hours of dedicated practice. This original theory is grounded in a 1993 paper co-authored by Anders Ericsson entitled The Role of Deliberate Practice in the Acquisition of Expert Performance1. Anders and his colleagues enjoyed considerable take-up of their core thesis with books on the subject authored by Malcolm Gladwell, Geoff Colvin and Daniel Coyle2. These books occupy a burgeoning section of non-fiction where sports meets self-improvement and cognitive science. Epstein opens the book by comparing Roger Federer to Tiger Woods. Woods might be considered an exemplar of the 10,000 hour rule – intensely coached by his father and associates from a very young age to become the second most successful golfer in the modern history of the game . Federer, by contrast, despite being the son of a tennis coach (mother in his case), was allowed to play all forms of ball sports into his teens and made the decision himself to begin to specialise in tennis, a full 10 years later than Tiger [...]

Investment Letter dated 19th June 2019

By |2019-06-19T16:21:40+00:00June 19th, 2019|Cerno Capital, General Investment, Investment Letters|

The approaching half year mark is a good time to gauge the health of world financial markets. 2019 has been better than 2018. World equities fell -7.4% in 2018 in local currency terms and have risen +15.9% YTD in 2019. World Bonds (in aggregate, using the JP Morgan composite) fell 1.0% in 2018 but have returned +4.7% so far this year (data to 18th June). It therefore appears that 2018 was a pause for consolidation, permitting the full-bore late cycle rally that has since transpired. If we have enjoyed rising bond and equity prices in this most recent period, how rare of an event is this? Looking back over the last 35 years to 1984, we observe that, in 26 of those heady years bonds and equities have risen in tandem. There have been no years in which they both fell, six years in which equities fell and bonds rose, the rarest instance being the three years in which equities have risen and bonds have fallen, the last one of these being 2013. We can see, at a glance, why balanced investment (a non-determinate mixture of bonds and equities) has been such a hoot. There is considerable and understandable anxiety [...]

BB Healthcare – being part of the solution

By |2019-06-05T10:38:15+00:00June 4th, 2019|Asset Allocation, Cerno Capital, Cerno Capital Posts, General Investment, Manager Selection, Strategy|

Healthcare offers a fertile hunting ground for investors with horizons beyond that of most market participants. In the search for companies capable of compounding earnings over long periods the unique secular demand underpinning the sector is a useful tailwind. Within Cerno clients’ portfolios we own companies in orthopaedics (Zimmer Biomet), pharma & technology (Johnson & Johnson and Waters) and post-operative care (Coloplast). 5 of the 27 stocks within our Global Leaders strategy are bracketed healthcare stocks with many more feeding their products and services into the supply chain. Newer, disruptive technologies are also represented in the Baillie Gifford Global Discovery Fund where healthcare represents 35-40%. Nevertheless, it is our observation that our investment footprint risks lagging the expanding opportunity set. As we set out in a recent missive, The New Ways, affordability is becoming an increasingly intransigent, and central issue for the effective delivery of healthcare. In the US healthcare spend is a colossal US$3.3tn, expanding at twice the rate of inflation. Traditional pharma has few tools in its locker to resolve the problem. The answer instead lies in a broad church of business, from medical technology (MedTech), to managed care, to healthcare IT. Technology often lies at the heart [...]

Renishaw Negotiates a Soft-Patch

By |2019-05-29T13:32:21+00:00May 29th, 2019|Cerno Capital, Cerno Capital Posts, Cerno Global Leaders, General Investment, Other Posts|

Renishaw, a UK engineering company held in the Global Leaders portfolio, held its annual Capital Markets Day on the 14th May in their Gloucestershire Innovation Centre, showcasing a selection of their machines. The company sells high precision measuring, gauging and calibration equipment to the high-end industrial and manufacturing sectors, enabling their customers to optimise processes and output, significantly reducing time and cost of production. Metrology has been core to Renishaw’s business since the founding of the company in 1973, when the original touch-trigger probe was invented by Sir David McMurtry, to test the integrity of finished aerospace components. Traditionally, finished parts are inspected at the end of the production line, if a defect is found, the entire batch is likely to be scrapped. For expensive components such as jet engine blades that cost northward of £250,000 a piece, this can become a costly undertaking. Exhibit: Renishaw Equator Gauging system next to a Fanuc Robodrill Source: Renishaw Renishaw’s value proposition to their customers is to integrate product inspection into the manufacturing process, tracking errors in real-time. Their probes and gauging systems are often found sitting alongside manufacturer’s machines on the factory floor. For instance, their flexible 5-axis probe (shown above), takes [...]

Nestlé – provenance and packaging

By |2019-05-21T09:59:38+00:00May 21st, 2019|Cerno Capital, Cerno Capital Posts, Cerno Global Leaders, General Investment, Global Leaders|

As the largest food and beverage company in the world, Nestlé leaves a significant footprint on the markets it touches. While Nestlé is not a primary producer, it maintains close links with agriculture to establish provenance and guard against reputational risk associated with poorly chosen inputs. While its products are mostly consumed, the packaging used to deliver product is a material consideration – Nestlé is concerned both with the source materials of packaging and its disposal after use. The investment that Nestlé makes in both packaging technology and ingredient sourcing is a competitive advantage that allows it to maintain Global Leader status. Rather than simply observing the practices used by agriculture, Nestlé is an active participant in the development of new practices that improve productivity, crop quality and environmental practices. Nestlé achieves this via its network of Plant Science R&D centres and directly employed agronomists. Each year, the company processes 10% of the coffee and cocoa produced globally. For an example of a practical initiative we can look to Jardin in the Colombian Andes where Nestlé sources high quality coffee beans for Nespresso capsules. Traditional processing of coffee cherries involves on-farm fermentation to remove the outer shell with the waste [...]

ASML – pre-eminent in photolithography

By |2019-05-14T08:47:54+00:00May 14th, 2019|Cerno Capital, Cerno Capital Posts, Developed Equities, General Investment, Global Leaders|

ASML is the dominant supplier of photolithography tools for semiconductor manufacturers. Photolithography is the process of printing with light. In semiconductors it is the process whereby a light source is used to expose circuit patterns onto a wafer via a photomask. Photolithography has played a pivotal role in the evolution of semiconductors. It was Robert Noyce (future co-founder of Intel) at Fairchild Semiconductors in 1960 who saw the potential of the process to enable the printing of electronic circuits on flat, silicon wafers. This vision gave birth to the first integrated circuit and catalysed the race to ever smaller geometries in chip design. As transistor scale approaches the atomic level, the next limiting factor for the continuation of Moore’s Law1 is the wavelength of light. The shorter the wavelength, the smaller the scale in which a circuit can be printed. A radical reengineering of the lithography process is required. For the last 20 years ASML has been working on just such a radical solution. EUV or Extreme Ultraviolet lithography drops the wavelength of light from 193nm to 13.5nm enabling the extension of Moore’s Law through 2025. The payoff for this commitment of capital, and shouldering of risk, is 100% market [...]

Global Healthcare – The New Ways

By |2019-02-15T16:08:03+00:00February 15th, 2019|Asset Allocation, Cerno Capital, Cerno Capital Posts, General Investment|

Nothing is certain but death and taxes. To this Benjamin Franklin might have reasonably addended ‘but people’s desire to avoid both should not be underestimated’. Putting aside the morality of the latter the desire to maximise one’s health speaks to us all. It is this desire which has helped the healthcare sector to deliver enviable multi-year returns. Globally the sector has generated a total return of 9% p.a. since 2005, outperforming the broader market by over 2% p.a. Source: Bloomberg, world = developed markets But fortunes have not been evenly distributed. Beneath the surface the drivers of growth are shifting. Since the late ‘80s cash earnings for the broad healthcare space have exhibited a rising trend against the market, illustrating the unique secular demand underpinning the sector. However, the beneficiaries of this demand have rotated. Large cap pharma, often a heuristic for the sector, continues to dominate the market cap spectrum, but better growth is to be found elsewhere. This is reflected in starkly contrasting stock performance. Despite representing some 50% of the whole, pharma gained only 46% since 2012 (a CAGR of 6%) against the sector up 112% (CAGR: 13%). Distributable Cash Earnings - US Healthcare vs S&P 500, [...]

Investment Letter dated 6th February 2019

By |2019-02-06T11:38:44+00:00February 6th, 2019|Cerno Capital, General Investment, Investment Letters, Other Posts|

The MSCI EAFE Index is an index of performance of world shares, ex US. EAFE stands for Europe, Australasia, Far East. This index is often used as a benchmark for US pension fund allocators whose traditional view of the world is divided by US allocations and International allocations. EAFE Equity mandates are granted to invest in shares anywhere in the world, excluding the US. Performance is measured against the MSCI EAFE Index. US$2.2tn is managed this way. The reason for displaying this is to understand the trend in global equity markets, outside the US. The Index, captioned below by the blue line, achieved a recent peak on the 25th of January 2018 and has fallen 16.7% from that peak until the time of writing. The wider All Country ex US (the green line which includes Emerging Markets) peaked on the same day and has fallen 16.3% since then. This data includes the January rally. In simple terms, the world, ex US, has marginally escaped the bear market territory (defined as a 20% fall in an index) which it entered on 17th December. The bigger picture is that the world is slowing, although not abruptly and not currently in the US. [...]

World Monetary Conditions – What Temperature is the Porridge?

By |2019-02-05T15:16:14+00:00February 5th, 2019|Cerno Capital, Cerno Capital Posts, General Investment|

If we cast our minds back to this time a year ago (or even 6 months ago), the common consensus was 2019 was going to be a period of tightening financial conditions. US unemployment was nudging below 4% and wage growth was finally perking up. The S&P 500 was on track for its best start in 30 years. The Fed appeared to be ahead of the pack in actively tightening rates and the ECB was making noises about stabilising QE and raising rates for the first time after the summer of 2019. Fast forward to the ructions of Q4 2018 and central banks seem terrified they have pushed too far too fast. The FOMC meeting in December turned the month from a correction into a rout with Governor Powell’s somewhat headstrong communique on rate increases and autopilot balance sheet runoff. In contrast the latest Fed minutes (only a month later) were as close to total capitulation as the Fed could reach without risking credibility in the markets’ eyes. In his comments, Powell made concessions on the rate path, number of hikes and most importantly on the balance sheet run off. On the other side of the Pacific, China’s Central Bank, [...]

What does credit default pricing tell us about the cycle?

By |2018-11-23T12:55:49+00:00November 23rd, 2018|Cerno Capital, Cerno Capital Posts, Credit, General Investment|

Credit risk is the risk that companies do not repay their debts. This risk can be measured and traded. CDX IG is an index comprising the 125 most liquid single name Credit Default Swaps (CDS) in the investment grade space in the US. The most commonly traded tenor point is 5 years and the index is refreshed by the provider every 6 months to maintain maturity and liquidity profile of the underlying names. We are currently on series 31 (meaning the index has been running in one form or another since 2002-2003). The index is quoted in terms of basis points and a quote represents the annual cost of insuring a notional amount of the underlying assets (as a simple approximation). For example; with CDX IG NA currently trading at 78bps (0.78%) an investor paying to insure US$10mn for 5 years would pay US$78,000 annually. In return for this insurance premium they would be made whole (minus the recovery rate) in the event of any defaults during the period, proportionate to the size of the constituent. On the flip side, the seller of such a contract would receive US$78,000 annually whilst being on the hook for the above obligations. These [...]