TM Cerno Global Leaders2020-04-21T16:07:14+00:00

TM Cerno Global Leaders

TM Cerno Global Leaders Fund Information

The best prospect for outperforming the World Equity Index is to invest long term, in a concentrated, high conviction and low fee portfolio and transact only when necessary.

TM Cerno Global Leaders invests in global companies with sustainable competitive advantages delivering above average returns. Its target is to deliver performance in excess of MSCI World Total Return (GBP) on a 3 year rolling basis.

The fund will  hold 25-30 securities, equally weighted, selected according to a distinct investment thesis that accents industry structure, the sustenance of return on capital and secular growth.

For more information on TM Cerno Global Leaders please contact Tom Milnes.

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TM Cerno Global Leaders Fund Manager

James Spence
James SpenceLead Fund Manager
James is a co-founder of Cerno Capital and lead manages a number of the firm’s collective and private portfolios. After qualifying as a chartered accountant in London (Coopers & Lybrand, 1989) he relocated to Asia. Between 1991 and 2004 he worked as an equity analyst, head of research, and latterly as an equity strategist at WI Carr, Paribas, HSBC and UBS, based variously in Hong Kong, Singapore and Jakarta. James graduated from the University of St Andrews, Scotland with an MA in Philosophy & Logic in 1986. James is a Member of the Chartered Institute for Securities & Investment.

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Latest Investment Letter by James Spence

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 about what might loom over the horizon. The phrase “late cycle” is suggestive of cyclical conclusion and it is therefore sensible to imagine what broad factors could trace the cycle’s end. Bull markets in shares are propelled by two things: rising aggregate corporate earnings and/or rising valuations. An intuitive perception of this cycle might be that we have enjoyed both – with valuations more consequential than earnings. But is this true?

Earnings per share in the US have risen by 6.1% per annum compound since 2008; this eclipses earnings growth of 5.6% per annum recorded during the halcyon days of expansion between the end of WWII and the market top in 1962. Whatever you might think of modern US capitalism, it has delivered the manna – in the form of earnings growth – that equity markets need to feed upon.

The current price to earnings (PE) multiple of the S&P500 is 18.1x, exactly the same PE as prevailed in June 2009, suggesting that valuation multiples have not expanded at all in this cycle, somewhat counter to the general thought that the equity market has become more expensive.

17 of the 40 equity markets that MSCI provide index data on world-wide have lower PE ratios than prevailed in 2009 (23 higher, by extension) and the median multiple current stands at 14.1x versus 13.0x in 2009.

As we know from past cycles, the fodder of bear markets is more often a fall in earnings which then exposes the valuation top. Valuations are seldom, if ever, the solitary marker. The TMT bust in 2000 is commonly regarded as a valuation top but broad market (S&P500) index earnings fell by 35% between the 3rd quarter of 2000 and the 4th quarter of 2001(-68% if extraordinary accounting items (losses) are augmented into reported earnings).

The question then becomes, what confluence of factors could generate a fall in earnings? If the epicentre of the last cycle end of 2007-2008 was personal finance vis the US housing market where valuations became high as affordability fell and leverage increased, we suggest that the key area of attention in this cycle is corporate leverage.

A distinguishing feature of this cycle has been rising corporate leverage, especially in the US. It is easy to see why. One of the attendant effects of Quantitative Easing has been to depress bond yields, the cost of debt and thereby reduce the corporate cost of capital. This has incentivised CFOs to take on more debt to boost Return on Equity. As more corporate pay packages become driven by Earnings Per Share (EPS) growth, the easiest way to goose growth in these variables is to take on debt. The Private Equity sector, which has been very high on the hog in recent years, provides further impetus to this by their model activity, typically via streamlining and gearing.

134 of the 398 non-financial companies in the S&P500 have net debt to equity or gearing ratios of in excess of 1:1, a rough measure of overextension. This is one third of the universe of the world’s most successful economy and up 13 percentage points the comparable universe 12 years ago.

The modern argot for estimating the burden of corporate debt on a company-by-company basis has shifted to Debt/EBITDA from pure balance sheet measures – which moves judgements from absolute measure of jeopardy to an affordability-based measure. This is an absolute to relative shift which can often lead to problems down the line.

It is also pertinent to note that private debt in the world runs at 4x public debt. It is convenient to point the finger at governments and central banks for the world’s travails but it is personal and corporate choices that are providing the conditions precedent for the next upset.

If Collaterised Debt Obligations written on willingly mislabelled baskets of mortgages were the truly stinky thing in the last cycle, the Dividend Recap could be this cycle’s nefarious worst practice. Divi Recaps typically taken place when a Private Equity firm takes control of a mature business in a mature sector. The new controllers then look to defray the cash flow cost of the buy-out by leveraging the balance sheet to pay themselves a dividend. This creates a floor for their investment. Even if the business ultimately fails, the new-owners’ downside is capped. Corporate Codes do not often result in owners being retroactively punished for imprudent stewardship. This moral and judicial failing is tacitly justified on account of the need to promote risk taking as the necessary lifeblood of the capitalistic system. Warren Buffet and Charlie Munger rail against this type of activity. Despite their fame, they can only truly influence companies under their control.

With these observations in mind, a rise in the cost of debt would be a very unwelcome shudder on the rudder. This does not seem likely and we have probably reached the cycle top in US interest rates. Whilst the Federal Reserve has yet to become demonstrably dovish in its comments, markets now expect two cuts in base rates this year. If the developed world faces a low growth, low inflation low interest rate future then the world is turning Japanese: a reference to conditions that have prevailed in Japan since its last big cycle top of 1989. This is not all bad but points to fluky markets: bonds flat on their backs and going nowhere and equities operating in big ranges but struggling to hitch onto an upward channel.

Another development to contemplate is the coming “techno-rift” between the US standard and the Chinese standard. Whilst the banning of Huawei is the sharp point of Trump’s government agencies’ attacks and he conflates this as more of a trade war than an intellectual property issue, the anti-Chinese approach is a winner in America and links the aisle in terms of Republican and Democrat. There are two likely consequences of this: firstly that market-by-market, companies and agencies will have to choose whether to take US technology as their standard or Chinese. These decisions will be fraught with geopolitical pressures but may ultimately help secure China’s pre-eminence provided it can achieve sufficient competency in a large enough array of areas. This will be a 20 year war and therefore well beyond the twin terms of President Trump and at the far end of Xi Jingping’s possible influence.

The second set of consequences relate more to manufacturing and here we are seeing more relocation decisions, often that have been delayed, to move contracting out of China. On-shoring is on the up and reallocation within Asia is rising. Other countries could have their moment in the sun: Vietnam is a clear beneficiary and both India and Indonesia have chances to prosper from these shifts.

There is a great deal of concern about what is termed “reverse globalisation” or “deglobalisation”. These concerns may be overblown. In the 21st Century, The President of the United States operates by the grace of US companies, like it or not. The shorthand way of understanding this is to look at the level of the S&P500 index. Decisions that negatively impact corporate America tend not to linger on the vine. Policy reversals are more the norm and this is part of the current construct. Re-allocation of manufacturing and supply chains around the globe are just part of pragmatic decision making and not the end of anything.

The big exception to this line of thought must surely be with respect to the planet and the environment where part of the necessary action must be lessening: less CO2, less plastic, less carbon. Less people, frankly. This is a difficult matter in a world that operates on a growth paradigm and one that is dividing the generations.

By |June 19th, 2019|

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TM Cerno Global Leaders Key Contacts

Tom Milnes
Tom Milnes

Business Development Director
[email protected]
020 7036 4126

Olivia Martin
Olivia Martin

Client Relations and Business Development
[email protected]
020 7036 4123

FAQs on the Cerno Global Leaders Fund

In 2017, Royal Philips, the Dutch company known for its lightbulbs and electric shavers, was reclassified into the Healthcare sector from Industrials, having undertaken a multi-year corporate transition to shift its portfolio from electronic goods to providing more personal and professional healthcare solutions.

Once the largest European consumer electronics conglomerate, Philips was famous for its industrial and fundamental research, pioneering cutting-edge products from compact cassette recorders in the 1960s to integrated circuits and transistor technology in the 2000s. Many companies today share their roots with Philips, including the leading semiconductor equipment makers ASML and NXP; and Universal Studios, whose previous life as PolyGram (founded by Philips), was the largest global entertainment label in the 1970s.

Despite being an innovation powerhouse, Philips made the classic conglomerate mistake of losing strategic focus owing to overdiversification, bloating its empire with unconnected low margin businesses. At its peak in the 1980s, Philips operated 13 major divisions and over 120 businesses across electronics, appliances, medical systems, entertainment, lighting, components and semiconductors, employing a massive workforce of 380,000 people. The indigestion was felt keenly when the company almost went into bankruptcy in the early 1990s. Its television tubes and lighting business was at risk of commoditisation from Korean and Japanese rivals, its chain of video stores were bleeding cash, and their foray into mobile phones was disastrously loss-making. On top, Philips as a company was mired in bureaucracy.

Turning around a supertanker was no easy feat. It took three CEOs over 20 years to restructure the company into its present slimmed down form. Mr. Boonstra’s arrival in 1996 set in motion a series of divestitures to weed out non-core activities, selling over 40 businesses, including Grundig televisions and music label PolyGram, shrinking the number of divisions down to five. His successor Mr. Kleisterlee continued this trajectory, spinning out its crown jewel semiconductor division, which, at one point was the single biggest contributor to group earnings. He also proposed belt-tightening initiatives to reduce overheads via outsourcing and improving efficiency by encouraging cross divisional collaborations.

Current CEO Mr. Frans van Houten, who joined in 2011, has gained a reputation for driving hard decisions. He established the long-term strategic direction of Philips to focus on healthcare technology, shedding the remaining television and entertainment businesses, and separately listing its lighting business, in which Philips still owns a residual 15% stake. This represents the last vestige of the lightbulbs business that traces back to the origin of Philips in 1891, with the aim to sell down the full position within the next two years (already sold down from 30%). Further, to increase profitability in line with competitors, he has pledged a target to increase group margins by 100 basis points per year with the proposed closure of 20 factories worldwide and to optimise the remaining 30 for higher productivity.

Today, Philips is a much more streamlined company with three outstanding divisions: Diagnostics & Treatment, Connected Care & Health Informatics, and Personal Health. Healthcare now represents over 60% of total group revenues, with offerings spanning large medical devices including MRI scanners, X-ray and ultrasound machines, where Philips competes primarily with Siemens Healthineers and GE Healthcare with mid-teens market share. It is also a leader in surgical tools for image-guided therapy (>40% share) such as cathlabs and smart catheters, and sleep & respiratory care devices to treat people suffering from difficulty breathing (high margin duopoly with 45% global market share). The rest is represented by the Personal Health segment, selling consumer products and small domestic appliances, such as electric shavers and powered toothbrushes (under the Sonicare brand), where Philips is a global leader with 45% and 30% market share, respectively.

Philips Azurion: Next Generation Image-guided Platform

The company is also striving to become a ‘solutions’ provider with a more entrenched position in chronic care, an area of increasing importance as the global population faces an ageing epidemic. With 60% of their R&D personnel working on data analytics, Philips is stitching together service and software with hardware sales to provide a more comprehensive offering to both patients and surgeons. By enabling connectivity and data analytics, it facilitates real-time patient monitoring and superior decision-support to the surgeons, helping to improve diagnostic accuracy and drive down the cost of care by keeping patients out of hospitals. This move aims to drive greater recurring revenues, which Philips expects could eventually become 35% of group sales.

Philips is the fifth healthcare addition to our Global Leaders portfolio. Armed with a more appealing corporate profile and clearer future vision, the company is on track to deliver 4-6% growth and margin expansion beyond 2020. It has a proven track record of innovation, and is able to leverage its 65,000 strong patent portfolio, bridging insights from its unique exposures to both consumer and professional healthcare markets. Its competitive position in the diagnostic & imaging market is characterised by a large installed base and high switching costs, and in the consumer segment it enjoys strong branding, where it plays in the higher-end markets with less competitive pressures and higher recurrent revenues (replacement blades and brush heads). While there is still much work to be done as the reshuffle close in on its final phase, we believe Philips will be able to execute their digital strategy and morph into a tech-enabled healthcare company that can stay embedded and relevant for the long-term.

Fund Facts

Fund Size £69.7mn
Fund Launch Date 01/11/17
Legal Structure UK OEIC (UCITS)
Dealing Frequency Daily
Suitable for SIPPs/ISAs/JISAs Yes

Available Share Classes

Name Class A Class B
Cerno Capital AMC 0.65% 0.55%
Investment Minimums £5,000 £10mn

Risk Data

Net Equity Exposure*
Gross Equity Exposure*
Short Equity Exposure*
Long Equity Exposure*
Best Month*
Worst Month*
Sharpe Ratio
Calmar Ratio
Upside Capture*
Downside Capture*
Maximum Drawdown*
Annualised Volatility*
Beta (vs World Equity Index)*

Fund Codes

ISIN SEDOL Bloomberg
A Acc GB00BF00QK62 BF00QK6 TMCGLAA LN
A Inc GB00BF00QJ57 BF00QJ5 TMCGLAI LN
B Acc GB00BF00QM86 BF00QM8 TMCGLBA LN
B Inc GB00BF00QL79 BF00QL7 TMCGLBI LN

Fund & Risk Rating

ARC 2015 3D Awarded

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