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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello, and welcome to On the Money, a weekly look how to get the best out of your savings and investments. So this is our last episode before we take a short two week summer break, and we'll be returning on Thursday, September 4. In this episode, I've interviewed James Thomson, who has been the lead full manager of the Rathbone Global Opportunities Fund since 02/2003. A portion of the fund is devoted to less economically sensitive and recession resistant stocks, which is the focus of this week's podcast episode. In the interview, James runs through the qualities he likes to see in what he calls weatherproof holdings.
Kyle Caldwell:He also names some stock examples. The interview took place towards the July, so let's now get to it. So, James, you have for a very long time ensured that the Rathbone Global Opportunities Fund has around 20% of its holdings in what you call weatherproof stocks. Could you firstly explain when you first decided to put this defensive buffer in place? And then could you define what a weatherproof holding is to you?
James Thomson:Well, after the great financial crisis of two thousand and eight, the fund performed very poorly as many did, but I felt I needed to learn from the episode and get better as a fund manager. While the fund was diversified by country, sector, and size, I think it was clear that it was just too adrenaline filled with economically sensitive stocks that traded as a group during the crisis. During market dislocations, investors tend to punish companies with the greatest earnings sensitivity to the economic cycle. For example, retailers with discretionary sales, advertising businesses, industrial order driven businesses, or tech companies where the high multiple makes them more sensitive to even small changes in demand. Weatherproof holdings have less of a link to economic growth, demand for their products and services that is less correlated to GDP growth.
James Thomson:This is the defensive part of the portfolio, usually about 20 to 25% of the fund. It tends to be a drag on overall performance during bull markets, but also provides a buffer during bear markets or a sudden crisis. So I think we what we've done is we've effectively clipped the tops and the tails, but that should provide a steadier ride in a world of inconsistent returns.
Kyle Caldwell:And could you talk through the types of qualities that companies need to have in order to be in charge of their own destiny in being less economically sensitive?
James Thomson:Yeah. Lower economic sensitivity, staple like demand, and recession resistant products or services, where demand is a need rather than a want or nice to have. Some obvious examples would be pharma, non elective health care, groceries, utilities, tobacco. Interestingly, it's not just low valuation that makes a weatherproof stock. Cheap doesn't mean safe, and the idea that the low valuation implies a margin of safety is a mirage.
James Thomson:For example, commodity stocks often trade on low valuations. That's because the revenue and earnings streams are volatile and closely linked to economic growth or unpredictable commodity prices. So they definitely wouldn't count as weatherproof. We want well managed, high quality, resilient, low variable, revenue variability businesses. But they still have to have the hunger to innovate and improve, even if the growth rate pales compared to some of my more racy growth stocks in the rest of the portfolio.
Kyle Caldwell:So you've highlighted the key ingredients that you look for in a weatherproof stock, and you've also highlighted some sectors that fit in to the weatherproof stocks and those that also don't fit in. Could you highlight some examples of holdings that you own today? I'd also be really interested to find out which weatherproof holding you've had the longest in the funds, and also which stock has been the newest name for this part of the portfolio. Well, even
James Thomson:in this part of the portfolio, we're trying to find weatherproof companies that are flying under the radar. It's obvious that a utility or a consumer staple is a defensive stock, but maybe we can be a bit more imaginative and not only win during market meltdowns, we also wanna participate in all market environments. Holdings in this part of the portfolio have changed too over the years, but the longest standing holding has been there since 2014. Rollins is an American pest control business, not obviously a defensive business, especially in the British climate, but in the hot sticky Southern United States, pest control is considered an essential service, the fourth emergency service. And it's not a service that's moving DIY.
James Thomson:Most of us don't wanna do a little pest control in the evenings. It's not a cathartic and soothing like gardening. But most importantly, it's not cyclical. Good economy, bad economy, the bugs just don't care. The newest name in this part of the portfolio is another one that might surprise you.
James Thomson:It's a US auto parts company called O'Reilly. Officially, it's designated a consumer discretionary stock, but in reality, 80% of demand is needs based. Most demand for car repair is mandatory, and that's a very resilient order flow type business. And this is one of the rare retailers that benefits from tariffs because of its slow turning inventory. Auto parts stores have to carry a lot of inventory on behalf of their customers as availability is key.
James Thomson:All of that inventory was purchased pre tariff. Tariffs come in, prices increase across the board, and they get a margin uplift from the pre tariff cost of goods sold. In a tricky economy, consumers hold on to their vehicles for longer. There are 280,000,000 cars on the road in The US alone that are getting older and need repair. EVs are just 1% of the mix, and even Amazon can't move fast enough to get car parts to mechanics and garages within hours.
James Thomson:From a single store in 1957, now with over 6,000, that will get us firing on all cylinders.
Kyle Caldwell:As you outlined earlier, this weatherproof part of the portfolio acts as a defensive buffer when stock markets become more volatile. Of course, earlier this year, we did see stock markets become more volatile in response to uncertainty over US president Donald Trump's tariff policies. So how did these weatherproof stocks hold up during that period?
James Thomson:Exactly as advertised. The market was down almost 5% in q one around the the Trump tariffs and Doge, but the weatherproof names were up or flat over the period. And that meant my fund was only down half as much as the average. So the weatherproofing is there to provide some protection, not total protection, but smooth the ride. Our top performers during that period were Rollins, a US and German telco operator that'll card a decade of double digit profit growth, and a US garbage collection business.
James Thomson:In The US, you pay directly for your bins to be emptied. So I'd I'd love to talk to you about the solid waste industry, recycling commodity prices, landfill, pricing that doesn't change whether your bin is full or three quarters full, but now is probably not the time. It is one of the most recession resistant industries as most homes or businesses rarely cancel their garbage collection.
Kyle Caldwell:And during that period in which there was a notable pickup in stock market volatility, how did you approach the rest of the portfolio, the 75 to 80%? Did you use that as an opportunity to top up existing positions and potentially introduce some new names as both share prices and valuations fell in tandem?
James Thomson:But when you're in the middle of a stock market correction triggered by some unprecedented and economically destructive events, it's hard to see when the off ramp will come. The primary cause of the stock market volatility was, as you say, the Trump tariffs that were escalating, inflationary, mutually destructive. Recession odds increased to about 50% in April, and bearish investor sentiment hit the third highest of all time. But markets turn when the primary issue that the market is worried about stops getting worse. It doesn't even get better.
James Thomson:It just stops getting worse. And I think that point was April 8 when Trump stopped jawboning tariff escalation and showed some sensitivity to rates and equity markets. But these points are pretty difficult to identify in the moment, so we've been buying both before and after this inflection point. We bought three new holdings this year during the turmoil, O'Reilly, that that auto parts company being one of them. We bought a long standing and broadly diversified industrial business that will benefit from a resurgent industrial capital spending cycle.
James Thomson:And we bought a technology ecommerce platform business that's been the best performer, up about 30% since we bought it a few months ago.
Kyle Caldwell:And the funds has for many years had a large weighting to The US. I say large, it's in line with the MSCI World Index, which is around 70%. Could you explain why you're continuing to back The US, particularly when there does seem to be a growing quarter to investors that are calling an end to US exceptionalism? I don't think this
James Thomson:is the end of US exceptionalism, given the extraordinary adaptability and resilience of US business. I believe they're stronger than any president. Yes. I have 70% of my fund invested in US equities. I've just bought three new American stocks, and my watch list is filled with more.
James Thomson:In my view, The US remains the home of innovation, innovation, adaptability, repeatable and mission critical growth. It outperforms on tax, business freedom, lower government spending, greater employment flexibility, and a hunger to innovate. There's higher r and d spending and double the venture capital spending as a percent of GDP. And I think that's why The US has $6,000,000,000,000 companies and Europe has none. But you're right.
James Thomson:Many investors are calling for an end to US exceptionalism and a pivot to Europe. But I have about 25% of my fund in Europe, so there are some great companies, just not enough. Europe tends to be dominated by old economy, order driven, economically sensitive, industrial manufacturing and auto related companies. They rely on the goodwill of neighbors and customers like The United States and China.
Kyle Caldwell:And in terms of how your US exposure differs from the broader global index, Could you summarize how it is different and which particular sectors or types of industries are you backing more than the index?
James Thomson:Yeah. My US exposure and my total fund exposure does differ from the index. Fund analysts track something called active share. Mine is over 80%, which implies high active bets and significant differences from any typical global equity index. But that doesn't mean that I'm not balanced or diversified.
James Thomson:In fact, just the Many tracker funds these days have a significant weighting up to 23% in the magnificent seven, for instance. Mine is below 13%. So I think that's a sensible choice if you're worried that the market has become too concentrated and reliant on one theme. We also diverge in other areas. We don't own any oil and gas, mining, or traditional commodity stocks.
James Thomson:We don't own pharmaceutical companies or biotech. We don't own any banks. We don't own any utilities other than my garbage collection company, which someone decided was a utility. And we're underweight the 30% technology waiting in the index. But that's because we found some clever ways to play technology via consumer facing businesses.
James Thomson:One good example would be Walmart. It's one of the most technology enabled retailers in The United States. More than 50% of their distribution centers are automated, automated storage and retrieval of inventory. Robotic forklifts controlled by AI and real people can improve output by three times compared to manual retrieval. In store, all the shelves have real time digital pricing.
James Thomson:No more paper pricing guns. At Sam's Club, you scan every item as you go and then just walk out. No more queuing for the checkouts and no change in shrink. When I see an ad on walmart.com and then go in store a week later to buy that item, they can connect the dots between those two events, and that drives their 70% EBIT margin advertising business. Technology may not take your job, but someone who really knows how to harness it will.
Kyle Caldwell:You mentioned the magnificent seven stocks. NVIDIA is your top holding, although I'm pretty sure it's actually underweight compared to MSCI World Index in terms of your percentage weighting. It's a very popular stock. Its share prices went up a lot since market started recovering from around the April 7. Could you outline your latest views on the company, and could you also detail when you first invested in it?
James Thomson:Yeah. A good example of the wild markets that we're in at the moment. In q one, NVIDIA was one of the worst performing stocks, down over 20% in the wake of the deep sea breakthrough, then up about 70%, as you say, from the lows. NVIDIA is one of the most compelling investment cases I've seen in my career. This is a new era in the computing cycle that usually comes around every fifteen to twenty years.
James Thomson:Think of the mainframe era, the PC, smartphone era, and now AI. And in each one of these eras, it's 10 times the size of the previous era. In these eras, one vertically integrated company, hardware, software, and chips, captures over 80% of the value, and that company is almost certainly NVIDIA. The integration of the ecosystem has created a wall around their dominance, and customers know that the greatest risk is underinvestment in AI. Missing out is fatal during big technology shifts.
James Thomson:We've owned NVIDIA for over seven years, but I must also recognize that we live in a world of left field events and that no single holding should dominate the entire portfolio. So we need to be nimble and nuanced and not just reflect historic performance. So we've taken profits in our NVIDIA position. In fact, we've sold 80% of the position in the last three years, but it remains the largest holding in the fund. We use the money to buy some other interesting stocks that I think are gonna be tomorrow's winners, but I can't give away all my secrets.
Kyle Caldwell:And finally, James, I appreciate I'm asking you here to gaze into a crystal ball, but I was hoping you could provide your outlook for the months ahead, particularly in relation to whether you think tariff concerns could rear their heads once again and cause a pickup in stock market volatility.
James Thomson:I think the tariff climb down has successfully avoided a recession, but volatility could easily pick up again as we approach the next deadline. And Trump wants to play hardball with China or more likely the EU. A strong stock market emboldens Trump just as it forced him to the off ramp in April. Markets will continue to be sensitive to policy uncertainty, and few investors are piling into equity markets with such a noisy and disruptive political climate. And yet markets are climbing the wall of worry and are likely to reach new all time highs.
James Thomson:Those second order effects, such as temporary inflation spikes and profit warnings, are likely to emerge, but the primary cause was tariffs where the downside risks are much better understood. So not really an obvious champagne popping moment, but remember that Trump is quick to quarrel, but even quicker to accept concessions and declare victory. So despite the short term noise, we remain fully invested and focused on the significant upside from these long term investment opportunities.
Kyle Caldwell:My thanks to James, and thank you for listening to this episode of On the Money. As mentioned in the introduction, we'll be taking a two week break for the summer, and we will return on the Thursday, September 4. If you enjoy On the Money, please do follow the show in your podcast app and do tell your friends about it. If you get a chance, please do leave us a review or a rating in your podcast app too. We'd love to hear from you.
Kyle Caldwell:You can get in touch by emailing otm@ii.co.uk. And in the meantime, you can find more information and practical pointers on how to get the most out of your investments on the interactive investor website, ii.co.uk, and I'll see you in a couple of weeks.