Global equity markets finished the first quarter in positive territory, with the US and emerging markets outperforming Europe. There are questions over the direction of the global economy, with the US’s outlook worsening in recent weeks, China’s post-covid performance starting to disappoint and a slowdown in German manufacturing. On the positive side, Latin America and Brazil, in particular, has stood out with strong performance driven by an improving macroeconomic environment, with GDP surprising to the upside.

The strategy outperformed the MSCI ACWI IMI reference index during the period, driven by positive stock selection led by both Brazilian education holdings, YDUQS and Afya. Yduqs, the Brazilian postsecondary education provider, was the largest positive contributor during the quarter, with the stock rallying +181%, driven by strong earnings, which confirmed a recovery in the core on-campus business and with robust guidance provided for Q2. The Ministry of Education’s consultation into a new government scheme to support student loans can potentially be a significant driver for Yduqs and the Brazilian Education sector more broadly. Abcam also performed strongly during the period (+82%), following reports of takeover interest from multiple players, including Danaher and Agilent (also held in the portfolio).

Carl Zeiss, the German provider of ophthalmic and microsurgery solutions, was the largest detractor during the first quarter (-22%) following a profit warning due to a weaker product mix with a lower share of consumables in China and inventory build due to covid lockdowns, as well as confusion on the mid-term outlook commentary from management. Given the company’s attractive positioning in high growth markets and strong pricing power, we remain positive following these near-term issues. Sartorius Stedim was also a detractor (-19%), following a significant cut to its 2023 targets. However, management have reiterated mid-term targets and we believe near term guidance is now sufficiently conservative.

The portfolio’s relative overweighting of small and mid-cap equities, while not an asset allocation decision but a structural bias driven by our strategy to invest in SMID cap companies that can grow into large cap companies over 5-10 years, has been a headwind year to date, driven by liquidity coming out of financial markets. However, small and midcap valuations are now at a level where they are attractive relative to the broader market on any metric. For example, MSCI SMID World is trading at 16.7x next year’s earnings, below the large cap portion of the MSCI World which is at 18.2x. We would expect smaller companies to trade on higher multiples, generally, relative to larger companies to reflect the higher long term growth potential. Relative valuations on a price-to-book basis are around the trough levels reached during the peak of the COVID shock in 2020 and the global financial crises in 2009.

We remain optimistic about the portfolio’s growth profile, given the highly innovative solutions that drive the investment case for each of the businesses we are invested in. This is a portfolio of idiosyncratic opportunities driven by the growth of the product or service at the centre of their businesses rather than short-term cycles, as demand for environmental and social solutions continues unabated. Given the underlying demand for the innovative solutions (of the companies) we are invested in, we expect portfolio company earnings to be resilient relative to the rest of the market, irrespective of whether the expected recession does materialise as a mild or more drawn-out slowdown. We also note that small and mid-caps tend to trough relative to large-caps when economic recessions begin. This makes us confident that the portfolio is well-positioned as we look out further through the year.