Kernow Asset Management commentary for the second quarter ended June 30, 2024.
Dear Investor,
The strategy experienced a 2.7% decline in June as the UK prepared for a new Labor government after 14 years of Tory-led administrations.
A new dawn. Labor is expected to introduce additional taxes targeting the wealthy, with the oil industry, private schools, non-domiciled individuals, capital gains, and private equity in the firing line. With the market adjusting to the expected associated hit to productivity, Kernow's c.75% sales exposure to the UK domestic economy negatively impacted our portfolio.
As mainland Europe shifts right politically, the UK appears to be returning to the center. We may also see the potential re-election of Trump in the US. As such, Kier Starmer might emerge as the key centrist world leader. This would positively impact UK markets. Given the years of turmoil we have just witnessed, the potential return of the UK as a beacon of stability would be quite the turnaround. While Starmer might be considered a bit dull, so is the national football team - and they might end up winning the Euros (please delete this last sentence on Monday!).
The most significant expected Labor policy impacting our portfolio is the nationalization of the railway operators. We are shorting a heavily indebted train company set to lose its license to operate beyond 2026 or possibly earlier if Labor succeeds in terminating its contracts ahead of schedule.
Our portfolio includes a significant long position in CMC Markets, which had an exceptional month. As the UK’s best-performing liquid stock, up 217% year-to-date, its transition from a spread better to a fintech firm is yielding impressive results. The B2B offering, highlighted by a recent white-label deal with Revolute, is leading this transformation.
Founder ownership is crucial in many of our long positions, fostering a superior culture, experimentation and a long-term approach. To illustrate this, we encourage you to listen to the first five minutes of CMC’s webcast on its most recent results. The founder, who owns 62% of the company, clearly demonstrates his alignment with shareholders, outlines the strategy, and explains how CMC plans to generate returns. This contrasts sharply with most other listed companies.
We have sold our position in Aviva, a successful trade over the past four years, yielding significant gains. Its strong performance, driven by new management and substantial buybacks, has slowed. Aviva had also become the most correlated position in our portfolio, reducing its alpha benefit.
The stock replacing Aviva is a fast-growing global technology company aiming to be the lowest-cost operator in its industry. It is the fourth fastest organically growing liquid company on the UK stock market. It is net cash positive and is highly profitable.
So, what’s the catch? The company often misses market targets and has uncertain operating leverage. This is due to chunky capex investments, which are sporadically spent and have returned varied payback rates. When it enters a new country, it partners with a local. However, to become the lowest-cost operator, it needs to disintermediate that local partner, which is the key value proposition. Building this moat for each country is a cumbersome, costly, and unique experience.
Experian once faced a similar situation and achieved a 10x increase post- Global Financial Crisis. Additionally, if we apply recent private market valuation metrics from a similarly sized competitor, our new holding would be valued six times higher (£40bn vs. £7bn). This suggests that our position is either extremely undervalued or the competitor is overpriced. The Kernow valuation implies that the true value lies somewhere in the middle.
Since its inception in November 2019, the Kernow strategy is up 38%, compared with the prevailing UK equity market, which has increased 31% over the same period. The collective upside in the portfolio is worth more than 233%.
