Rathbones' James Thomson on value, rates and the tech sector "Kool Aid"

January’s sell-off has been quite the humbling start to the year for many heavyweight global equity funds. Scottish Mortgage Investment Trust's (SMT) share price went down by around a fifth over the month, with Fundsmith Equity (GB00B41YBW71) suffering a decline of around 9 per cent. And although Lindsell Global Equity (IE00BJSPMJ28) had a better month than most, it only moderately bucked a painful trend.

Rathbone Global Opportunities (GB00BH0P2M97) has been no exception to this grim pattern, shedding nearly 13 per cent over the same period. That’s perhaps unsurprising, given its focus on growth stocks and a heavy allocation to the US. But its investment team’s approach is more nuanced than this performance suggests.

James Thomson, lead manager of the fund, has not previously wilted in the face of volatility. For example, when the prospect of an economic shutdown sent markets into a spiral in early 2020 he heralded it as a tremendous buying opportunity. But this time around he has taken a more circumspect approach.

In late January, he noted: “I thought the sell-off when we went into the first lockdown was the buying opportunity of a lifetime and I think this is building up to be the second best. But it’s hard to get your timing right – it’s a dark art and we’ve seen some reversal of some very deeply embedded trends.”

This has meant something of a wait-and-see approach. While Thomson selectively added to some of the fund’s positions last month, he adds that “for the most part we’ve been keeping our powder dry until we can properly frame the path of interest rate rises. We’re really having trouble framing the trajectory of future rate rises because we haven’t really seen a ceiling in the inflation rate.”

While he argues that calling this ceiling could see the market “regain its poise”, the manager's comments highlight the dilemma which investors currently face. The extent and duration of future inflation remains a big unknown, while predictions about the number of US rate rises due this year have varied wildly, with some recently estimating as many as seven. So, for investors, deciding whether growth stocks look oversold or justifiably cheap has become a daunting task.

This may explain why Thomson, who has worked on Rathbone Global Opportunities since 2003, is attempting to keep feet in different camps. “This is an environment that calls out for balance, a blend of reopening and pandemic winners, pro-cyclical and defensive, reflation and resilience, [and] growth and value, even though I’m not the home of pure value investing,” he explains. “It’s not the time for one-way bets.”

In practice, this has meant tilting the fund slightly away from some of the trends that drove such big gains for growth funds in 2020. Last year, Thomson dialled back tech sector exposure from 29 to 20 per cent of the fund’s assets by selling pandemic winners such as TeamViewer (DE:TMV) and Salesforce (US:CRM).

He has also added less glamorous stocks with a level of economic sensitivity, buying into regional banks for the first time in five years via positions such as First Republic Bank (US:FRC). And he has put money into “picks and shovels old economy industrial businesses” such as Deere & Co (US:DE) and Sandvik (SE:SAND).

“We’ve also been accumulating retail businesses, luxury goods [and] transport – things that benefit from the reopening and the end of the socialising recession we’ve been in,” he adds. “It’s doing that without getting into pure value parts of the market that I think have deserved this rally but are on a limited time offer.”

Tech issues

The definition of a tech company has become notoriously fluid, but it’s notable that Rathbone Global Opportunities Fund’s 29 per cent allocation to this sector last year pales in comparison to that of some of its peers. But of the 60 positions in the fund at the end of 2021, its 10 largest include classic “big tech” names Alphabet (US:GOOGL), Microsoft (US:MSFT) and Amazon.com (US:AMZN), as well as Nvidia (US:NVDA) and Adobe (US:ADBE). Thomson believes in the “mission critical role” such companies play in our lives, adding of the tech majors: “I still strongly believe in the resilience, longevity and gold standard growth many of these companies have.”

From Amazon’s tendency to enter and later dominate new markets to Microsoft’s strong relationship with its corporate clients, Thomson appears convinced of the enduring strength of some of the biggest names in the US. He also believes that there is plenty of momentum left in the “tech arms race”, with even old economy businesses having to spend more on IT to provide better customer service. “If companies want to succeed they need to embrace IT or their customers are going to abandon them,” he says. He singles out luxury goods and healthcare as just two areas where tech can bring competitive advantages.

However, Thomson warns that tech investors must still avoid getting carried away with the hype and drinking "all the Kool Aid". He remains sceptical about the 'metaverse' (digital world) and stresses the importance of fundamentals in the tech space.

The sheer clout of the tech majors explains why the FAANG stocks – Meta Plaforms (US:FB), Apple (US:AAPL), Amazon.com, Netflix (US:NFLX) and Alphabet – have dominated the S&P 500 in recent years and why US equities made up nearly 70 per cent of MSCI World index at the end of 2021. But this dominance has resulted in one of the fund’s selling points taking something of a back seat. While the fund's investment team buys companies of all sizes, its literature states: “Our sweet spot is mid-sized companies in developed markets.” Similarly, its investment team’s stated speciality is finding winning businesses before they become household names.

With 87.9 per cent of the fund in large-cap stocks with a market capitalisation greater than £10bn at the end of 2021, and just 8.9 per cent in mid caps with a market cap between £1bn and £10bn, a strategy of running winners appears to have led its investment team away from that particular remit for now. This is an important consideration for investors who believe tomorrow’s winners are not the same as today’s. But Thomson argues that it makes sense given the strength of the biggest stocks.

“In some parts of the market the strong get stronger, and trying to buy the nippy upstarts can be a losing bet when you’re up against such powerful, innovative and creative businesses that have built very powerful moats (key competitive advantages),” he says. “If you want to try and buy an early-stage disruptive business you better have a very keen understanding of who they’re going up against. If they have to go up against Apple, Amazon [or] Google, I think that’s a pretty tall order.

“Even though 85 per cent of this fund is in large caps I think you have to remember that many of these companies started life in this fund as a mid cap and have really grown up over the years. Some of our recent buying activity has been mid caps, but I wouldn’t expect any sweeping changes overnight. But I still believe that is a very exciting and interesting place to invest – for out-of-favour growth stocks.”