Quarterly Report - Mackenzie Global Equity & Income Team

From the desk of the Mackenzie Global Equity & Income Team Q3, 2024

Mackenzie Global Dividend Fund

Highlights:

• Despite inflation easing and rate cutes by the US Fed and ECB, there are concerns about market disconnects and potential risks, including geopolitical tensions and election outcomes
• Interest-rate sensitive sectors led market gains. Energy was the only sector with negative performance. Asia Pacific (ex-Japan) surged nearly 13% on the back of China’s stimulus package, while Europe, the US and Japan saw more moderate gains
• China’s recent stimulus measures boosted market confidence at the time but long-term challenges remain. The government’s commitment to addressing economic issues is notable, although comparison to Japan’s 1990s struggles suggest cautious optimism

Global markets as reflected by the MSCI World index were up +5.1% in the third quarter. The portfolio kept pace and was up +5.2%. The market again reached all-time highs. Inflation is abating, both the US Fed and ECB are cutting rates, and implied volatility went back to its recent lows after some excitement during the quarter. While markets being up 22% thus far this year feels great, it might bely what’s going on underneath the surface. There is a bit of a disconnect to where the markets are today, and the lack of risk being applied to those prices. Questions still swirl around the probability of a hard landing in the US and how the markets will react post-election. Does a Republican victory result in a new round of tariffs that ultimately do more harm than good? Will Democrats cripple the economy via higher taxes and expanded entitlements? And, unfortunately, the Middle East and Ukraine situations remains unresolved.

For the quarter every sector in the MSCI World index was up except for Energy (-3.6%), which was dragged down by cooling economic growth across the world. This again highlights the futility of trying to make short term predictions or trying to convert a macro view into investment results. If you told us a year ago there would be Israeli ground troops in Lebanon but the oil price would be lower today than it was a year ago, it would have come as a surprise. Info Tech was basically flat for the quarter (+0.3%) with semiconductor stocks relatively weak, although this segment is still up significantly YTD.

Interest rate sensitive sectors were up the most this quarter. Utilities (+16.2%), Real Estate (up almost +15.4%), and Financials (+9.4%) lead the way. This was not surprising given that the US Federal Reserve lowered rates 50 basis points, and the European Central Bank delivered its second deposit facility rate cut in three months. The Bank of Japan caught the market off guard by raising rates in early August from zero to a heady 0.25%, which triggered a significant rally in the yen and the sudden unravelling of the yen carry trade, a strategy predicated on low Japanese interest rates. This weighed on equity prices as the Nikkei declined more (-12%) in one day than at any other point in its history. Prices mostly recovered following the BOJ’s pause in September and its relatively positive economic outlook.

From a geographic standpoint Asia ex-Japan was up almost +13%, driven by a massive resurgence in Chinese equities which had been previously deemed “un-investable” by some investors. It rallied on the announcement on a sweeping stimulus package in late September. Europe was +5.3%, the US +4.6% and Japan was +4.5%.

In the beginning of September, the consensus view on China as an investment opportunity was that it was, to put it mildly, uninteresting. The country was in decline, the issues its economy faced were structural, and the government did not have the stomach to act. One month later, after the Chinese Politburo introduced a broad stimulus package, what was once deemed structural became a cyclical issue, and investors suddenly began debating how much further it had to go versus being left completely for dead. Well-known and highly successful macro investor David Tepper (just don’t look at his track record as the owner of the Carolina Panthers) caused a stir by publicly announcing, more or less, this time is “different”.

From a macro standpoint the Chinese issues are well understood. The country is suffering from a crisis in consumer confidence which is manifesting itself in a decline in personal consumption and weighing down the entire economy. What’s behind that is up for more debate: some mixture of aging demographics, debt levels at the provincial level, and property market deflation. The new policies announced include interest rate cuts, capital injections to support lending from large state-owned banks, the Chinese central bank providing liquidity to support stock purchases, general promises of future counter cyclical fiscal policy to support consumption, employment, low and middle-class income, and multiple policies to assist both property buyers and troubled property developers. This last point may be a key aspect of the policies because property has been the most important and largest store of wealth for Chinese households in recent decades.

It’s clear that these policies have helped the Chinese stock market the past few weeks, but we should note given the depressed level of the stock market, it would be fair to say ANY good news would have caused a reflexive bump (although we did not see a 35%+ trough to peak move in two weeks!). Whether these measures can ultimately overcome the broader economic challenges China faces, we are taking a “wait and see” position. On one hand, this time feels different in terms of the government’s commitment to tackling the problem, not just because the government addressed the primary concerns of the market, but also due to more nuanced factors we observed. For instance, that these measures were announced outside of the Politburo’s normal meeting cadence implied a shift in tone. But one can’t help but compare China’s situation to the one Japan found itself facing in the 1990s. Namely, an export-oriented economy that was also coming out of a massive property bubble. The classic moment in 1989 when Tokyo’s Imperial Palace was valued more than all the real estate in California comes to mind. During the ensuing years after the commercial property peaked and the economy entered into a deep malaise, Japan’s central bank provided several rounds of capital injections into the financial sector, multiple rounds of fiscal stimulus, and decades of zero interest rate policies (DZIRP?). Did these policies help avoid the reckoning that a true banking crisis would have created? Perhaps. But has it at best allowed the Japanese economy to limp along while hopes regarding stimulus spurred occasional market rallies? In that environment, the highest quality companies in Japan were still able to thrive despite the economy. That’s how we are approaching China. And while we currently don’t own any A-share listed companies, we have what we consider reasonable exposures through companies like HK Exchange (via their support of dual-listed shares), Siemens (significant presence in Chinese factory automation), Itochu (mainly through its Citic stake), and Merck (through its Gardasil vaccine). At this time we view this as the most prudent approach.

And finally, we touched upon our high-level thoughts as it relates to election results and portfolio positioning last quarter. In summary: we are unlikely to make significant moves that “bet” on a particular result. But we are not naïve to the tail risks, specifically the potential impact on global trade if Donald Trump wins and is able to push through significant tariffs. Areas of concern would include Chinese imports, where a 60% tariff on certain goods is being considered. Electronics and textiles being imported from Mexican and European companies that don’t have a US manufacturing presence could also be at risk. Fortunately, we have minimal exposure to these industries. For instance, many of our European healthcare companies such as Roche, Astra Zeneca, and Novo Nordisk have a significant US manufacturing footprint. This is true for many of the non-US staples and industrials that tend to support their US sales with local production. Nestle, Haleon, and Assa Abloy come to mind here.  TSMC is perhaps our most significant exporter, as it manufactures most of its chips within Taiwan, with over 50% of its revenues coming from the US. And if one considers their non-US revenues generated from the likes of US-based companies such as Apple and Qualcomm, they are a very US-centric company. In addition, in response to US policies aimed at reducing dependence on semiconductor imports, TSMC has been granted incentives to build advanced production chip facilities, with mass production expected from its Arizona facility in 2025. Would the US be willing to unduly harm TSMC given this fabs importance to the country’s future semi production capabilities?

To close, while we appreciate the volatility the next few months can bring, we are comfortable with our investments. We continue to own a well-diversified portfolio by sector and region, and that most changes we make are a response to our assessment of individual stocks risk-adjusted potential returns.

What contributed positively to performance?

Hong Kong Exchange (HKEX) was up over 30% and a top contributor to the portfolio for the quarter due to significant investor enthusiasm over fiscal intervention from the People’s Bank of China (PBOC). As we commented on earlier, the PBOC announced a slew of support measures including a 20bp rate cut on short-term rates (7-day repo rate); in addition, the PBOC decreased the reserve requirement ratio by 50bp for financial institutions and cut rates from 2.3% to 2.0% on RMB300bn worth of one-year medium-term loans to large financial institutions. As a result of these factors Chinese economic activities may accelerate, which directly benefits trading volumes for HKEX on top of an already strong Q2-24 performance. In Q2-24, HKEX saw Average Daily Turnover (ADT) of equity products increase by 23% yoy in addition to Derivatives products seeing 12% yoy growth, reaching record half-year volumes. The Chinese IPO market continues to recover, with a 79% yoy increase in IPO funds in Q2, albeit coming off extremely depressed levels. If economic conditions in China recover, HKEX, as a high-quality financial proxy of the Chinese market, will likely continue to benefit from the economic uplift.

Oracle (ORCL) was a top performer (+19.5%) thanks to a blowout quarter that included an ambitious $104bn revenue guide for 2029 behind accelerating Oracle Cloud Infrastructure (OCI) spending. Oracle has always been a dominant on-premise database management company. However, it was the anticipated OCI growth that drove us to re-establish a position last year (and add to in the summer) and we are pleased with recent results thanks to securing significant OCI contracts with companies like Berkshire Hathaway, TikTok and Bing Chat. Additionally, due to client demand for OCI, Oracle has established partnership agreements with the big three hyperscalers (Amazon, Google, Microsoft) to offer OCI on their infrastructure, a key proof point for Oracle that supports the $104bn 2029 revenue guide.

Phillip Morris (+19.7%) was a top contributor to our performance this quarter, as recent financial results have been strong, and investors are rewarding the change in portfolio mix with a higher multiple. Today, Phillip Morris has the leading portfolio of Reduced Risk Products within the nicotine category globally, which is now approaching close to 50% of overall profits. The RRP business is currently growing 25% per year, at similar if not better ROIC’s than combustibles. Management expects RRP’s to be 66%+ of profits by 2030, and eventually 100% in the long run.

What detracted from performance?

For the first time in many quarters, owning Novo Nordisk hurt performance as it was down -19%. While we still own shares, we had been managing our position size even as the company (and stock) continued to perform well. We are starting to see early trial data of future competitive products for Wegovy, their main weight loss product. And while we still believe Novo’s leadership position (along with Ely Lilly) is well-entrenched, the market is starting to give credit to potential competing products and perhaps even build in lower market share for Novo in the future. Questions about US-based insurance companies’ willingness and ability to continue to pay for what an expensive treatment also came more into focus. We are still comfortable owing Novo Nordisk at these levels and size (currently <1%of the portfolio) and will be opportunistic if the market presents us the opportunity to add to our position at a level that overly discounts its future prospects or competitive long-term threats.

McKesson (MCK) was a detractor after a quarter (-16.3%) that featured lowered profit guidance on its Medical Surgical and Prescription Technology Solutions segments. We believe the competitive environment has increased in Medical Surgical and that Prescription Technology’s growth rate is normalizing after elevated demand for GLP-1 authorizations. While it was disappointing that management cut guidance after reaffirming the previous quarter, we continue to have confidence in McKesson’s ability to hit their EPS guidance for fiscal year 2025 and the core thesis remains intact.

Lam Research (LRCX) was another detractor (-24%) as the entire semiconductor complex took a breather after a blistering 2023 and first six months of 2024. Lam sells highly specialized equipment to semiconductor fabrication facilities, so it does experience a “bullwhip” effect from any small changes in demand at the end customer. However, over the long term we are bullish on Lam’s dominant position in etch technology due to the increasing complexity of semiconductor architectures and expected increase in semiconductor fabrication capital intensity. Another saving grace for the company is that it has roughly 40% of revenues related to spares, services, upgrades and support which should be more resilient during periods of market weakness.

What changes have we made to the Mackenzie Global Dividend Fund?

We established a position in Nvidia (NVDA) this quarter. Nvidia is a semiconductor design company with a leading position in Graphic processing units (GPU’s), the key input to running AI workloads over the cloud today. While Nvidia has long been a dream team company, the business has improved significantly over the last couple of years. Its dominant source of revenue has transitioned from less resilient and more speculative gamers and bitcoin miners to the largest technology companies in the world as they aggressively build out accelerated compute data centers. Additionally, Nvidia has a burgeoning network component business that alongside CUDA, their proprietary software, gives them a dominant vertically integrated ecosystem. Despite the unmistakable improvement, Nvidia briefly traded at a five-year low on valuation in early September reaching a level that mirrored the depths of the Covid-inspired selloff in early 2020. We felt it was prudent to diversify our accelerated compute exposure and elected to add Nvidia to the portfolio.

There were no exited positions in the quarter.

 

Portfolio Management Team

Darren McKiernan, Head of Team, Senior Vice President, Portfolio Manager, Investment Management, Mackenzie Investments

Katherine Owen, Vice President, Portfolio Manager, Investment Management, Mackenzie Investments

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns as of September 30, 2024 including changes in security value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

Index performance does not include the impact of fees, commissions, and expenses that would be payable by investors in investment products that seek to track an index.

This document may contain forward-looking information which reflect our or third-party current expectations or forecasts of future events. Forward-looking information is inherently subject to, among other things, risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed herein. These risks, uncertainties and assumptions include, without limitation, general economic, political and market factors, interest and foreign exchange rates, the volatility of equity and capital markets, business competition, technological change, changes in government regulations, changes in tax laws, unexpected judicial or regulatory proceedings and catastrophic events. Please consider these and other factors carefully and not place undue reliance on forward-looking information. The forward-looking information contained herein is current only as of October 28, 2024. There should be no expectation that such information will in all circumstances be updated, supplemented or revised whether as a result of new information, changing circumstances, future events or otherwise.

The content of this commentary (including facts, views, opinions, recommendations, descriptions of or references to, products or securities) is not to be used or construed as investment advice, as an offer to sell or the solicitation of an offer to buy, or an endorsement, recommendation or sponsorship of any entity or security cited. Although we endeavour to ensure its accuracy and completeness, we assume no responsibility for any reliance upon it.

On July 26, 2013 the Mackenzie Global Dividend Fund changed its mandate from investing in equity and fixed income securities of companies that operate primarily in infrastructure related businesses to investing primarily in equity securities of companies anywhere in the world that pay or are expected to pay dividends. The past performance before this date was achieved under the previous objectives.

The rate of return is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values of the mutual fund or returns on investment in the mutual fund.