Consumer discretionary stocks remain a favoured theme for Benjamin Zhan, lead manager of Dynamic European Equity, which allocates a 35% weighting to the sector, compared with 9% for the MSCI Europe Index. Zhan, who has managed the Morningstar 5-star rated fund since 2009, is a portfolio manager with 1832 Asset Management in Toronto, which manages the Dynamic family of funds.
"I think one of the strongest secular forces in the world today," says Zhan, "is emerging market consumers. Europe is the only home for the world's most prestigious consumer brands in luxury goods. I call Europe a match made in heaven for emerging market consumers." Zhan's enthusiasm is based on his fundamentally-based investment approach to identify sector growth industries, seeking the strongest players and waiting to buy them at a discount.
In the past, Zhan says that luxury goods were mostly about consumers in Europe and the United States, but these two regions together only represented 10% of the global population. "Recent studies," says Zhan, "show that Chinese consumers alone spend 87 billion euros a year in luxury goods, and that can more than triple to more than 280 billion euros by 2030. The entire Swiss watch-making industry generates 18 billion euros in sales per year, so a potential 280-billion-euro increase is significant." And those numbers do not even include consumers from Brazil, India and Mexico, adds Zhan.
Zhan uses a bottom-up investment process to find roughly 45 holdings for the fund, with a strong preference for very old, large-cap companies that have proven sustainability over history and market crises.
A top holding in the mandate, The Swatch Group, based in Switzerland, "is a perfect embodiment of our investment thesis," says Zhan. "Today the company has a market cap of about 20 billion euros with no debt. It is a very consolidated industry, and Swatch is the market leader." On the demand side, he thinks Swatch is also the most direct beneficiary of the growth in Chinese consumption. "It is estimated," says Zhan, "that more than half of watch sales come from Chinese buyers on a global basis." In his opinion, the stock is a bargain given the massive potential for the company's products in the future.
LVMH Moet Hennessey Louis Vuitton, based in France, among the top 10 holdings, also illustrates the strategy. "For anyone who cares about the luxury goods industry," says Zhan, "it is difficult not to like that largest of players, LVMH." Along with Louis Vuitton, it's behind brands such as Givenchy, Sephora and numerous others. "The quality of that brand, the diversified market exposure and the consistency of their operation are truly remarkable." He also considers it one of the best run companies in the world above and beyond the luxury sector.
Zhan also highlights Dassault Systèmes, a technology company based in France, as very relevant to the consumer discretionary sector. "Dassault Systèmes," says Zhan, "provides integrated software solutions, such as 3D simulation programs to enhance design in the production of everything from shoes to aircraft. We are really at the very beginning of a massive upgrade cycle and Dassault is the global market leader with one-third market share."
Zhan and the Dynamic global core equity team of six bought the stock a while ago at a much cheaper valuation than today but it remains a top holding. "I believe the upward trajectory does not stop here." Zhan says Dassault also illustrates how the investment team identifies the trends and the winners.
Many of the top holdings have been in the portfolio for many years, such as The Swatch Group that has been there from the beginning. "We hold the most loved companies," says Zhan, "but we use contrarian ways to enhance the performance. If a sector is moving up too much, into unreasonable valuations, we trim them, and when the markets panic, we buy them back."
For example, in late 2016, a lot of UK stocks were added to the mandate after the Brexit drama and the ensuing market sell-off. "Today," says Zhan, "I'm aggressively buying more stocks that are sold off because of the worries over a trade war with China."
Risk management in the fund includes a preference for blue-chip industry leaders, with a long track record of success, and strong balance sheets to provide liquidity support in the event of a crisis. As well, "I am obsessed with total transparency of a business," says Zhan. If a business is so complicated that public information alone is not sufficient to make a judgment, he stays away from those stocks.
Looking ahead, "there is no guarantee," says Zhan," that the companies cannot fail in the future. But if we invest our money in companies that have been surviving for over 100 years, at least history is on our side, and time tends to be our friend."
