Key Takeaways
- STS Global Income & Growth Trust managers say that while AI is a transformative technology, the market is over confident about profit potential.
- Investors in the trust have seen poor returns, but Harries says the market’s focus on AI stocks is opening up opportunities elsewhere.
- The dividend-focused trust is underweight technology, but has recently bought Novo, LVMH, and Vinci, which have underperformed the wider market.
It’s been an extremely tough year for STS Global Income & Growth STS investment trust, with the fund posting losses at a time when global stock markets have been rallying thanks in large part to the artificial intelligence buildout.
Not owning energy, mining, or artificial intelligence stocks has hurt the trust’s performance, says comanager James Harries. But he says the market’s intense concentration on AI winners and potential losers has created opportunities elsewhere.
Harries and comanager Tomasz Boniek typically invest in 30 to 50 dividend-paying global companies. They look for businesses with durable competitive advantages, strong cash generation, high returns on capital and management teams that allocate capital sensibly. Top holdings include CME Group and British Tobacco and Harries highlights Novo Nordisk and LVMH as recent picks.
This approach has left the trust well behind it’s peers, however. STS lands in the bottom 10% of its category for one-, three, and five-year time frames. As of the end of July, the fund lagged its Morningstar category index by 30 percentage points and was trading at a discount to NAV of around 2%.
Morningstar manager research direct Jeffrey Schumaker wrote that the last year has been a “dismal period” for the trust and its investors.
Still, Harries and Boniek demonstrate “deep insights into the companies in their investable universe,” Schumaker wrote. “The managers remain committed to their long-term approach, a stance that investors should mirror to realize the strategy’s potential.
AI Technology Believer, But AI Trade Skeptic
Harries does not dispute that AI will transform the global economy but his concern is whether the companies supporting the infrastructure boom will generate sufficient profits from the money being invested.
“You can hold in your mind that this is a transformational technology and that we’re late cycle in terms of the capital expenditure,” he says. “Those two things are not inconsistent.”
Harries questions whether revenue from large language models will ultimately justify the spending. These services require substantial continuing investment, while competition between models could prevent any provider from establishing a winner-takes-all position.
He compares AI’s potential development with the airline industry: essential to the global economy, but capital-intensive, competitive and frequently low margin.
The investment cycle will eventually slow, he argues, particularly if revenue and profits do not emerge quickly enough. Given the scale of the expenditure, that could affect the wider economy as well as the companies directly involved.
“We’ve never seen this much money allocated this quickly into a single theme,” Harries says. “History would suggest that when you allocate money that quickly, it gets allocated quite poorly.”
“One thing that happens in great booms is that everyone forgets about risk management,” he says.
Looking Outside Tech For Opportunities
One recent purchase is Denmark’s Novo Nordisk NOVO B, which has fallen sharply after losing ground to Eli Lilly in the weight-loss drug market. “They allowed Eli Lilly to steal a march on them, which is unfortunate given that they were the pioneers in this area,” Harries says. “But there’s room for more than one player, and we think there’s an important role for Novo Nordisk to play.”
Harries expects demand to increase as prices fall and oral treatments become more widely available. Novo’s Wegovy pill has enjoyed a strong US launch, suggesting patients reluctant to inject themselves may be more willing to take the treatment orally.
Despite its position in a structurally growing market, Harries says the company was available at approximately 13 times earnings.
“It is neither an AI winner nor a loser,” he says. “It’s a good business and it’s very out of favor.”
French luxury group LVMH MC represents a similar opportunity, he says. Demand has weakened, particularly in China, but its collection of brands provides diversification, while luxury companies’ pricing power supports high margins. “We think the core of the business, the reason it’s attractive, doesn’t change, but the valuation has changed dramatically,” he says.
The trust has also established a position in French infrastructure and construction group Vinci DG. Its toll roads provide predictable cash flows, while its energy and construction operations offer exposure to European infrastructure spending and electrification. Harries describes Vinci as offering “a really nice balance of predictable cash flow” and potential upside from increased infrastructure investment.
These purchases have partly been funded by selling companies including Nestlé NESN and McDonald’s MCD. Harries still regards them as good businesses, but he says their valuations did not reflect their relatively modest growth.
Key Morningstar Metrics for STS Global Income & Growth
- Morningstar Medalist Rating: Gold
- Parent Pillar Rating: Above Average
- People Pillar Rating: High
- Process Pillar Rating: Above Average
