This news service interviews J Stern & Co about an equity strategy and its approach to themes and its relatively concentrated holdings.

This news service recently met with some senior figures at J Stern & Co, the investment firm that has roots in Europe and a strong presence in North America. We have interviewed the firm before. In this latest interview, we talk about its World Stars Global Equity Strategy and focus on big themes such as healthcare and life sciences, digital transformation, consumer spending and industrials and infrastructure. Artificial intelligence is a big topic for the firm, as are the sort of new businesses spawned by the race for “net zero.”

We talked to Christopher Rossbach, chief investment officer and manager of the J Stern & Co World Stars Global Equity Fund.

Information technology makes up the single largest slice of the portfolio. Do you expect this to persist? 
Our rigorous approach to investing in companies that have quality and value for the long term leads us to invest in the world’s largest and best companies, many of which are also disruptors. These companies have enduring and sustainable competitive advantages in attractive long-term growth industries, notably information technology but also consumer products and services, healthcare and life sciences, and industrials and infrastructure. They have above-average pricing power through branding, ownership of intellectual capital or similar and low exposure to the main areas of current inflationary pressure in their cost base. 

We are only at the beginning of the digital transformation of the global economy and there is much more to come. Computing capacity will increase exponentially and offer many opportunities for companies providing products and services to businesses and consumers. 

Companies such as Alphabet and Amazon have been holdings for the past 10 years. Last year we bought Nvidia and this year we bought ASML. These companies will be long-term beneficiaries of digital transformation and we expect them to continue to represent the largest part of our portfolio.  

The portfolio of 29 companies is highly concentrated. On average, how much rotation is there in the portfolio?
We do not seek to time markets, but to choose quality companies that will deliver significant returns over time, through economic and investment cycles, and periods of uncertainty and adversity. This philosophy has delivered in previous periods of volatility and we remain confident that it will continue to do so going forward. It also lends itself to a low turnover and minimal rotation. Our average stock-holding period is three to five years. But some stocks we hold for 10 or 25 years and even occasionally longer. 

The Stern family has been invested in Nestlé, for example, for more than 50 years. The average annual turnover is between 10 to 15 per cent in line with a 5 to 10-year holding period. We change the portfolio as required and take decisions proactively, not reactively. We base our decisions on company fundamentals and valuation. This is an ongoing process. It can take several months for us to decide to buy or sell a position but it can also take a day if there is significant information that we believe requires immediate action.

In what ways is the fund seeking to “play the AI story,” and what approach can it take to make sure it holds “the disrupters” and is not caught out by holding firms that can be “disrupted”?
We believe that AI is comparable to prior industrial revolutions such as the steam engine and electricity generation. It will greatly improve productivity and have a transformational effect on the global economy.

There are many use cases and our approach is to consider carefully industries and companies that will benefit from being able to process data more quickly and effectively. Some of the companies that will benefit are the biggest tech companies in the world, including tech companies like Nvidia, which produces the GPU chips that enable accelerated computing, or ASML which produces key equipment for semiconductor manufacturing, digital platforms such as Alphabet and Amazon, which provide cloud capacity for computing and will benefit from AI to deliver better search, advertising and e-commerce services to their customers, or software companies like Adobe, which has already launched an image-generative AI platform that makes generating images easier and faster.

We also believe that many industrial companies we hold will benefit, for instance Eaton, a world leader in power management for data centres, warehouses and semiconductor fabs, Amphenol, a provider of connectors or Sika, a maker of cement additives and waterproof membranes for the construction and refurbishment of commercial and industrial buildings. Our most important resource for identifying disruptors that will benefit from AI is the fundamental analysis of the companies we own and understanding the use cases they have for AI.

The world has taken a lot of hits (Covid, interest rates, inflation, creeping protectionism, geopolitics). Has some of the bad news peaked or do you think investors have to regard all this mayhem as a sort of new “normal”?
We believe that interest rates have finally normalised for the first time since the financial crisis and we are very close to peak rates in the US and Europe. We may or may not be there in the UK – but that is the result of specific issues. The US economy is ultimately what matters the most for the global economy and for most of the companies we are invested in.

We do not believe that Interest rates have to rise much from here but we also do not believe that they need to fall. We are in a Goldilocks environment, where economic data will be too hot or too cold, but the outcome will be just right. This normalisation of interest rates is a positive and we very much believe that ‘the new normal’ which people have been so worried about, will be more like the good old days.

When I started my career in investment banking, we were using risk-free rates of 4.5 per cent. We have essentially never used anything else. A world in which nominal interest rates are between 4 and 5 per cent, where inflation is sustained at 2 to 4 per cent and therefore real interest rates are between zero and 2 per cent is a world to look forward to – not to be afraid of.

Let’s talk about silicon chips, Taiwan, and ways countries are taking to reduce exposure to Taiwan in the event of a potential Chinese invasion. How can investors such as J Stern play that? 
The semiconductor manufacturing industry is strengthening its supply chain to increase resilience, especially after some of the bottlenecks during the Covid-19 pandemic. Both the US and Europe have introduced subsidies in the form of the CHIPS Act to encourage more local manufacturing.  

The top three largest semiconductor manufacturers are investing significantly into building new fabs (plants), many of which are outside Taiwan, and all these fabs will require new machinery.   

We own ASML, a Dutch company that specialises in lithography technology which is required to mass-produce semiconductors. It is very well positioned as it benefits from the structural growth of demand for high-performance semiconductors arising from the increasing need for greater computing capacity as well as from the diversification of the global manufacturing base.   

Your top stock holding – based on the latest fact sheet – is Nvidia. Can you give some reasons why you like this company in particular?
We are very positive about it because its semiconductor technology and chips are necessary for accelerated computing. Its chips enable artificial intelligence to work on training and developing artificial intelligence models. We have seen significant order demand from the big tech companies to buy their chips this year, as these are used too. We are at the very early stages of this transformative technology and we believe that the current generative AI applications such as ChatGPT4 barely scratch the surface of what is capable. AI has use cases across many industries and so the addressable market is very large.  

Nvidia has a clear technology leadership with its chips delivering superior performance. It has designed other products alongside its GPU so it can provide an all-in-one solution for customers. It has developed a deep library of software and pre-trained models making it easier for customers to use. It has its own proprietary CUDA language that keeps customers in the ecosystem. It is accelerating its own pace of innovation; competitors will find it hard to match Nvidia for its performance and ease of use. There will be custom chips developed by the big tech companies for their specific purposes but we believe that Nvidia will capture the lion’s share of the overall market for AI computing. 

Also, can you give some words about Eaton, the industrial group and why you like it?
Eaton benefits from its exposure to structural growth areas within the electrical market, most notably the transition to net zero. Increased energy efficiency requirements, the emergence of intelligent and interconnected systems (including smart homes and cities), tighter regulatory requirements, the growth of electric vehicles, and investments in renewable resources that require connection to the utility grid, are all structural drivers fuelling investments in electrical infrastructure globally. 

We have seen an inflexion in the reshoring of critical infrastructure, for examople, semiconductors as well as in EV penetration. Importantly these are rich content and complex specification projects which favour larger players like Eaton. 

Car manufacturing is changing. Can you elaborate on your views of the automotive sector and how you might want to get exposure to it? 
We are not convinced whether the future of transport will be electric cars at all. We think the future of transportation will be more about systems and software. Urban and commuter traffic may well be autonomous driving pods that are owned or rented, which would be much more efficient and ecologically sustainable.

We will still have cars over the medium term. But even Tesla and other EV companies face big questions. One of the biggest concerns battery technology – lithium-ion batteries are a legacy technology and the way the materials are extracted is highly polluting.

You hold the stock of Disney, a firm with its share of controversies and challenges. Why do you like it?
In recent years, Disney has transformed itself with its focus on its theme parks and its investment in its streaming business. Pixar, Marvel, and Star Wars are taxes on parents; you have no choice but to subscribe, and that gives Disney pricing power.

Walt Disney has a set of very attractive assets and we believe that the company is undervalued with great potential for future growth. Our view is that it is not monetising these assets as well as it could and we believe that the recent management overhaul could reinvigorate this growth. 

In media networks, the company owns a deep library of iconic content and franchises, which it can leverage into a very profitable streaming platform at scale. The overall industry is transitioning away from the cable bundle, and whilst Disney will lose revenues from this, it can gain much more from its streaming platform. It also owns ESPN which is the leading sports TV network and live sports are becoming an increasingly valuable asset. Having priced Disney+ low to gain share, Disney now has scope for rate increases.

In parks and resorts, Disney owns the Disneyland and Walt Disney World theme parks (as well as other parks, cruises and holiday destinations), which have seen a resurgence in attendance post-pandemic. Disney theme parks also attract higher purchasing power consumers.

We continue to believe in the strength of Disney's franchises and see great upside ahead. We can see its share price return to peak as it delivers on the increasing volumes and price increases across its core businesses.