Investing in global companies that are leaders in their sectors, it might seem natural that Cerno Capital’s James Spence would be attracted by US tech giants such as Facebook and Amazon. 
But the manager of the £86m TM Cerno Global Leaders fund, said he prefers companies where the customer isn’t the product and finds it surprising that some of the big tech companies have been able to grow to enormous sizes without tighter regulation.
He said: “There are clearly ethical issues surrounding the accrual and use of data, and we’re not keen on businesses where the customers become the product.”
There has been a growing concern over how companies such as Google and Facebook exploit the data of its users for financial gain.
Facebook was the centre of attention a few years ago when it allowed political consultancy Cambridge Analytica to access sensitive user data whilst touting the protection of user privacy.
Just a few weeks ago, the US justice department filed antitrust charges against Google for its alleged monopolistic practices in what could be the beginning of further regulatory challenges to come for big US tech.
He has other reasons for avoiding most of the FAANGs (Facebook, Amazon, Apple, Netflix and Google-parent Alphabet).
“I think at Facebook, you have an obvious governance issue, and you have a split-share structure,” he revealed. “We’re not keen on split-share structures where more votes accrue to some shares.”
He also criticised the split-share structure of Alphabet – the parent company of Google – and the opacity of its business operations.
“It’s unnecessarily complex,” he added. “It’s easy to see where they make their money and their core business, but of course, they want to divulge as little as possible about all their other investments and strategies.”
E-commerce giant Amazon has also recently been charged by EU authorities for breaking competition laws for using data from its third-party sellers to gain dominance in the market.
Despite the ethical and regulatory challenges, however, one of the main reasons Spence (pictured) hasn’t invested in Amazon is down to its margin structure.
“The business model is really predicated on the evisceration of other retailers, and to do so, they need to operate a pretty low margin,” he explained.
“Now, at the group level, it looks a bit better than that, because they have this big and fast-growing Amazon Web Services. But I think if that were to split and go public, I’m sure it would get a really hefty multiple if it were separated, look at the rest of Amazon.
“Some people say, ‘well, all they need to do is stop investing and their margins will go up’, I think the opposite. I think the margins are necessarily quite small and low.”
It is a different story when it comes to Netflix, given the high amount of leverage and debt in the business, which precludes Spence from investing in it.
“We’re also for industry structure reasons a little bit reluctant about investing in entertainment,” he added.
“Not so much because the industry is being reshaped by the move to streaming but because in the long history of entertainment, it is really hard to be a leader over the kind of time periods where we’re looking for. Things tend to shift.”
The TM Cerno Global Leaders manager admitted that Apple was one of the closest possible candidates to invest in, but he had been held back by the sheer dominance of its handsets business.
“While they’re doing very well with all their other complementary businesses, and you could argue they still have an edge in handsets because the iPhone is still much desired, but the technological edge that they once had has been chiselled away a little bit by other handset makers,” he explained.
This goes back to his earlier point: that long-term leadership in certain sectors can be difficult. The same applies to hardware technologies.
“We’ve not seen a company retain leadership for several decades,” he said. “20 years ago, we’d have been talking about Sony, and it’s not quite where it was then.”
One company that Spence recently invested in that isn’t a FAANG stock but is still part of US big tech, is Microsoft.
“There are basically two ways to conduct yourself in this sector,” he said. “One is to be a collaborator, and one is to be a very aggressive sort of soloist, and the traditional US technology business model is to be a soloist.
“Microsoft was once a soloist and they hit the buffers with the regulators.”
However, he said, culturally, the firm has improved considerably since then and has made strides in becoming more of a collaborator, making it more investible.
Spence said: “I think some of those hard edges have been knocked off Microsoft, and you can certainly connect that with the fact where we are two clicks on from the founder Bill Gates.”
One example of a global leader that Spence does like and has been in the fund’s portfolio for more than six years is UK-listed Renishaw, which specialises in measurement and is best known for its coordinate-measuring machines.
Performance of Renishaw over 6yrs
Source: FE Analytics
Fergus Shaw, partner at Cerno Capital, described Renishaw as “a company that we shouldn’t be able to invest in”.
“It didn’t have a need to list when it came on to the London Stock Exchange, it was going on perfectly happily. But David Murphy was persuaded to sell half of the business to the market,” he recalled. “So fantastic, that means we can own it.
“The very first tool he made was quite simple, it was a probe that uses a laser to measure, very accurately, complex shapes,” he explained. “That was important when he designed that product, and it’s becoming more and more important as manufacturing gets more and more complex.”
Another reason why the fund is overweight Renishaw is because the company is “very much integrated into their customers’ businesses”, rather than simply being a tool supplier.
“That’s important for creating their moat, their competitive advantage,” said Shaw. “They are inextricably linked with their customers.”
One example of this is the additive manufacturing segment that makes 3D printers for industry, or the fact that they “built a whole new complex with effectively Chinese walls”.
“These were areas where their clients could come in and be taught how to use the machines in the knowledge that there was no way that any of their intellectual property could be moved around to other customers of Renishaw,” he finished.
Performance of the fund vs sector & benchmark since launch
Source: FE Analytics
Since launch in 2017, TM Cerno Global Leaders has returned 45.4 per cent compared to 29.93 per cent from the MSCI World benchmark and 28.62 per cent from the average peer in the IA Global Sector. It has an ongoing charges figure (OCF) of 0.87 per cent