Return is the headline. Risk is the small print

Key takeaways

• Risk management remains central to the team’s investment approach, with a focus on valuation discipline, avoiding market booms and being cautious of overly promotional narratives.
• W1M European Funds have historically outperformed more often in falling markets than rising ones, a feature of capital cycle investing and avoiding the hype.
• The team remains underweight AI-related stocks, believing there are better opportunities on offer in other parts of the market. They prefer idiosyncratic stories in healthcare, consumer staples, and materials. 

“Most investors are primarily oriented toward return and pay little attention to risk”[1]

Seth Klarman, Margin of Safety: Risk Averse Value Investing Strategies for the Thoughtful Investor, 1991You might expect Seth Klarman’s words above to be uttered by a multi-asset manager justifying exposure to bonds or commodities. We view our role as equity fund managers in similar terms: not simply to seek return, but to manage the risk taken to earn it. We try to do this through valuation discipline, by avoiding obvious booms, and by remaining cautious of overly promotional management teams. If something sounds too good to be true, it normally is.

Over time, this should allow for strong alpha capture, but it can be hard when the market is gazing in only one direction. We think this tendency for most market participants to “orient toward return” is what leads us to underperform in real go-go markets, but capture good alpha when markets turn.

Across the 100 or so quarters that our Capital Growth Fund has been investing, we have outperformed falling markets 70% of the time, while outperforming in only 50% of rising markets. Our competition is at 60% and 50% respectively, a much more even skew. This pattern is even more pronounced for our Dividend Growth Fund, which has outperformed in 84% of falling markets. [2]

Avoiding the market’s one way stare

[1] Seth Klarman, Margin of Safety: Risk Averse Value Investing Strategies for the Thoughtful Investor, 1991

[2] Source: W1M

[3] Outperformance over benchmark MSCI Europe ex UK

We believe the recent outperformance of our peer group (+12.5% versus the benchmark +10% in Q2 2026) reflects the fact that many peers look far more like the benchmark than we do. When the large consensus trade — AI — does well, so do they.  The inverse is also true.

"If Europe was only half-pregnant with the AI trade before, it is now fully expecting"

If Europe was only half-pregnant with the AI trade before, it is now fully expecting. This quarter we have seen a full-throated attachment to all beneficiaries of the theme, with little attention paid to risk. Valuation increases in the top semiconductor stocks in Europe — the likes of STMicroelectronics, Infineon, BESI, ASMI and ASML — drove a large proportion of the index return.

We are underweight and have underperformed.

Our underweight is not because we are anti-AI.  Quite the opposite. It is precisely because AI looks so genuinely revolutionary that the risk of a bubble is high. History shows that the most powerful technologies often attract the most excessive capital. This excessive capital then creates what we worry about with AI right now – expensive valuations where the risk of disappointment is high.

Railroads, oil-enabled mass manufacturing and the internet all changed the world, but each also produced periods of overinvestment, excess capacity and poor investor returns. The issue is not whether AI matters. It clearly does. The issue is whether today’s valuations and capital spending adequately reflect the risk that too much money is chasing the opportunity too quickly.

At its heart, fund management is a question of relative opportunity cost and risk management. Our current view is that there is better risk/reward in stocks that have not already been re-rated on increased earnings, and which do not require ever more ebullience to work. These idiosyncratic stories aim to generate alpha based on very different lifecycles to the current technology transformation gripping markets.

The SpaceX deal provides a useful illustration. The company initially sought to raise $20bn but ultimately increased the transaction to $25bn after attracting almost $90bn of investor demand. At first glance, those figures suggest a market still short of bonds. Yet despite the enthusiasm, SpaceX still had to offer investors an attractive entry point to complete the deal, and the bonds subsequently traded below their issue price. The message is not that demand has disappeared. Rather, investors are becoming more selective as the supply of new bonds grows. That marks a subtle but important change for a market that has spent much of the past decade supported by a shortage of paper.

Fresenius Medical Care - Unloved, unglamorous, indispensable

A good example is Fresenius Medical Care (FMC), in which both of our funds recently initiated a position following an investor trip Charles Walker made to Paris earlier this month. We believe this is a classic case of a company mispriced for the stage it is in its competitive lifecycle.  We think it has started to make the changes to put it on a similar path to DaVita, the US peer.  We identified two of our key triggers – management improvement and headwinds turning into tailwinds.

[4] 10-year trailing GAAP EPS growth

The company was formed in 1996 through the merger of Fresenius’s dialysis business with National Medical Care in the US, creating the global leader in dialysis products and clinics. The US remains, in our view, the underappreciated jewel in the crown: effectively a duopoly with DaVita, offering kidney dialysis through clinics to the US population in a market with low-to-moderate growth, high regulatory intensity and limited appeal for new entrants.

This is now changing. In 2023 FMC simplified its legal structure, from a quirky quoted partnership to a normal German stock corporate, although Fresenius remains its largest shareholder. The business is therefore moving from a historically complex group structure toward a simpler, more independent, more shareholder-oriented model.

Management has also become more commercial. The first major savings programme was completed ahead of schedule, with around €1bn of savings achieved. A further programme now runs through to 2030, focused on moving manufacturing to lower-cost locations and rationalising the clinic footprint.  There is also an upcoming product cycle with a new machine that even DaVita must buy as it promises more consumables, better patient outcomes and easier operational use.

These savings programmes alongside the new machines should help improve margins from current levels of around 11% toward 15%+, closer to the level achieved by its US peer. [5]  They should also free up more cash flow than the current €1.5bn run rate, all of which the company plans to return to shareholders through dividends and buybacks now that deleveraging targets have been reached. This is against a market capitalisation of around €11bn.

[5] Non GAAP EBIT margins

The common bear thesis is that SGLT-2 inhibitors and GLP-1s will mean fewer people need dialysis, denting the future patient pool. We are taking the other side of that argument. SGLT-2s have been around for about a decade, and whilst they are reaching generic stage, they have not, so far, changed the industry growth profile in a meaningful way. GLP-1 penetration also remains low relative to the target population, and in our view is not yet large enough to justify the degree of market concern. More importantly, the long-term effect is not straightforward: GLP-1s may initially delay the need for dialysis, but by improving cardiovascular outcomes (heat attacks) and extending lives, they may also increase the likelihood that patients eventually live long enough to require treatment.

"The sun is currently shining very brightly on the uplands of AI"

The sun is currently shining very brightly on the uplands of AI. That is not in and of itself a reason to avoid the area; transformative technologies deserve capital. The risk, however, is that the brightness becomes blinding. When markets become too focused on one theme, they can become sclerotic and misallocate capital in very meaningful ways.

In the shade of the valley, away from the obvious beneficiaries of the current boom, we think there are compelling stories being overlooked. Fresenius Medical Care is one such example: a lowly valued, cash-generative market leader where expectations for volumes are depressed, management is improving the business, and the return opportunity is driven by self-help rather than by ever more excitement about expanding Data Centre capacity.  Indeed, FMC remains one of the most shorted stocks in the German index, which underlines how firmly the bear case is embedded.  We are hopeful that these will unwind in time, adding to upside potential.

As ever, we would like to continue to thank all our investors for their ongoing support.  Please get in touch with us if we can be of assistance.

Glossary

Alpha: The return generated above a benchmark through investment decisions and stock selection.

EBIT Margin: A measure of a company's operating profitability, showing how much profit it generates from its core business before interest and taxes are deducted.

Market Capitalisation: The total value of a company's shares in issue. It is calculated by multiplying the share price by the number of outstanding shares.

Buybacks: When a company repurchases its own shares, reducing the number in circulation and returning excess capital to shareholders.