Interest in HALO (heavy asset low obsolescence) businesses surged earlier this year as investors sought to diversify from tech-heavy portfolios; but this has progressed into “infatuation”, according to Ben Needham, UK portfolio manager at Ninety One Asset Management.
“The market’s quite good at coining terms, and HALO is the latest that every Tom, Dick and Harry is talking about,” he told Portfolio Adviser. “Everyone seems to think there’s going to be a wall of money heading towards these assets.”
“We just think there’s an infatuation with them at the minute,” Needham explained. As a result, many investors have developed overtly optimistic expectations of their potential, he argued.
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Investors, he said, may have lost sight of the issues with investing in a capital-intensive business. As an example, he pointed to farming or agricultural businesses. He argued there are hidden costs behind a successful agricultural business, such as finding new land to grow on or paying for essential machinery.
On top of this, outside factors such as weather or commodity prices can be headwinds to growth, he said.
“It’s just a really difficult business to run, and the cost growth is just awful,” Needham said. “I think a lot of people forget that really basic point about those HALO businesses.
“That’s the same for an energy stock and the same for a mining stock.”
Compare this, he said, to a business such as AJ Bell. “It’s growing its customer numbers over 20% per annum, and the cost of acquiring new customers is next to nothing, because it’s done almost entirely by word of mouth.”
Year to date, the firm’s share price is up almost 39%, according to data from Hargreaves Lansdown.
“Its [AJ Bell’s] services and prices are brilliant, and so they can compound their free cashflow per share at double-digit percentages for a long time,” The Ninety One manager said. “Whereas a farmer is still going to be held by the wheat price in 20 years.”
On top of this, he argued the market fixation with HALO businesses in the UK means investors risk missing out on opportunities elsewhere in the UK.
“By definition, [this trend] means all of the inverse is getting forgotten about,” he added. For example, he pointed to what he called SALO businesses (soft asset, low obsolescence) companies, which sold off earlier this year due to concerns that AI would eat into their offerings.
The FTSE All Share Software and Computer Services sector is down 2% year to date, and at one point was down as much as 28% during the SaaSpocalypse in February. For comparison, the wider FTSE All Share is up 11.9% so far this year, according to FE fundinfo data.
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As a result, there’s now a set of “softer asset” businesses trading at “unprecedented valuations”, with great economic moats that have become a hunting ground for Needham’s team.
Software and computer services stocks are currently the largest overweight sector position within the Ninety One UK Franchise strategy, at a 12.3 percentage-point overweight to the FTSE All Share. Many of its top holdings include names that have been batched into the ‘AI loser’ bucket this year, such as RELX, London Stock Exchange Group and Amadeus IT Group.
“If we can find a capital-light business, with a strong competitive advantage and a strong moat behind it, we’ll buy that all day long over a hard asset company,” he concluded.
That said, while Needham was critical of the market’s fixation with HALO businesses, he did not dismiss them entirely.
A handful that look fair value and are at strong points in the capital cycle can be compelling opportunities, and he even owns a few of them, he added.
As examples, he pointed to airline business Ryanair, poultry processing company Cranswick, and pub chain JD Wetherspoons, all of which are traditionally capital-intensive businesses.
“They have those two things we’re looking for: structurally low cost of serve and they allocate capital well through a cycle,” he said. “We’re definitely not ignorant of the opportunities in HALO companies; you just get these obsessions in stock markets, and we think that’s happening currently.”
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