Polen Global SMID Company Growth Portfolio Q4 2024 Commentary

Summary

• Over the fourth quarter of 2024, the Polen Global SMID Company Growth Composite Portfolio (the “Portfolio”) returned -2.28% gross and -2.66% net of fees, respectively, versus the -3.37% return of the MSCI ACWI SMID Capitalization Index (the “Index”).
• Shifting economic expectations and uncertainty surrounding political elections weighed on equity markets.
• The top contributors to the Portfolio’s relative and absolute performance over the fourth quarter were Warby Parker, Revolve Group, and Sanrio.
• The most significant detractors from relative and absolute performance were Insight Enterprises, Indutrade, and TopBuild.
• In the current environment, with several uncertainties, we remain focused on our Portfolio companies’ long-term value propositions, competitive advantages, growth opportunities, and potential earnings power.

Seeks Growth & Capital Preservation (Performance (%) as of 12-31-2024)

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Commentary

Global small and mid cap equities encountered moderate headwinds over the quarter, influenced by evolving interest rate expectations, heightened economic uncertainty heading into 2025, and increased volatility primarily driven by upcoming election-related risks.

The key development during the period was the outcome of the U.S. Presidential election. In early November, Donald Trump and the Republican Party secured a decisive victory, fueling expectations of pro-growth policies, including the potential for further tax cuts, expansionary fiscal measures, and deregulation. Outside the U.S., the election result was met with caution. Concerns over heightened trade policy risks, coupled with a strengthening U.S. dollar and fears of a less accommodative U.S. monetary environment, weighed on international equities. Amid the evolving economic backdrop, the U.S. Federal Reserve delivered two interest rate cuts during the quarter, bringing the target Federal Funds Rate range to 4.25%-4.50% by the end of 2024. Meanwhile, Europe experienced renewed weakness, with political uncertainty in Germany and France and ongoing concerns about subdued growth in the U.K.

In China, the government announced plans to stimulate growth through increased spending and lowering interest rates. However, the market’s reaction remained muted as the magnitude of stimulus has disappointed market expectations so far, and fears of potential tariff escalations from the U.S. dampened growth sentiment. Elsewhere, oil prices softened as global demand weakened, while gold prices declined amid a strengthening U.S. dollar.

Against this backdrop, the Index delivered a negative return. Among sectors, Financials and Information Technology were the strongest performers, while Materials and Real Estate were down close to 10%. At a country level, Japan, Australia, and the U.K. were the notable laggards, while the U.S. was the only large market (>1% index weight) to see a positive return. Developed markets performed better than emerging markets over the period, and large caps outperformed SMID caps. From a style perspective, growth fared better than value.

While our quality growth-oriented Portfolio has not been immune to recent volatility, it displays resilience. When stock prices rose beyond what fundamentals justified, we right-sized positions and sourced funds to add to new and existing ideas with better risk-return profiles, reinforcing our opportunity cost mindset. This approach helps to ensure that capital is allocated to areas with the highest potential for long-term growth and return.

Despite the weight of a weak SMID cap market, we believe the Portfolio has meaningful latent growth and appreciation potential. The heightened volatility and resulting market dynamics have reinforced our commitment to maintaining a disciplined, long-term investment strategy, focusing on high-quality companies with robust fundamentals that we expect will thrive over the long term.

Portfolio Performance & Attribution

Over the fourth quarter, the Portfolio returned -2.28% gross of fees and -2.66% net of fees, respectively, versus the Index return of -3.37%.

Portfolio outperformance was driven by positive security selection, with sector allocation also positive. Security selection was strongest in the Consumer Staples and Materials sectors and outweighed weaker selection in Financials and Communication Services. Sector allocation, an outcome of our bottom-up selection process, also contributed to relative returns, primarily due to the Portfolio’s underweight in Materials. At a country level, security selection was strongest in Japan and Israel and weakest in Germany and the U.K.

Our most significant individual contributors to relative and absolute performance over the fourth quarter were Warby Parker (WRBY), Revolve Group (RVLV), and Sanrio (OTCPK:SNROF).

Warby Parker, a U.S.-based omnichannel retailer of eyewear products with a unique vertically integrated direct-to-consumer business model, reported encouraging quarterly results. The company experienced compelling growth in its glasses business and continued momentum in contact lenses and optometry. The substantial investment in optometrists is yielding results, driving improved gross margins through enhanced utilization. Warby Parker appears to be emerging from a challenging period, where it was adversely impacted by post-pandemic changes in consumer behavior. Company management’s steps to reduce costs appear to be paying off. More recently, we’ve seen fundamentals starting to inflect, with marketing spend recovering now that margins have settled. We think the company has the potential to enhance its profitability as demand continues to recover and it completes and capitalizes on heavy investments in areas like optometry services, which previously weighed on margins.

Revolve Group, an online apparel retailer targeting primarily the Millennial and Gen Z demographics, was another top performer after demonstrating improving fundamentals following a challenging period to end 2024, with the stock’s total return up over 100% for the year. While the consumer environment remains under pressure, we are encouraged by the company’s efforts to drive cost efficiencies, reduce return rates, expand product lines, and continue its international push. We believe Revolve is well-positioned to grow earnings at an accelerating rate over the near term while the long-term outlook remains intact.

Sanrio, a Japanese entertainment company known for its Hello Kitty franchise, reported robust results over the period. The company saw growth across its licensing and theme park businesses, improved margins, and subsequently increased its dividend payout. The better-than-expected results were driven by successful character development and other initiatives to diversify its revenue base and increase domestic and foreign tourism. We continue to hold Sanrio in the Portfolio due to the attractive long-term opportunity from the continued growth of Hello Kitty, increased penetration of anime, and margin expansion from licensing growth in China and the U.S. However, following the recent share price strength, we trimmed the position late in the quarter for risk management purposes.

Our most significant detractors from relative and absolute performance were Insight Enterprises (NSIT), Indutrade (OTCPK:IDDWF), and TopBuild (BLD).

Insight Enterprises, a global provider of IT solutions to small and medium-sized businesses across various end markets, disappointed over the quarter. While the company has established itself as a trusted technology partner enabling IT modernization and cloud migration over recent years, during the fourth quarter, revenue, margins, and forward guidance were all below previous estimates. This was driven by challenging IT spending trends in Insight’s underlying client base. Our research suggests that Insight will benefit from a return to more normal levels of IT spending as companies prioritize hardware upgrades and continue to migrate workloads to the cloud.

Swedish industrial conglomerate Indutrade pulled back over the period as it reported EBITDA for the third quarter that missed expectations, primarily due to weaker sentiment from wider economic uncertainty among its client base. Demand, however, remained stable, exhibiting the resilience of its diversified structure. We maintain our conviction that the company’s management team are exceptional capital allocators, capable of driving attractive growth by strategically expanding the portfolio with new products and geographies while consistently enhancing margins through the improved mix and internal efficiency programs.

TopBuild, a U.S. market leader in insulation distribution and installation services in the residential construction, commercial, and mechanical insulation markets, was weak over the quarter after posting soft quarterly results. In our view, TopBuild remains the number one player and offers exposure to the secular tailwinds from years of underbuilding in new homes. It also has a superior, high-return business model that should prove more resilient than traditional homebuilders.

Portfolio Activity

Over the quarter, we initiated five new positions and sold out of four holdings. We also adjusted existing positions, including trimming holdings to raise capital for new investments and adding to companies where we believe the market underappreciates the quality of the business.

We initiated a position in Asics (OTCPK:ASCCF)(OTCPK:ASCCY), a leading footwear manufacturer in Japan that has undergone a significant turnaround in the last year driven by new management. The company is refocusing on core high-priced running shoes, cutting low-margin entry-level models, consolidating its distribution footprint, and expanding in China and the U.S. via new brands and products such as Onitsuka Tiger. This has led to revenue growth accelerating to mid-teens and EBITDA margins expanding. We believe with the continued margins further. At the time of purchase, shares were trading at 16x EBITDA FY25, which was favorable compared to global strength of Onitsuka Tiger, the new focus on selling higher-margin products, and the significant white space in the U.S. market, Asics can continue to grow earnings to mid-to-high-teens and expand footwear and consumer peers that trade on mid-teens and above multiples.

We also bought Cellebrite (CLBT), an Israeli company that is the global leader in digital forensics software. In layman’s terms, they hack cellphones and other electronic devices and then collect, analyze, and store that data for law enforcement. This business is seeing booming demand as digital evidence is now the most important evidence in most crimes. In addition, Cellebrite has been expanding its market by adding new product features and functionality that have allowed it to upsell and cross-sell customers and drive higher average revenue per user. We believe the business can grow revenues by 25% per year and maintain or expand its 25% EBITDA margins for the next three years while trading at a discount to its global peers.

In Japan, we bought Sanwa and Kinden. Sanwa (OTCPK:SNWAF) is a Japanese building and housing materials company that supplies shutters, building and garage doors, and window sashes. We see steady growth in Japan for their non-residential business, while in their overseas business, we see strong growth potential in the U.S., driven by residential and non-residential demand and continued pricing increases. The shares trade at 10x EBITDA, and we anticipate a low-teens IRR (Internal Rate of Return), driven by earnings growth, additional capital return via buybacks and dividends, and a potential modest re-rating to 11x EBITDA, aligning more closely with global peers. Kinden is a leading Japanese electrical contractor benefiting from growing data center demand and electrification in Japan. Revenue growth is accelerating from a low base, margins are improving as pricing power improves, and the company is starting to return capital to shareholders. About half of the market cap is in cash, and we see an attractive IRR from earnings growth and capital return with possible further upside from a potential re-rating.

Finally, we started a new position in Rambus (RMBS). This U.S.-based company plays a foundational role in fueling innovation within the data center and server environments, serving large memory OEMs (Original Equipment Manufacturers) and hyperscalers. With its fabless model, Rambus generates strong free cash flow while maintaining a steady reinvestment into R&D to sustain its industry-leading memory interface chips and silicon IP solutions. We estimate Rambus is well-positioned to compound earnings and free cash flow per share at a high-teens rate through the cycle.

To fund these trades, we trimmed positions across the Portfolio and sold out of four positions fully.

We exited our position in US-listed Aspen Technology (AZPN) due to its announced acquisition, which we believe limits its future return potential. We sold Clearwater Analytics (CWAN) after substantial share price appreciation led to valuation levels that diminished its relative attractiveness within the Portfolio. While the company remains a high-quality business in our view, we believe these proceeds can be more effectively deployed elsewhere.

In Japan, we sold Japan Elevator Service, a company we have followed for many years. We decided to upgrade the Portfolio to more attractive reward/risk ideas. While nothing is fundamentally broken with this business, the valuation looks full relative to other Japanese industrials, and there is limited upside to market expectations for growth and margin improvement.

Finally, we sold out of the Italian luxury fashion brand Moncler (OTCPK:MONRF)(OTCPK:MONRY). While we believe it remains a high-quality company with an attractive EBITDA margin, a robust competitive position in luxury outerwear, a visionary CEO, and optionality from M&A, we believe this will be a slower-growing business in the foreseeable future.

China has been a significant growth driver, and the consumer environment there has yet to improve. It also remains unclear whether the significant North American opportunity will be able to offset these headwinds. Furthermore, Moncler has benefited from pricing increases that need reinvesting into the business, leading to margin degradation. While valuation is attractive compared to luxury peers, that alone is not a reason to continue to hold the shares.

Outlook

While market sentiment has shown signs of improving and we are cautiously optimistic about stabilizing interest rates, the reality is that uncertainty persists. This underscores why we stay focused on the long term and on competitively advantaged, financially flexible businesses. We believe that consistently owning businesses with robust balance sheets and the ability to reinvest in any environment trumps short-term temptations to own lower-quality businesses.

Looking ahead, we see significant opportunity for the asset class, and particularly for our investing style. In our opinion, high-quality SMID cap companies have greater latent potential for growth relative to more mature businesses. Further, we believe the most compelling SMID cap companies will take advantage of robust balance sheets and continued reinvestment to advance their competitive position, tackle adjacencies, and present greater potential for value-added acquisitions. Of course, many companies do not meet this high hurdle, which is why we hold a concentrated portfolio of companies that do not just offer growth and high returns but also durability, robust financial models, the ability to self-fund growth, and what we believe to be superior management teams.

We believe great investing requires a clear and proven philosophy, a disciplined process, and conviction. It also requires humility and a willingness to adjust one’s view when the evidence requires it— something we are always prepared to do. We look forward to keeping you updated on our views in future commentary.

Thank you for your interest in Polen Capital and the Global SMID Company Growth strategy. Please feel free to contact us with any questions.

Sincerely,

Maneesh Singhal and Rayna Lesser Hannaway

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.