Metronome Capital, the London-based long/short equity manager led by former Lehman Brothers banker and Parvus Asset Management partner Sharif el Khazen, is flying high – powered by a mix of long conviction trades in European luxury brand names and a cluster of short bets on assorted declining sectors.
Metronome Capital, the London-based long/short equity manager led by former Lehman Brothers banker and Parvus Asset Management partner Sharif el Khazen, is flying high – powered by a mix of long conviction trades in European luxury brand names and a cluster of short bets on assorted declining sectors.
Launched in January 2014, Metronome’s strategy made 17.58 per cent last year – its sixth successive year of positive gains. On a three-year basis, the fund has annualised 10.7 per cent, while its annualised return since inception is 6.93 per cent.
The portfolio comprises concentrated long and short positions in a range of predominantly European stocks, with selected pockets of US exposure.
It has a particularly strong focus on luxury goods, and it is this sector – which currently accounts for between 15 to 20 per cent of the investment portfolio – which has contributed handsomely to the fund’s performance.
“Luxury had an amazing year,” explains chief investment officer el Khazen, who spent five years at TCI-affiliated equity hedge fund Parvus before striking out on his own with Metronome, which today manages just under USD100 million in assets. “You have a structurally growing industry and, within that, a group of companies that are structurally growing their market share.”
On the flip-side, the fund’s short bets remain focused around a mix of grocers, telecoms companies, restaurant outlets, postal services and cinema chains – mis-priced companies “that structurally destroy value for their shareholders”.
Brand values
Setting out his broader investment philosophy on luxury, el Khazen points to the more than 100-year legacy of dominant players such as Hermes, Chanel, Louis Vuitton and Gucci in a sector where barriers to entry remain prohibitively high. “To recreate that heritage today is extremely difficult – probably impossible,” he explains.
This perspective ultimately underpins Metronome’s conviction plays in companies such as LVMH, Kering, and Moncler – firms described by el Khazen as “market share takers”, whose leading brands offer sustained desirability and returns-on-invested capital (ROICs) around 50 per cent.
“Generating returns in luxury was much more about selecting the right stocks, rather than just buying the overall luxury sector. In the past three years, the industry’s growth rate did not accelerate – but those market share takers dominated the competition,” he observes. “Last year, LVMH was up 63 per cent, while Kering was up 45 per cent, and Moncler was up 40 per cent. These are some of the companies that have performed very well since we launched in Jan ’14.”
Expanding further, he describes LVMH and Kering as well-run, founder-led businesses, boasting long-term investment horizons and each with a growing stable of formidable brands and divisions.
Kering’s flagship brand is Gucci, followed by Saint Laurent and Bottega Venetta, with a collection of smaller, younger brands – including Balenciaga, Alexander McQueen, Brioni and Boucheron – being primed for future expansion.
LVMH – formed from a merger between Louis Vuitton and Moët Hennessy – has enjoyed surging growth in its fashion and leather goods and perfumes and cosmetics divisions, with a burgeoning interest in high-end hospitality. The group has recently bolstered its presence in luxury jewellery with the acquisition of Tiffany & Co.
“These companies invest in their businesses and brands in a pretty consistent manner, which leads to mechanical market share gains,” he continues. “They have a huge capacity for investing, which in turn leads to structural market share gains and consistent above-GDP-type growth. Even in downturns, they may slow down, but demand proves resilient.”
Elsewhere, Moncler – which specialises in niche luxury outerwear, with its roots in skiing and mountaineering – offers a slightly different investment case for the fund. It has benefited from a strong management team, which has elevated the brand’s positioning, coupled with a selective retail strategy and frequent use of external creative collaborations – or ‘Genius Drops’ – with different designers, says el Khazen.
“This has attracted a lot of new customers to the brand. Almost half of these customers have come as a result of these ‘Genius Drops’. It has powered growth in the past two years.”
Fresh challenges
“In the long-term these companies are close to bulletproof – there are so many drivers that mean that these businesses should do well for the next 10, 20, 50 years. But obviously there are short-term risks,” el Khazen concedes, as talk turns to potential risks and challenges facing this market.
He pinpoints a possible squeeze on Asia-based growth, stemming partly from the effects of the still-unfolding coronavirus outbreak.
“On the one hand, the vast majority of the growth in the past decade has come from the Chinese consumer, which has represented 70 to 90 per cent of incremental industry growth,” he says, pointing to the close links between the luxury and the travel industry.
“On the other hand, roughly 40 per cent of the world luxury market is based on tourism, the remainder being local demand. So when you have something like the coronavirus that brings together travel and the Chinese consumer, it is the worst possible scenario in the short-term for luxury companies.”
While the ultimate impact of the coronavirus outbreak remains unclear, el Khazen draws comparisons to the 2003 SARS outbreak – which depressed growth in the sector for several quarters before pent up demand led to a rebound.
“If it’s a six-month situation, with quarantine and travel restrictions, it will heavily impact Q1 and Q2 growth,” he says. “The Chinese consumer represents roughly a third of the luxury goods industry today, so if there is an abrupt slowdown in Chinese travel and spend, that’s a short-term risk.”
Nevertheless, el Khazen maintains a longer-term perspective, and believes current concerns surrounding the virus will not alter Metronome’s view of the companies or the investment case for the sector.
“Our strategy is based on identifying high-quality businesses experiencing a short-term headwind,” he adds. “When we entered these positions between 2014 and 2016, there was already a China-related short-term headwind – the anti-corruption drive from the government, which aimed to clamp down on the practice of gifting officials with expensive items. That impacted growth.
“The quarterly numbers may disappoint, but if these stocks move irrationally then we will view it as an opportunity to increase our exposure to the sector, comfortable in the knowledge that these businesses are resilient and at some point, they’ll recover.”
It is this approach that also frames much of Metronome’s approach to its short trades. “We look for companies that struggle to generate cash with very low returns on invested capital,” he adds. “We try to identify structurally-challenged industries undergoing some short-term tailwind, surpassing expectations and exciting the market for a few quarters, but which will be in a different, worse state ten years down the line.”
