Please refer to our disclaimers, which can be found in the footnote of this page and here.
3Q 2024 performance was +6.1% net (vs. the MSCI ACWI at +6.6%). Since inception (1 Jan 2019), the portfolio has compounded at +18.2% gross / +15.4% net (vs. the MSCI ACWI at +13.4%), representing +4.8% gross (+1.9% net) annualised outperformance. Year-to-date, the top contributors were Salesforce, Alphabet, and Meta Platforms, while the top detractor was Charter Communications.
As mentioned in our prior letter, we increased our Charter Communications position during 2Q 2024 following the share price decline. The stock price rallied almost 50% into the third quarter, and we sold half of the position as it had grown too large in the portfolio relative to the quality of the business, despite the forward return remaining attractive. As outlined in our 1Q 2024 letter, we penalise the quality of the business due to its capital upgrade requirements, and because its moat relies on participants remaining economically rational.
We discussed Pinduoduo in our 2Q 2024 letter, noting that we had not acquired stock at that time. During the third quarter, a significant price correction occurred following the earnings call. Management highlighted increased competition (as discussed in our Alibaba update in our 1Q 2024 letter) and reduced long-term margins due to re-investment. They also ruled out short-to-medium term capital returns. Our conservative underwriting already accounted for these factors (particularly regarding the take-rate), so we used the price drop to build a full position. The stock has since rallied significantly due to China's stimulus announcements.
Pinduoduo is the only new position year-to-date. The cadence of investments we expect is about one new name per year, with a handful of adjustment trades each quarter where price movements, relative to value, are extreme. We are on track this year.
We’ve followed the global payments ecosystem for a long time. We are attracted to the secular tailwinds driving digital payments including the continued share-gain of cards over cash/check and the growing share of online commerce, where there is greater economic capture. We first began our work with an industry study where we sought to understand the duration of the secular tailwinds and how the power in the value chain was evolving. We may share this study in a future letter.
Our work led to two investments, Visa and Block. We think the card networks (Visa and Mastercard) will continue to maintain their dominance. While there has been some increasing power in other parts of the value-chain, and a modularisation of some of their services[1], these networks remain irreplaceable assets. We follow both Visa and Mastercard but prefer Visa on valuation grounds.
We observed increasing integration between point-of-sale (“POS”) services, gateways, payment facilitators, and merchant acquirers to provide superior software and data-driven value-added services such as fraud detection, lending, inventory management, payroll etc. Within this segment we have preferred those focused on small-to-medium sized businesses (“SMEs”) like Block. SMEs are more likely to seek a one-stop-shop payment solution leading to higher yields for the provider, with price less likely to be most important variable. In contrast, enterprise customers prioritise pricing, with large customers often appointing multiple providers to avoid lock-in and enable real-time payments routing to optimise cost. We looked closely at Adyen[2], for example, but did not get there on business quality for this reason (it’s unclear to us whether the business will commoditise). We landed with Block because it had a dual ecosystem of merchants in its integrated POS / payment facilitator business (Square) and consumers in its banking business (Cash App). We saw merit in the potential synergies between these two ecosystems and without this, Block would not have met our quality criteria. We discuss Visa in this letter and will save Block for a future discussion.
We first invested in Visa in November 2021 (see chart below). As the market declined, we used Visa as a source of capital to invest in stocks with higher forward returns. We reinvested in Visa in November 2023, due in part to worsening forward returns in other names.
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Crash Course in Payments for those Unfamiliar
Payment networks are built on a four-party model that includes the consumer, the consumer’s bank that issued the card (issuing bank), the merchant, and the merchant’s bank (merchant acquirer). When a card purchase is made, the card network routes the payment request to the issuing bank. Once the issuing bank authorises the transaction, the transaction is posted to the consumer’s account and the issuing bank pays the merchant acquirer less an interchange fee (the issuing bank’s charge). The merchant acquirer then pays the merchant less an amount called the merchant discount (i.e. the fees to all the facilitating participants including the interchange fee). Typical merchant discounts rates are around 2% for credit (closer to 3% online, or if involving payment-related software services on top, and cheaper for debit). The issuing bank takes the lion’s share given it assumes the credit risk in most transactions (unless the merchant isn’t using certain security measures). The other participants each take a small share. The card networks also coordinate the clearing and settlement information for the banks and offer various value-added services in the process, including real-time fraud analysis to assist issuing banks in the authorisation decision. The card networks also set the rules regarding payment disputes and will manage the dispute process as an added service if required. When payments are made online, card details are collected by a gateway (akin to the physical card terminal), which can be an independent company or integrated with either the merchant acquirer / payment facilitator or the card network.
Source: Goldman Sachs
Source: Goldman Sachs
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