Why this emerging markets equity strategy is among the largest global investors in European luxury goods?

In the past decade, Invesco Developing Markets Strategy has invested considerable research — and capital — into the luxury good ateliers of Western Europe. While these companies are domiciled in developed markets, we believe they offer a uniquely robust structural growth opportunity that’s principally driven by the developing world, most notably China. Our wide-ranging approach to investing in extraordinary businesses that operate in emerging market (EM) economies has led us to this unique opportunity.

Today, we have approximately $3.9 billion invested (or 8.3% of the strategy’s AUM) ¹ in five luxury houses, which makes us one of the largest investors in this niche consumer discretionary industry. Three of these investments – Kering, Richemont and Prada – are particularly meaningful, representing 7.9% of AUM.¹

Why we are invested in these companies

We invest exclusively in businesses with characteristics of sustainable growth, durable advantage, and real options that we believe will unfold, often over many years. Rising affluence in the developing world coupled with the pervasive rise of social media (and in our view, the consequential social anxiety and desire this has created) are pivotal drivers of accelerated growth in the luxury good industry.

New geographic leadership. Luxury’s extraordinary pivot to China has become one of the most inexorable themes to EM investors, with Chinese nationals accounting for 35% of the global personal luxury goods purchases in 2019, up from merely 1% in 1995.² Structurally, China is on track to contribute approximately half of all luxury goods consumption by 2025.² In fact, mainland China has become the single largest growth driver for the luxury goods industry worldwide — it was the only region globally to end 2020 on a positive note, growing by 45% to reach €44 billion,³ driven by re-shoring of consumption with pandemic travel restrictions.

New channels. Amid consumers’ rising affinity for digital discovery, big online luxury retailers like YNAP, Farfetch and Tmall were offering the increasingly diverse luxury consumer base with comprehensive and tailored multibrand shopping experiences, with enhanced curatorial and fulfillment capabilities for customers. And more importantly, they were expanding the catchment area for brands given enormous distribution reach and better targeting data.

New models. Furthermore, innovative luxury resale businesses like the Real Real were also conducive to a more diverse and inclusive industry ecosystem, with circularity initiatives increasingly endorsed and adopted by socially responsible leaders like Kering.

We focus on durable advantages in the highly competitive luxury good industry

We are interested in structurally advantaged companies and are long-term investors in scarce, extraordinary brands. We’re not inclined towards investing in transient brand momentum (aka fashion trends). As mentioned previously, our significant investment in the industry is concentrated on three high quality companies that balance heritage with innovation, and marry creativity with rigorous industrial execution.

Scale has become increasingly critical in this business, particularly with the demise of traditional wholesale models (multibrand retail and department stores). As direct control over distribution has become far more relevant, operating leverage has increased across the industry. Despite the evolutionary shift towards digital commerce, we believe luxury goods will remain a retail network-oriented business with high-cost real estate in key global cities. Control of distribution — both in directly operated stores and through brand.com and e-concession businesses — is extremely important, both to maintain profitability in the short term and to maintain brand strength over time.

Scale is also important given heightened digital transformation investment requirements. These include higher capital expenditures to support digital channels and greater communication expenses to manage the increasingly fragmented digital communications channels.

Successful companies must consistently invest across the business to generate a positive feedback cycle of growth and market share gains, most notably in product innovation, multi-channel distribution and communications. After decades of relative operating stability, change is accelerating across the industry. These changes include:

• New consumers (China, millennials, Gen-Z) with different values and product and communication preferences (collabs, “drops,” streetwear, activism). Gucci’s stratospheric growth under Alessandro Michele illustrates that the winning brands in the industry are increasingly those that resonate well with millennials and respond to the new cultural values of the moment. Consumers demand intelligent and disruptive product projects like the Aria collection and Vuitton’s artist collaborations — which are subtler than simple co-branding, taking iconic pieces and molding them into something new. The younger customer cohorts have a completely different set of values and creative expectations around sustainability and inclusion. Balenciaga has overhauled the traditional norm of luxury communications, garnering high engagement through unconventional branding initiatives including launching an eccentric collection through video games and posting wacky yet enlightening social media content that is at the polar opposite of the carefully curated “shoppable” posts created by peers. 
• New, more fragmented digital communication channels. Social media and “influencer” endorsement models have expanded reach and awareness, but require constant “newness,” increasing business complexity. Gone are the days when fashion rules were made by the fashion editors, and when consumers turned to Vogue to learn how to dress and to follow the latest trends and hot brands. Most luxury brands are devoting more than half of their marketing spends to digital channels, as opposed to traditional print media and extravagant catwalks.
• New distribution. Higher capital requirements to wow consumers at the store (with events, exhibits, pop ups, exclusives) are coupled with substantial investments in omnichannel and multibrand digital commerce platforms. All this implies that the long-term winners will have to invest in gaining greater direct control of distribution — in both physical and digital channels — to both improve economics and sustain long-term brand strength. 
• New business transformation technologies to improve decision making and operational excellence — customer relationship management systems, analytics, merchandising, logistics, IT. And omnichannel initiatives that enable consumers to enjoy a more seamless experience (in store and online) and improve business economics by capturing greater consumer data to inform creative direction, collections and merchandising, and supply chain and inventory management.

Alongside sustainable advantage, we spend most of our research time thinking about real options embedded in the businesses we invest in. Real options are particularly visible in the long tail of smaller brands which are being increasingly nurtured by conglomerates. The transformation of many ateliers in the universe of French luxury goods specialist LVMH has been dramatic over the past decade of acquisitions — Loro Piana, Bulgari, and the consolidation of Christian Dior. We thought Kering and Richemont, the other two large conglomerates, demonstrated the same potential with brands such as Saint Laurent, Bottega Veneta and Balenciaga. We believed they had a wide tarmac of growth potential across geographies and product categories as conglomerate synergies were optimized over time.

Conclusion

We are investors in extraordinary business across the developing world. And in our view, some of the greatest brands in the developing world — including almost the entirety of the luxury goods businesses — are domiciled in Europe. We have become amongst the largest global investors in a clutch of these wonderful business that have the ingredients we look for across all our investments: durable growth, sustainable advantage, change and real options that we expect to emerge over many years.