Quality is the answer as cocktail of uncertainty haunts investors
• Resilience, balance sheet strength and competitive advantage are just some worthwhile traits
Investors face a seemingly endless list of global risks: the destabilising threat of escalating trade wars around the globe; high levels of debt across government, corporate and household sectors; political uncertainty; and potential contagion from recent events in Turkey and Argentina.
The initial boost to US growth from tax cuts earlier in 2018 is fading. In addition, while we believe global debt levels and late-stage cycle conditions are likely to hold back significant increases in inflation or interest rates, monetary conditions are tightening in the short term as central banks start to remove liquidity from the system.
The implications are farreaching for companies and asset prices. The bond markets are already reflecting a more uncertain outlook as yield curves flatten and credit spreads widen. Elsewhere, there has been volatility in currencies and commodity prices.
In equities, cracks are showing in some high-profile US technology stocks that have led what has been a relatively narrow market recently.
To add to the cocktail of uncertainty, increasingly disruptive forces of technological, social, environmental and demographic change mean there is much in the world to make investors nervous.
The market correction in the first quarter of 2018 is an important reminder of how quickly and significantly volatility can return to markets.
In these uncertain times, we continue to position our portfolio for resilience and structural growth by maintaining our focus on attractively valued quality companies. The characteristics that we seek in companies do not change: enduring competitive advantages, high and sustainable profitability, resilient and growing cash flows, low capital intensity and balance sheet strength.
In constructing the Investec Global Franchise portfolio, we have carefully combined the more established and defensive quality stocks with newer, quality opportunities that are offering faster growth.
Some examples of what we consider to be traditional quality companies are in the consumer staples and health-care sectors, such as Unilever, Beiersdorf, Nestlé, Johnson & Johnson and Becton Dickinson. They provide defensive attributes and have provided returns that are less correlated with the market.
They also offer sustainable and dependable growth as they continue to invest heavily in their brands and in innovation; position themselves in attractive categories, markets and channels; and, as global players, they benefit from key trends such as ageing populations, wellness and urbanisation.
We have also invested in a new “wave” of quality companies, still with the quality characteristics we seek, but with faster growth potential.
One example is ASML, which has a near monopoly position in the manufacture of lithography equipment, a critical component of computer-chip design and production.
Its global, dominant position and technological leadership gives it significant barriers to entry in an industry with huge growth prospects, particularly when considering trends in digitalisation, and new technologies in areas such as robotics, artificial intelligence, augmented reality and the internet of things.
Importantly, what these quality businesses have in common is the opportunity for structural growth, with a lower sensitivity to the economic and market cycle.
In these late stages of the bull market we believe portfolio resilience is more important than before. We maintain discipline by investing in quality companies at a reasonable price, not quality at any price. Valuations must be properly assessed in context, whether that context be the quality and growth characteristics one is paying for, longer-term history, the wider market or other asset classes. In our view, this helps protect the portfolio on the downside.
As the outlook ahead becomes increasingly uncertain, we believe our focus on attractively valued quality companies will serve our clients well in delivering strong risk-adjusted returns for the long term.
MONETARY CONDITIONS ARE TIGHTENING ... AS CENTRAL BANKS ... REMOVE LIQUIDITY FROM THE SYSTEM
● Rossouw is head of quality at Investec Asset Management.