Dull beats sexy as virtue fund thumps 4IR in annual returns
• Will the cycle turn in favour of value or should we favour solid, dependable companies?
Investing in a global equity fund would have enhanced returns over the past year. Even the worst performer, PSG Global Equity, did no worse than its domestic counterpart with a 5% loss.
There is a clear distinction between the performance of value-orientated funds and those at the quality/growth end of the spectrum, though perhaps not as pronounced as a year ago. Absa Global Value, run by Schroders, is no longer in the red, giving a decent 8.2% return, in rand at least. The less nuanced Counterpoint fund, run by Sam Houlie, gave just 3%, though he claims he is no longer a deep-value zealot.
Investors are being rewarded for virtue, as the Old Mutual World ESG (environmental, social and governance) fund was the best performer at 22.5%. In this case dull beat sexy, as the team that runs the ESG fund, Old Mutual Customised Solutions, thumped Magda Wierzycka’s sizzling 4th Industrial Revolution Fund, which gave 13%.
Of course new clients will not benefit from any of this performance. Are we to believe that the cycle will soon turn in favour of value, or should we favour funds that are prepared to pay a (reasonable) premium for solid dependable companies with good brands?
To refer back to last week’s column, are growth managers no more than momentum junkies with limited intellectual underpins? That isn’t true of the Investec Global Franchise Fund, which is a good example of a well-run fund in the sector, With a 16% return over the past year it is comfortably ahead of the faddish fourth industrial revolution (4IR) fund.
In fact the only large IT share in Franchise’s top 10 is Microsoft, which even the value managers were buying in the poor Steve Ballmer years before the business was reinvented around the cloud. Fund manager Clyde Rossouw’s largest holding is Visa at almost 9% of the fund, and it is hard to see much threat to its duopoly with Mastercard in the global payments market.
Pieter Fourie, who manages the Sanlam High Quality Global Equity Fund, points out that quality investors are paying a record premium for the safety of strong balance sheets and reliable profitability.
The official MSCI Quality Index trades on an earnings multiple of 19, with the broad World index on 16. Fourie says we remain in an environment where slowing economic growth and pressure on margins make it tougher for companies to deliver on earnings expectations. The recent good performers have not been the traditional quality shares such as Coca-Cola and Unilever, so much as healthcare related shares such as Medtronic, Bayer and Allergan.
Fourie has also invested in a sector not all fund managers consider quality hotels through InterContinental Hotels. Medtronic makes devices such as the Pacemaker, which regulates heart beats. For obvious reasons, its clients are unlikely to desert it for some cheap and nasty competitor. Hardly the same as buying a noname porridge.
Bayer has suffered from the controversy around Roundup weed killers, inherited when it bought Monsanto. But this is now being settled and it sold its animal health business for a good price. Fourie bought Allergan and has no doubt become more familiar with its anchor product, Botox, as he approaches middle age.
InterContinental Hotels might seem an odd choice in the age of Airbnb but it is still underrepresented in the Asia region and its largest brand, Holiday Inn, remains the default choice for the American travelling salesman. The group owns few assets in its own right (it rarely owns the real estate, operating under a management contract) and is expected to show a 7% free cash flow yield.
Rossouw says the case for a quality portfolio is simple: it can compound investors’ wealth over time, helping them to keep their purchasing power intact. The Franchise Fund has been competitive in rising markets but comes into its own in moderate markets (with positive growth but less than 10% a year) and especially in falling markets. When the MSCI World has fallen, the cumulative total of negative months over the past decade has been 14.8%.Over those months the Franchise Fund has lost 5.4%.
A large part of what defines quality companies is competitive advantage. This takes the form of brands, licences and distribution networks. These companies are less prone than more cyclical and geared companies such as miners and banks to see a decay in those returns. It certainly reduces the randomness of investing; 72% of companies started with aboveaverage profitability were able to maintain this over a rolling five-year period. As quality companies are strong cash generators they have the opportunity to reinvest cash to maximise their potential and also to buy back shares when it is more appropriate.
They invest heavily in research & development as well as advertising and promotion to keep their products top of mind. And a big attraction is that they are much less sensitive to the economic cycle than the broader market. This helps explain the robustness of quality funds in a weak market, though the fund market might say their stock-picking skills should take the credit.
It is important that your fund manager screens these shares carefully. They can still pay too much. It is easy to be dazzled by sexy names, particularly in technology when core quality shares are often mundane. Look at Reckitt Benckiser with its portfolio of dishwasher detergents, roach killers and Harpic bleach. Those George Clooney ads for Nespresso might be glamorous, but Nestle makes money from more workaday products such as Gerber baby food and Maggi pot noodles. Quality and sexy aren’t quite the same.
THE RECENT GOOD PERFORMERS HAVE NOT BEEN THE TRADITIONAL QUALITY SHARES SUCH AS COCA-COLA
IT IS IMPORTANT THAT YOUR FUND MANAGER SCREENS THESE SHARES CAREFULLY. THEY CAN PAY TOO MUCH