The global market is second only to the US in terms of where it is most difficult for active managers to add value.
Data from FE Analytics shows the MSCI World index has made 138.71 per cent over the past 10 years, compared with gains of 103.55 per cent from the IA Global sector. Of the 137 funds in the sector with a track record of that length, just 43 have beaten the index over this time.
Sector vs index over 10yrs
Source: FE Analytics
This does not mean long-term outperformance of the index is impossible, though, and one fund that appears to be on the right track is Sanlam Private Wealth Global High Quality. Since launch in April 2008, the fund has made 218.68 per cent, which is 68.05 percentage points or 45.18 per cent more than the 150.63 per cent made by the MSCI World index over the same period.
As its name suggests, the fund aims to invest in high-quality businesses for long periods. While manager Pieter Fourie says he “doesn’t want to bore anyone” with his definition of a quality business, the latest note from the fund describes them as: “Companies that typically have sustainable competitive advantages supported by durable assets, significant free cash flow after capital expenditure, low balance sheet leverage and strong management teams.”
It further notes: “In our view these businesses have the ability to compound returns in excess of the market as a whole due to superior long-term growth rates and returns on capital.”
Fourie says it is important to note that a quality business is not just one that exhibits these characteristics over three or four years.
“These great quality businesses are difficult to find from scratch. It’s easy afterwards to say it was obvious Alphabet would be a great business 10 years ago but it’s trickier to identify them today and marry to that position for the long term to extract maximum value.”
Instead, the manager prefers well established businesses where he can forecast the future cash flow they will generate over a normal cycle.
“For example, you look at the many challenges companies like Coca-Cola and Dr Pepper face, but they have what we call a ‘wide moat’ and the ability to change their business.”
“They also have significant excess returns on capital and they will probably continue to have that characteristic for the next 40 to 50 years. That’s the type of quality we are looking for in businesses.”
Performance of fund vs benchmark since launch
Source: FE Analytics
One of Fourie’s key rules once he has identified one of these quality companies is not to sell too early – which can be difficult to square with his policy of refusing to overpay for quality if valuations are stretched in the short term. Instead he will trim positions, as was the case with Unilever recently.
“I think that if you look at a name like Unilever, it is looking fully valued. That doesn’t mean we will sell completely, although we have started to take some profits off the table at £40.”
“But we also think that over time the business has the ability to move to 20 per cent margins from 16 per cent, so although it has nowhere to go in the short-term, we don’t want to sell out just because it is fully valued. Mastercard is another example of a company that’s probably fully valued today but where there could be more growth going forward.”
The flipside is that Fourie does not invest in lower quality companies just because they are undervalued: he will take advantage of volatility to increase exposure to high quality companies that look cheap. He is helped in this regard by a maximum cash weighting in the fund of 22 per cent.
“We will use any political volatility to find opportunities. That’s exactly what happened to us on 24 June,” the manager explains.
“There was a huge fall in Diageo, its shares were down 9 per cent, so we aggressively bought it because it was perfectly de-correlated from a weak sterling. Anyone selling Diageo at that point was stupid because its bottom line benefits from a weak sterling.”
Fourie admits he doesn’t always get it right, however – and that when he gets it wrong it is because he has misjudged the business model.
“We were wrong with Rolls Royce but we were absolutely right to get out within 24 hours of the fourth profit warning,” he continues.
“That was a good decision, the stock has underperformed another 30 per cent since then.”
“Then what we do is we go and buy more of the companies we like. Often it leads to our second golden rule, don’t overpay for quality. If something’s cheap, there’s normally a reason for that. It takes plenty of years of experience to find that out the hard way. But that also means don’t overpay for quality at any price.”