Quality growth investors should beware that their chosen strategy is no safer than a value one – and this is according to one of its leading practitioners.
Gerrit Smit, manager of the $2.4bn (£1.7bn) Stonehage Fleming Global Best Ideas Equity fund, looks for attractively valued quality companies with a competitive edge.
To find these companies, he looks for four “pillars”: sustainable organic growth, a good management and culture, high returns on capital and strong free cash-flow generation.
This has proved to be a successful strategy, helping the fund deliver 226% since launch in August 2013, compared with gains of 160.1% from the MSCI AC World index and 142.7% from its IA Global sector. It also has a lower maximum drawdown than both.
Performance of fund vs sector and index since launch
Source: FE Analytics
Yet despite this strong performance during a period that has frequently been disrupted by bouts of volatility, Smit warned this does not mean quality growth is an inherently “safe” strategy.
“I'm not naïve enough to think that growth is less at threat than value,” he said.
“But on the condition that you do your research to identify sustainability, on balance you've got a better chance for a respectable return than trying to read short-term cycles and ride the value opportunities.”
The manager said this is the main problem with a value strategy – you not only have to buy in at the right time, you also need to know when to sell, which is often where people go wrong.
“Along with that, you make many more decisions with a much better chance of having some of them go wrong than you do in a growth buy-to-hold strategy,” he added.
In terms of the biggest threat to his strategy, Smit was not unduly worried about inflation, saying he believed the Federal Reserve’s claim that the current high level is transitory. He pointed to the recent pullback in commodity prices as evidence that it is being brought back under control.
And, although inflation is generally seen as more favourable for value managers over their growth counterparts, Smit said he welcomed the move upwards this year.
“Inflation before the pandemic was too low,” he added. “We know the Fed targeted 2% and couldn’t get it there.
“When everything is back to the proverbial new normal, we may well settle a bit above 2%, but for me that's comfortable, that oils the wheels of the global economy. That's better for economic growth than low inflation or deflation.”
He predicted the economic environment of the coming years will be characterised by spurts of strong growth, rising interest rates and outperformance from value.
“But I think these are probably going to be relatively short periods, we would be naïve to think that the financial crisis, followed by the pandemic, hasn't hurt the world economy,” he continued.
“And while the recovery now is fantastic, I'm not overly optimistic on high and sustainable economic growth. I think it's going to continue, but be pedestrian, which is obviously good for the bond market and therefore growth-oriented equities.”
The manager said he was worried about sociopolitical issues however, noting “a glass half empty scenario in Afghanistan could become quite threatening” and “what's happening in China is not comforting”.
“But the biggest threat would be investing in the wrong technology and not realising your technology is becoming obsolete,” he added.
However, he said this also represents an opportunity, with technology-driven businesses one of the dominant themes in his portfolio.
One example is Accenture. Although this is a consultancy business, Smit said three quarters of its consulting is now focused on helping early-stage businesses use the most appropriate technology, in areas such as cloud computing and cybersecurity, to drive themselves forward.
He added new and better technology is always under development, forcing clients to maintain Accenture’s services if they want to remain competitive.
“In essence it sells expertise, not products, not equipment, so it hasn’t got manufacturing costs: predominantly just the consultants it employs.
“It’s a very strong, sustainable, cash-generative type of technology company,” he finished.