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RLAM’s Rutter: It’s our job to buy companies nobody has heard of

13 September 2019

The manager of the Royal London Global Equity Diversified fund said it is also important to tell companies “we don’t believe you”.

By Rob Langston,

News editor, FE Trustnet

The highly competitive nature of the IA Global sector means anyone hoping to break into the small group of top performers needs to buy companies “no one has heard of”, according to Royal London Asset Management’s Peter Rutter.

The manager of £2.2bn Royal London Global Equity Diversified said the funds that have topped the tables in the sector “have all had it in the same way”, adding “they’re just in growth and tech stocks, basically”.

“We’ve good performance, but we’ve done it quite differently, with companies that no one’s ever heard of. But that’s good. That’s our job,” he said.

“You know, people give us their money to go and find these businesses and that’s what we’re trying to do.”

“To be successful, you need to do something different. That’s valuable because there are a lot of people competing in global equities.” 

Rutter said there are two actions that separate his process from his peers’.

The first is how the firm measures corporate performance using cash metrics to cut through any manipulation or distortion of accounts.

“It’s pretty interesting because we often see corporate claims about performance, but when you crunch it through our system, you just say, for want of a better phrase ‘BS, we don’t believe you,’” said the manager. “And that, for us, is actually a valuable insight.”

Its proprietary process allows it to compare companies in different countries with different accounting regimes, including some countries such as Japan where there is a “complete mishmash” of accounting standards.

“We convert all of those different accounting treatments back to a standardised set of data,” Rutter added. “And you can see why that is really valuable as an investor, because you end up being able to see things that other people might not.”

The second thing Rutter does differently to peers is place all global equities into a corporate life cycle framework, which assesses them on how they will perform throughout different stages of the business cycle, based on expected return on productive capital – or invested capital.

“You have early-stage innovation companies like Amazon, they make quite low returns despite an influx of capital, why? Well, they’re investing heavily in growth all the time, they don’t have huge returns on invested capital. But if they’re successful, their returns on invested capital increase.

“Alphabet is an example of a company we call a compounder, where it’s been really successful at innovating and now makes a really big return on invested capital.”

As such, Rutter said innovation can drive returns. But that can cause problems for companies at other stages of the corporate life cycle.


 

“Unfortunately, one person’s innovation is somebody else’s problem and competition,” the manager explained. “IBM is a really good example. It’s a decent business, but it’s just slowly fading, slowing and maturing. It’s actually had no organic growth now for about five years.

“It’s not collapsing, it’s just fading. And the reason why it’s fading is because Amazon, Alphabet, Microsoft, everyone is on the other side innovating.”

Performance of stocks over 5yrs

 

Source: Bloomberg Markets

He added: “Numerically, most companies are actually here, they make returns on invested capital at around the cost of capital. They’re not bad businesses, they don’t lose money, but they don’t have any excess profitability above what it costs them to fund their business.”

In contrast there are other once-innovative companies that Rutter said are now fading, as returns on capital go lower and sink below the cost of capital.

“The exciting thing is that this is a global phenomenon. Sony’s fade has been driven by Apple’s success,” he said. “Ten years ago, Apple was actually an accelerator and now it’s slowly maturing again.

“So you get these cycles of innovation and competition.”

Yet Rutter’s team takes the view that money can be made at every stage of the corporate cycle. It is possible to make money in a turnaround, for example, if the company turns around and you don’t hold it for any other reason

“You need to know the turnaround is going to turn around, otherwise it’s just a value trap,” said Rutter.

“You can make money with accelerators like Amazon, that’s pretty obvious but you need them to keep winning. Strangely, you don’t make money with accelerators if they just do okay. They have to keep winning because they’re often quite expensive when you buy them.”

He added: “If you think about why Amazon has done so well it’s because it’s gone from books, to DVDs and CDs, to general merchandise, to the cloud, to advertising, to retail: it’s just killing everything.

“But it needs to keep opening up new sources of innovation and disruption to keep outperforming.”


 

The firm’s research shows that the majority of US companies in the MSCI World – which has led developed markets higher since the global financial crisis – belong to fast-growing accelerators and compounders, given its dominance in the technology and healthcare sectors. Conversely, 75 per cent of Japanese companies belong in the turnaround and more mature business sectors.

In addition, the global equity team has uncovered a common misconception about emerging markets, said Rutter.

“People think about emerging markets as growth markets,” he said. “They’re not really. Most of the emerging market stocks are in the tail-end of the life cycle.

“The economies are growing but their corporates aren’t actually that innovative or growthy. They’re actually – in the main – later life cycle and they’ve performed like that, they haven’t performed like growth stocks.”

There is one market that the manager is not paying too much attention to: the UK.

“We’re bit on the fence now in the UK, definitely the fundamentals are poor and there are risks to the outlook,” he said. “But we think a lot of it is beginning to be factored into the price now. It’s one of the most shunned parts of global equities.

“There’s a lot of negativity around the UK. It’s not to say there isn’t a horrible scenario out there, but there are lots of other scenarios.”

 

While the Royal London Global Equity Diversified was launched late in 2017, Rutter has run the strategy for around six years in another vehicle.

Performance of fund vs sector & benchmark since launch

 

Source: FE Analytics

Since launch, the fund has made a total return of 22.49 per cent, against a gain of 21.17 per cent for the MSCI World benchmark and a 15.94 per cent return for its average IA Global peer. The fund has an ongoing charges figure (OCF) of 0.41 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.