First of all, what is a global leader? How do you identify them?
We look for companies with leading levels of value creation, as measured by the level and stability of cash flows compared with the investments necessary to generate those cash flows. These are often large companies, which have strong brands and which operate businesses with leading market shares around the world. We focus on high and sustainable cash flow return on investment (CFROI) when selecting companies. Additionally, we like to see exposure to growth opportunities: while tobacco companies typically have high CFROI, their growth outlook is, in our view, unattractive.
Which firms are your global leaders now? Which countries do they come from?
We seek out high-value creative companies operating in very different business sectors. The operations of the luxury goods company LVMH (Louis Vuitton), the leading insurance broker AON, and the payments company Visa have very little to do with each other, which allows high levels of diversification in our portfolios. Some sectors are struggling with value creation, notably capital-intensive sectors, such as energy, materials and telecoms. Geographically, the USA and Switzerland show the highest levels of value creation, and these markets have notably outperformed in recent decades.
Do you have any companies from emerging markets? Why/why not?
In the “global leaders” strategy we have an indirect exposure to emerging markets. Around 16% of the revenues of our companies are benefitting from typically higher growth rates. We prefer this indirect exposure to direct investments in EM companies, given the latter’s higher volatility and less attention to value creation, as well as to ESG-related issues at those EM-based firms.
Is there always a significant presence of US companies in the fund? If so, why?
As mentioned above, the USA and Switzerland have shown high levels of value creation, and have outperformed global equities, despite trading at higher short-term earnings multiples. More than others, US and Swiss companies are focused on capital efficiency, innovation and R&D spending. Many strong brands come from the US and the IT and healthcare sectors are home to companies with high and stable CFROI.
Are there any Spanish names like Inditex? Could they be included?
After a decade of rising CFROI levels, Inditex has seen some decline in growth rates, margins and CFROI over the last few years. Accordingly, value creation and share price performance had been impressive, but these have lost some momentum in recent years. The IT services provider Amadeus has delivered results that fit the concept well. The company has seen value creation at steady and high levels of 20% CFROI over the last decade.
Slower growth and the margin mix could lead to sideways performances for a while, but if they successfully deliver on the Travelclick acquisition and manage the transition from global distribution systems to IT solutions, the stock will be an ongoing value creator.
What opportunities does the strategy offer in a slowing growth environment?
The strategy has done well in such environments, as investors preferred the quality angle of high and stable value creation. The companies that are chosen are more resilient and have visible business models with larger market capitalisations and lower levels of debt than the overall market. The most relative performance versus global equity markets has been created in periods of sideways and volatile markets: the European sovereign debt crisis in 2011, the industrial recession in 2015 following the oil price drop, and the market slide in 2018 were all periods of relative outperformance. Also, during the overall rise in markets over the last decade, the strategy has been doing generally better than the market.
Have trade tensions impacted the strategy’s performance?
The fear of trade tensions has negatively impacted the more cyclical and trade-oriented companies, like the automotive sector. The strategy has no exposure here, so any solution to concerns about trade would be a potential temporary headwind for relative performance.
Which other risks do you face? How do you cover them?
While the quality focus should do well in a recessionary scenario, stock prices would still fall and relatively high earnings multiples may decline. In a rapidly improving macroeconomic and political environment, the strategy would still rise in value, but may lag sharply behind rising markets. Other risks are company-specific issues that lead to declining CFROI contrary to our expectations. We are looking for long-term, successful business models, and we analyse the 5–10 year investment outlooks rather than taking the short-term view of the next quarter’s earnings. This approach means we have a very low turnover; typically only 3–5 positions are changed in any given year.
How is the strategy performing this year? What do you expect for the rest of the year in terms of returns and opportunities?
2019 has been a strong year with solid absolute and relative performances. This follows a relatively good 2018, where the strategy held its ground against a market on a downward trend. The focus on quality stocks in the first eight months of 2019 was helpful; more recently the market has been reaching new highs by trying to buy the laggards, and the fund is close to its annual high. For the rest of the year, the current positive momentum could hold up, especially if supported by a turn in the still weak purchasing manager indices.
Co-Head of Swiss and Global Equity