In circumstances such as these, investors' instinctive response should be to devote a large proportion of their overall portfolio to shares in companies best placed to deal with the uncertainty, and to continue growing despite the economic turbulence.
Identifying such companies is the key. For some investors, a low share price is reason enough to invest. However, this may not be the best approach: there are many examples where a low price mainly reflects a company's mediocre performance and inability to restructure effectively. In the last few years, dividends have become a key criterion as investors have searched for yield. But again, a company's generosity towards its shareholders does not provide any assurance that it will deliver long-term growth.
Fortunately, there is a financial indicator that allows an investor to gauge a company's ability to create value over time: it is cash flow return on investment, or CFROI. For a company to generate value, its CFROI must exceed its cost of capital. The wider the spread between those two variables, the greater its ability to create value.
This is where Swiss equities have a proven track record. Since 1988, the SPI index – which comprises all stocks listed on the Zurich stock exchange – has consistently outperformed the MSCI World index (in Swiss franc terms), as well as being less volatile. We argue that SPI's outperformance, over numerous cycles, is due to the superior ability of Swiss companies to create value, supported by a CFROI that is robust and stable over time.
The United States also shows a solid CFROI, primarily because the US market is heavily exposed to innovative technologies that rank among the main creators of value. Europe, meanwhile, is lagging behind, but that was not always the case. In the early 2000s, European markets had attractive CFROIs, although they tended to weaken during cyclical troughs. Since the 2008 financial crisis, Europe's sluggish economic performance seems to be preventing CFROIs from rebounding.
In Switzerland, although economic growth has remained modest, the resilience of some sectors with large index weightings – such as pharmaceuticals, healthcare services in general and consumer staples – means that CFROIs are still high.
That resilience is the result of the strategies adopted by Swiss companies, starting with their openness to international markets. How can a company from a small country with only 8.5 million inhabitants fulfil its expansion ambitions, if not by addressing the rest of the world in order to conquer new markets or relocate production?
For a long time now, Switzerland’s political and social consensus, which favours a liberal economic approach, has accepted foreign production. The benefits of that strategy have become especially obvious since it allows companies to mitigate, at least in part, the Swiss franc’s almost uninterrupted rise over the last 20-plus years. Another advantage of Swiss companies’ extensive international exposure is that their revenues are much more geographically diversified than those of companies in other countries. More than 90% of Swiss companies’ revenues come from abroad, with a good balance across all geographical zones and between developed and emerging markets.
The Swiss franc’s ongoing strength also requires Swiss companies to adapt on an ongoing basis, encouraging them to focus on innovation and to position themselves in niches where high entry barriers give them strong pricing power. This constant quest to add value is shown by the amounts that companies spend on R&D. In 2017, Swiss companies accounted for more than two thirds of the country’s R&D expenditure (CHF 22.6 billion). In terms of R&D spend relative to revenue, Swiss companies rank above Japanese and US companies and way ahead of European companies. These efforts are not restricted to the pharma sector. In consumer staples, for example, Nestlé devotes a much larger proportion of its revenue to R&D than its foreign rivals.
Similarly, Swiss labour is expensive, and so companies constantly strive to make their production processes more efficient. Far from being regarded as a potential source of workforce tension, cost control and productivity gains are regarded as crucial disciplines in Switzerland, and automation as a necessity.
Together, these characteristics mean that the “Swiss Made” label holds unrivalled appeal for both investors and consumers around the world. That appeal is increased further by the emphasis that Swiss management teams place on meeting the highest environmental, social and governance standards.
These key features also underpin the long-term outperformance of Zurich-listed stocks. The Swiss stockmarket is made up of high-quality companies capable of generating value over the long term and is particularly resilient, with potential risk-adjusted returns among the world’s highest. In today’s uncertain climate, these advantages deserve to be taken into account by investors. This is especially true since valuations in the Swiss market currently look reasonable relative to the US market, the global market and historical levels.
Eleanor Taylor Jolidon
Co-Head Swiss & Global Equity