The last three years have seen major swings in sentiment and resultant performance between regions, sectors and currencies. Well entrenched momentum patterns were broken several times along the way and for active investors like ourselves, this presented very compelling opportunities.
As Global Equity Investment Analyst for the Sanlam Global High Quality Fund, the last year has been satisfying. From a total return point of view, the strategy reached new highs against the market, but interestingly hasn’t regained its previous highs from early 2022. Whilst past performance is not a guide to future returns it is this, the opportunities afforded to us by the equity market over the past 18 month to both invest in new companies and reduce or exit some of our winners makes the valuation of the portfolio even more attractive now. It offers a selection of companies at valuations still making sense against major equity markets like the US, where equity risk premiums have collapsed and now have to compete against alternative asset classes - which have been violently repriced.
The average investor is essentially driven by price momentum. As a team aiming to deliver excess returns beyond the index, this is precisely why we want to avoid “chasing trends”. In practice, it means that we are starting to question companies we invested in during very poor sentiment last year which now, along with the wider market, have seen aggressive recoveries. Our observation is that we see trends emerging similar to those in 2021 where the biggest stocks are also the best performers and investors are chasing them higher. We are leaning against this trend on a very selective basis, acting in a contrarian fashion last year when there was value in many quality growth companies.
Better value outside the US?
A further observation is that the rally from the October 2022 lows has resulted in many US mega caps like Apple, Microsoft and Google either being at, or close to their all-time highs. However, many high quality companies outside the US where sentiment became very depressed over many years for stock specific reasons have the ability for improved fundamentals and sentiment to continue to recover. We believe these companies could have growth prospects that are far larger over time than the ability of some of these US mega-caps to continue to grow at the pace they have historically.
This year 75% of the returns of the global equity market has been driven by the United States which in turn is largely driven by the mega size stocks. We believe these mega size stocks are quite expensive based on near term earnings estimates hence our decision to reduce names like Microsoft in June.
Should there be disappointments some of these mega size stocks leave little margin of safety given their valuations. It’s a conundrum for index investors this year, when the top few names trade on 3% free cash flow yield and have contributed the majority of the market’s returns - you could now have an opportunity to add alpha by not owning them.
In summary if you were a fundamental focused, intrinsic value investor like ourselves, you were buying great businesses like Intuit, Edwards Lifesciences and Thermo Fisher last year as they collapsed even though fundamentals only took a temporary back seat. Existing long-term holdings in good quality compounders like Alphabet, Yum! Brands and Microsoft were added to aggressively depending on the October to January time-frame where they reached their respective lows.
Fundamentals over interest rates
While we would not be surprised to see a significant setback in markets as the impact of higher interest rates flows through to earnings, we are not overly focused on such predictions. Instead, we just focus on fundamentals.
Two examples are worth mentioning – China sentiment took a turn for the worst in 2021 and yet we were buying very selectively in high quality companies we have owned before in the strategy such as NetEase and Yum China. Equity market volatility has always been a friend of ours, as we use periods of sentiment swings to act in the best interest of our investors. Just as sentiment reached a short term peak in January, we were selling Yum China after a 60% rally from the October lows. We also noticed later in the year how growth themes dominated initially from a tech/AI perspective then spilled over into other areas like medical technology and even industrials. It was on this basis that we exited Edwards Lifesciences when we believed the market again became very complacent on valuations.
Principles we followed during extreme market conditions:
Positioning – avoid unsustainable business models
Don’t overpay for quality companies, no matter how good the business
Secular growth industries are favoured, especially in a tough macro environment
Be prepared to act on an overreaction when bubbles get purged
The end result of being a fundamental quality investor is that you add the most value when things are at their most extreme, and we think we have reached some form of extreme again in the US in particular. The bifurcation of returns between the select few names dominating the global equity market’s returns this year however, and those left trailing behind leaves us excited for the opportunity to invest in high quality companies at compelling valuations.
Hannah Gooch-Peters spoke to CNBC in more detail on why she is betting on quality stocks over trends. You can watch the full interview here
Past performance is not a guide to future performance. Capital at risk when investing. Stocks mentioned are for illustrative purposes only and not a recommendation to buy or sell.
Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. A table with five years’ performance is available in the fund factsheets.
The Fund may invest in companies based in emerging markets which may involve additional risks not typically associated with other more established markets such as increased risk of social, economic and political uncertainty. The Fund has holdings which are denominated in currencies other than sterling and may be affected by movements in exchange rates. Consequently the value of an investment may rise or fall in line with the exchange rates.
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