Clyde Rossouw discusses the quality investment approach in the current global economic climate.
Lindsay Williams: With me is Clyde Rossouw, who is the Co-Head of Quality at Investec Asset Management based in Cape Town. We are going to talk about Investec global allocation and ‘quality’ is a word that is often overused, Clyde, but if you have a look at the dictionary, it says here definition: “is the standard of something as measured against other things of a similar kind, the degree of excellence of something”. What does it mean when it comes to Investec Asset Management?
Clyde Rossouw: I think those characteristics are 100% spot-on when you think about the kind of companies that we would like to invest in. So again, in simple terms, there are three things that make a really good quality investment from our perspective.
The first one is the ability of the company to produce very high returns and that typically is a result of selling a product or service that is relatively scarce, relatively unique and therefore the company can charge a premium for it or it is sufficiently differentiated that it can actually earn good returns for a long, long period of time.
The second important point is that these companies must be able to produce sustainable cash flows over long, long periods of time as well. So the idea that you can think about this business as being relevant 5, 10, 15 years from now is also important.
Then, lastly, the company must be able to reinvest at pretty high rates of return into its own business in order to grow faster than an average alternative company that one could invest in. So those are the three things that we think are incredibly important to remember when you are looking for a good quality or high quality idea.
Lindsay Williams: Are these companies easy to find these days because, as I have said so many times to yourself and also your colleagues, we are very long in the tooth when it comes to a bull market in developed countries? So are the characteristics you have just described available these days or are they becoming more and more scarce?
Clyde Rossouw: Look, it is fair to say that the world is not overly well-endowed with a high number of really, really good businesses that have these durable characteristics and, as a result of that, we have always had fairly concentrated portfolios that we invest. So, typically, we have round about 30 stocks in our global portfolios, which I think reflects the degree of scarcity that we are talking about here.
So that’s a general point and then, in terms of where we are in the economic cycle, I think it is also fair to say that, whilst everyone has a different view in terms of where stock markets are going and some people believe they are going down, we certainly think that there is still a number of businesses that one can invest in where the economic fortunes are not 100% linked to the global vagaries of geopolitical tensions and trade and obviously some slowing economic activity.
So, in short, there are companies that one can invest in but one has to make sure that you find them at the right prices. We certainly are still seeing today that there is a sufficient number but it is not a very large – I mean you cannot construct portfolios with 80 or 90 companies that have these characteristics.
Lindsay Williams: You talk about the obvious – consumer staples, tech companies, healthcare and certain capital-light financials – but has it evolved from there as the bull market has continued its momentum? Have you started to look elsewhere?
Clyde Rossouw: Look, it is fair to say that, if you think about our definition of quality that I mentioned upfront, it is very important, as an investment manager, that you continue to look for these kinds of characteristics in all parts of the market and, if you also have a little bit of a focus on valuation levels in general, you need to make sure that you pay a fair price for what you own at the end of the day.
So there has been an evolution in terms of the way our portfolio has evolved over the course of the last 12 years since we started investing and we have moved away from consumer staples into other parts of the market. Consumer discretionary, technology, healthcare and even financials have certainly in the last couple of years been featuring more heavily and this, importantly, is not a change of the requirements or what we are looking for in terms of the characteristics of the businesses. It is a function of where we have been able to find these kinds of characteristics at a fair price and I think that is very, very important to understand.
Lindsay Williams: When you look at the presentation which you kindly sent me, it starts like this: “Global equity allocation, the need for durable, defensive and differentiated alpha”. Describe “durable, defensive and differentiated alpha” to the layman please.
Clyde Rossouw: Yes. Clearly, nobody invests in markets unless you are 100% committed to a passive portfolio to get the return of the index. So when we talk about durable performance, we are talking about outperformance with a high degree of consistency. So that is what we mean by durable, something that, hopefully, is going to persist going forward because of the characteristics of what we invested in.
In terms of defensive, we have looked at the way in which our portfolio performance evolves over time and, historically, we have been able to do better in tougher market conditions than in buoyant market conditions. I mean anybody can do well in a bull market (you just have to have some sort of exposure to those trends) whereas we typically like to participate in the bull markets but we don’t generally offer massive outperformance in those environments. So the defensive part is the fact that we do better in down markets, and have historically done so.
In terms of differentiated, I mean ultimately you want to make sure that, if you look at the source of outperformance over time, investors increasingly are not wanting to pay for so-called systematic biases. So they don’t want to pay for people who have been lucky by being exposed to the US stock market or being exposed to China or being exposed to some big themes.
They are wanting to pay for intrinsic opportunities where the analysis actually comes through in terms of performance and we found that, with a limited number of companies in our portfolio, so looking at currently 29 today, these are businesses that are not necessarily all related to one another and have unique drivers and therefore the return outcomes in our mind should be fairly differentiated. So we are not just sort of buying a theme or a sector or a country or certain trends. We are looking for things that generally are quite unique.
Lindsay Williams: Final question: would you say that your portfolio of 29 or 30 stocks is insulated from a potential downturn in the global economy and therefore a downturn in global stock markets?
Clyde Rossouw: I think, look, the best way of describing this, we ultimately are equity investors so there will be some degree of volatility in terms of the way in which the market prices our companies. Often that volatility is more so than what the fundamentals of the businesses we own changes. But what we have seen historically, that if you are looking to protect or looking to try and minimise the drawdown risk, which is sort of how much money can you lose any particular one day or down trading session which might last a couple of weeks in the markets, we have typically found that, by investing in businesses that have much less financial leverage and, in general terms, the companies in our portfolio are very close to having no net debt, and, secondly, by having very low stock market sensitivities, that is a good way to minimise your drawdown of capital in tough markets. And that is outside of typical valuation characteristics. Some people believe that if you own cheap shares, they will protect you on the down whereas we found that that is not always the case if those cheap shares are very risky.
So, in general, those have been the characteristics that our portfolio has displayed. We still have those characteristics in abundance in the portfolio today and therefore we would reasonably expect that, if market conditions were to continue to be difficult or there be unforeseen drawdowns, we will have the same performance characteristics we have had in the past and I think that is very important.
We made some reference in our document to how we have done during a variety of different drawdowns historically and, whatever causes the market drawdown, whether it is geopolitical, whether it is currency-related, whether it is macro-related, it doesn’t really matter. The performance signature has been quite consistent.
Lindsay Williams: Clyde, thanks so much for your insight. That is Clyde Rossouw, Co-Head of Quality at Investec Asset Management based in Cape Town.