We recognise the importance of growing investors’ capital and providing sustainable, inflation-beating returns over time. Our focus, therefore, is on compounding investors’ wealth over time, thereby helping them to keep their purchasing power intact. We see equities as the engine of inflation-beating returns over the long term, with global equities continuing to offer the best opportunity. South Africa is a small, emerging market largely dependent on exporting commodities, which in turn rely on the strength of global economic growth cycles. Selecting the appropriate offshore equity fund is key for South African investors to complement their domestic assets and bolster risk-adjusted returns. Here are ten reasons why investors should consider the Investec Global Franchise Fund.
Risk for us means a permanent loss of capital – our focus is on providing downside protection and avoiding losses that cannot subsequently be recovered. The Investec Global Franchise Fund has largely kept pace with strongly rising markets. But it is in moderate markets, and in particular falling markets, where we have historically outperformed. This has resulted not only in attractive outperformance over a full market cycle, but also significantly smaller drawdowns in down markets, as illustrated in Figure 1.
Figure 1: Average rolling 12-month performance
Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Source: Morningstar, 30.06.17. Returns are calculated on a lump a sum, NAV to NAV basis, net of fees with gross income reinvested, in USD. Market indices are gross of fees. The comparative index changed from the MSCI World Index to the MSCI All Country World Index from 1.10.11. Rolling 12-month periods since launch simulation date: 10.04.07. Highest and lowest returns achieved during 12 month rolling periods since launch simulation date: 28.02.10: 54.4% and 28.02.09: -38.7%.
The Fund recently celebrated its tenth anniversary. It has built an enviable track record of long-term outperformance at lower volatility than the MSCI All Country World Index (MSCI ACWI), as shown in Figure 2.
Figure 2: Ten-year risk versus return
Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Source: Morningstar, as at 30.06.17. Returns are calculated on a lump a sum, NAV to NAV basis, net of fees with gross income reinvested, in USD. Launch simulation date: 10.04.07.
Quality companies with enduring competitive advantages, in the form of intangible assets such as brands, copyrights, licences and distribution networks, have typically not only generated higher returns on invested capital (ROIC) than the market as a whole, but have also been less prone to mean reversion or a decay in those returns. These competitive advantages are most prevalent in the consumer staples, health care and technology sectors. This is where the Investec Global Franchise Fund is primarily focused, and it is these consistent businesses that we label ‘quality’.
Sustainably high returns have translated into strong performance for shareholders. Our analysis of MSCI All Country World Index data over 28 years (1988-2016) revealed that 72% of companies that started with above average profitability (as measured by ROIC) were able to maintain this above average profitability over a rolling five-year period. These quality companies delivered outperformance of 4.5% p.a. on average versus the market. This strong long-term performance is why we favour a quality approach – it maximises the probability of investment success for clients.
While profit figures can be manipulated and can mask the true operating performance of a company, cash flow is much harder to manipulate and is a truer reflection of business strength. Quality businesses are by their nature capital light, and require minimal capital expenditure to grow. As a result, the aggregate profits of companies in the Fund convert fully into cash, and the growth of that cash flow has been consistently strong over the long term.
Quality companies’ cash generation and balance sheet strength provides their management teams with flexibility. They can simultaneously reinvest cash, either organically or inorganically through acquisitions, to maximise future growth potential. And they are still able to return substantial excess cash to shareholders through share repurchases and dividends. Through active management of positions, and the capital allocations decisions made by the companies we own, the portfolio has been able to sustain high levels of profitability, at a significant premium to the wider market, as shown in Figure 3.
Figure 3: Superior profitability − return on invested capital (ROIC)
Past performance should not be taken as a guide to the future, losses may be made. Source: Investec Asset Management and FactSet, 30.06.17. Investec Global Franchise Fund re-weighted excluding cash and equivalents, since inception. The ROIC is different from the actual fund performance and past performance is not a guide to the future.
We are attracted to cash-flush quality companies that invest heavily in research and development (R&D) and advertising and promotion, as it bolsters product innovation and brand loyalty. We believe this not only contributes to future growth, but strengthens barriers to entry and protects these firms from competitive threats. For every one dollar of sales, companies in the Global Franchise portfolio in aggregate spend four times as much on R&D than the wider market, and still generate higher margins and a higher return on invested capital.
Quality companies are typically found in stable industries, generating sustainable recurring revenues driven by diversified, defensive and repeat business. These companies are not reliant on leverage to drive growth. In aggregate, the net debt/EBITDA1 of companies in the Fund is 0.8x, nearly a third of the MSCI ACWI (as at 31 May 2017). Combined, these characteristics have resulted in a defensive return profile, and low sensitivity to the economic and market cycle.
We conduct in-depth proprietary fundamental analysis of the stocks in which we invest, seeking to ensure that a company’s business model, financial model and capital allocation are aligned with the long-term interests of shareholders and other key stakeholders. Both qualitative and quantitative analysis are essential to fully assess the sustainability of a company’s competitive advantage, and a valuation focus helps to ensure we do not overpay for companies with the quality characteristics we seek.
In the context of longer-term history, valuations of the wider equity market and other asset classes, and the quality attributes associated with our stocks, we do not believe current valuations are stretched. We prefer free cash-flow and enterprise-value metrics, as a price-earnings ratio tells you nothing about the cash-generating power of a business or the strength of the balance sheet. Also, the earnings figure can be easily manipulated. When compared on free cash-flow yield and enterprise value to operating profit, the Fund’s valuation is in line with the market yet with a significant premium in terms of quality, as measured by ROIC.
The Investec Global Franchise Fund is a high conviction portfolio of leading global companies with strong business models capable of withstanding most economic conditions. We expect returns from select global equities to exceed domestic equity market returns over the medium to long term as South Africa’s growth is constrained and its currency does not reflect this. We are getting less excited about domestic-orientated businesses as they can’t compete with cash and government bonds. As a rand investor today, it is fair to say that the prospects for offshore equity returns are favourable given a vulnerable rand and the fact that the global opportunity set at our disposal is just so much larger than the domestic market.
1Earnings before interest, tax, depreciation and amortisation.
All information provided is product related, and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing, up to 10% of fund net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. The fund is a sub-fund in the Investec Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). Issued by Investec Asset Management, July 2017.