Towards the end of a discussion on the demanding, bottom-up stock selection that forms the basis of the Investec Global Franchise Fund, portfolio manager Clyde Rossouw’s attention turns to his fund’s moderate risk level and its self-professed “high” annual tracking error of 4.3% over the past year.
Rather than feeling the need to justify such fundamentals, Rossouw says they are inherent in actively managed funds and serve to differentiate them from their passive counterparts. In other words, if they were not there, he would not be doing his job properly.
“If you are an active manager, then you do not simply want to replicate an index,” he says. “If you approached a portfolio like that, then you would not outperform the benchmark. Unequivocally, an actively managed fund is going to have some risk; we might underperform the market sometimes but we will never just give you the market – that’s for sure.”
Voice of experience
Rossouw’s confidence here should not be taken with a pinch of salt, coming as it does on the back of 16 years of running money at Investec throughout both its South African and international divisions.
His defiance of the MSCI All Countries World Index, against which the Global Franchise Fund is weighted, can be best seen through its majority holding in the consumer staples sector, last recorded at 48.2%, 38.5% higher than the benchmark and 28.1% higher than the next biggest sector, information technology (20.1%).
Rather than concerning himself with holding too many of the fund’s 30 total stocks in one sector, Rossouw takes the view that a good company is a good company, and that sector weightings should not inform purchases but should instead be a by-product of them.
“The reason we have so many stocks in the consumer staples sector goes back to the philosophy of how we run money,” he says.
“In 2012, we didn’t start the fund with the intention of having a certain sectorial bias or weighting towards anything in particular, we simply looked at where we had the highest probability of achieving consistent, compounding returns. And companies with these characteristics tended to come from the consumer sector.”
Staple diet
As an example of the benefits of consumer staples stocks, Rossouw points towards Nestlé, which is currently the fund’s second highest holding at 5.9% and has been in its top 10 stocks since inception, with its weight varying between 3% and 10% over the years.
He says Nestlé has been growing its top line by 5% to 6% for many years through a combination of operating efficiency, new products, an increasing global footprint, limited levels of debt and strong, free cashflows.
Despite these factors leading to attractive dividends, Rossouw says the perception of the company’s sturdy governance and gradual growth as “boring” has led many fund managers to look elsewhere.
“Many fund managers would not have Nestlé as a top holding due to a belief that it is expensive and samey,” he says. “Instead, they would use their analytical prowess to try and make money on a nine-month horizon. That is fine, but when you nest eggs for anything longer than 12 months at a time, the power of compounding comes through and that is where you make your returns.”
To demonstrate, he points towards his top 10 holdings, which include multinational consumer goods company Reckitt Benckiser (6%), technology company Microsoft (4.8%) and credit rating agency Moody’s Corp (5.1%). By and large, he identifies these as “big-return” companies, which require holding periods of six to 10 years to generate turnover of between 10% and 15% a year.
While the fund’s ethos is not against snapping up mis-priced stocks in a bid for high returns, Roussouw says this characteristic has in recent years become synonymous with internal business problems.
“Anything that is growing is not massively valued; that is the dilemma you have,” he says.
Search for yield
After consumer staples, the two biggest sector holdings in the fund are information technology and healthcare, at 20.1% and 16.2%, respectively. Financials comes in fourth at 6.1%, despite the fund only beginning to make investments into the sector in 2009.
Despite the growing trend for companies in these sectors to meet Rossouw’s requirement for good track records and steady growth, there is still a noticeable lack of stocks in the utilities, telecommunication services, industrials and energy sectors.
Rossouw’s reason for bucking the benchmark here lies in his belief that companies within these sectors tend not to generate a high, free cashflow and that they are too capital-intensive, rather than an aversion to the sectors themselves.
He points to the utilities sector, where companies are stringently regulated, have limited pricing power, spend up to 17% on capital expenditure and require large amounts of revenue expenditure to keep going. Ultimately, the companies can often generate very little money, he says.
“Some businesses in sectors in which we are less invested seem cheap initially but, when you look at their yield, it is inferior to the market. We do not see the logic for wanting to own stocks that do not generate growing, free cashflow schemes.”
The fund is also underexposed to emerging markets, with Rossouw claiming just 2% is directly exposed to the sector through its Samsung holding in South Korea.
High definition
The Morgan Stanley Capital Index says an emerging market must have a “significant” openness to foreign ownership and ease of capital inflows/outflows, a “good and tested” efficiency of the operational framework and a “modest” stability of an institutional framework. Meanwhile, a developed market must have “very high” capabilities in all these sectors.
When it comes to making investment choices, Rossouw says these definitions are too simplified to hold any weight when compared to looking at companies from a bottom-up perspective, regardless of their geographic positioning.
“The definition of developed and emerging markets is not clear cut. For example, Greece is a developed market and yet it is showing signs of submerging rather than remaining buoyant. Meanwhile, there are many emerging markets countries that are powering ahead.
“There is no substitute for a company with a good business model, even if it is in a slow-growth country. This factor will allow you to extract value.”
A major factor that turns the Global Franchise Fund away from companies based in emerging markets is their tendency to carry higher corporate governance concerns and volatility than those in developed markets, although Rossouw stresses that this is not a factor related to the emerging markets sector in general.
“We would love to own more businesses listed in emerging markets but many are less strictly governed as a result of the nature of their country’s independent regulator,” he says. “Additionally, we know currency has been particularly weak in some individual emerging market countries, for example, commodity exporters such as South Africa and Brazil.
“Typically, emerging market opportunities have much higher market beta and drawdown characteristics, and that does not appeal to us from a consistency-of-return perspective.”
