Global IMPACT 2021
Thank you for joining us at Global IMPACT 2021. Recordings and post event collateral is available below.
Jul 5, 2021
‘Quality’ is a term and an investment approach that has been increasingly adopted by investors in recent years given the proven long-term track record of this style of investing. However, wider adoption has also led to both inconsistency and impurity in the definition of ‘quality’ being used. In particular, the lines have become blurred with growth investing, as growth has outperformed other styles in recent years.
The Ninety One Global Franchise Fund reflects a purer and more consistent expression of quality that is focused solely on what we believe to be attractively valued best-of-breed ‘franchise’ companies. They have the following key attributes: hard-to-replicate enduring competitive advantages; dominant market positions in stable, growing industries; low sensitivity to the economic and market cycle; healthy balance sheets and low capital intensity; and sustainable cash generation and effective capital allocation.
We are often asked why we do not own any of the ‘FAANG’ stocks, when these companies seemingly display many of the quality attributes we seek, such as enduring competitive advantages and dominant market positions. The strength of these businesses is evident in the strength of their share prices but that does not necessarily make them right for our investment approach. We typically prefer our technology-focused businesses to have subscription- rather than transaction-based revenue models, as these are more consistent, dependable and less cyclical. We also seek high and consistent conversion of profits into cash, strong balance sheets, and exemplary capital allocation. In addition, we are mindful of business tail risks such as platform obsolescence, and regulatory risks around data privacy, antitrust legislation and taxation. Finally, even the best businesses don’t make the best investment cases as valuation is also a critical consideration.
One or more of the above issues currently prevents us from owning any of the FAANG stocks in our portfolio. Instead, our approach favours Microsoft, a Big Tech company not captured in the FAANG acronym. We believe it stands out as the best fit for our approach in the Big Tech space. Recurring revenue streams from its subscription-based cloud offering; a dominant market position in enterprise software with an entrenched global user base; over $50bn of net cash on the balance sheet; and sustainable cash-flow generation from its platform that can be scaled and monetised for many years to come, make Microsoft a compelling investment.
We favour businesses in the Financials sector when they exhibit capital-light business models, highly differentiated competitive positions, structural tailwinds, or preferably a combination of these traits. For that reason, we have held Moody’s for many years, a dominant player in the oligopolistic market for credit ratings, where brand recognition and trust are almost insurmountable barriers to new entrants. The market for independent credit ratings has benefited from a structural tailwind since the Global Financial Crisis, as banks around the world have de-levered and debt financing has incrementally shifted from bank loans to capital markets.
Charles Schwab is another financial stock held in the portfolio. We admire the customer-centric way in which Schwab manages its business. This approach and the continuous reinvestment in the customer experience have led to significant growth. Schwab now offers brokerage and asset management (among other investment services) to millions of customers, boasting over $7 trillion in client assets.
It is interesting to consider how specialised software players can provide attractive exposure to some end markets that themselves tend to be lower quality. For example, Autodesk – while exposed to the architectural, engineering and construction industries – displays many of the characteristics we seek. Autodesk has a leading position in a number of Computer Aided Design (CAD) software categories for commercial and industrial use cases. This, as well as interoperability across users and projects, results in an enduring competitive position. Following a cloud transition, Autodesk’s software is predominantly subscription based, resulting in less sensitivity to economic and construction cycles. We believe this portfolio holding has a long and profitable runway of growth in the years ahead, underpinned by the positive environmental and regulatory tailwinds. The business is highly cash generative, has a strong balance sheet, and a sensible approach to capital allocation.
Looking beyond short-term sentiment, we do not believe the environment has changed the fundamentals of the stocks we own. The companies in the Ninety One Global Franchise portfolio are still generating far superior returns on capital, but today are valued at a discount to the broader market not seen for 10 years.
We believe that our consistent purist approach to quality investing – captured in stocks such as Microsoft, Moody’s, Schwab and Autodesk – can continue to compound intrinsic value and therefore shareholder wealth, and this approach is well suited to both current conditions and for uncertain times ahead.