Feb 23, 2021
2020 was an extraordinary year, with the global economy, society and markets all heavily impacted by COVID-19. Very few investors would have predicted during the market lows in March that global equities would end the year at record highs. Despite the rollercoaster the markets provided, the Ninety One Global Franchise Fund not only managed to protect investor’s capital but generated strong absolute returns over 2020 (15.3% in US dollars).1
During the sharp market sell-off in March and April, which caused the broader equity indices to fall by about 20%, our portfolio experienced a much lower drawdown. As markets started to recover (second and third quarter), investors became more selective over who the COVID winners and losers would likely be, and we participated extensively in the market upturn.
The last few weeks of 2020 was characterised by market exuberance and a large appetite for risk. Positive vaccine news, reduced political uncertainty following the US election and expectations of further stimulus measures in 2020 and beyond, sparked optimism that this would lead to a widespread economic recovery. In turn, we witnessed a rotation to more cyclical stocks, i.e. cheaper, more economically sensitive, lower-quality shares. Equity market indices across the world, including emerging markets, experienced a very strong end to the year.
Markets are awash with liquidity, continuing to fuel excessive risk-taking across equity markets and sectors. The Federal Reserve (the Fed) has injected a staggering $7 trillion into the US economy. Given the size of the US economy, (GDP of around $21 trillion), this represents very substantial support to the world’s largest economy. We’ve seen stimulus measures also in other countries and regions such as China, Japan and Europe.
Figure 1: Policy response from the Fed is unprecedented
US Fed balance sheet (USD billions)
Source: Bloomberg and Ninety One, 12 January 2021.
We are in an environment that favours growth assets. There is a significant tailwind from stimulus; the roll-out of vaccines brings a COVID recovery closer; and record-low interest rates seem set to remain in place as central banks around the world are committed to keeping rates lower for longer, Typically, in this part of the cycle, investors tend to value a very broad exposure to markets when an economic recovery seems on the cards. We also witnessed this after the Global Financial Crisis, and during the height of quantitative easing (QE) stimulus in 2013/14.
So, when the market becomes convinced that there is money to be made everywhere, then the attraction of owning high-quality companies that have defensive business models may seem less appealing to investors. But this doesn’t mean that we are going to change our investment strategy because we have seen that, over time, these businesses create an outperformance footprint that is attractive for investors. The average business within our portfolio delivers a 26% return on invested capital, relative to 16% for the average business in the MSCI ACWI. This means that, on average, our portfolio companies earn a return of 26 cents for every dollar of capital invested. That is much higher (1.6 times) than the average businesses in the index.
Figure 2: Superior profitability (return on invested capital) ROIC)
Past performance is not a reliable indicator of future results, losses may be made. Sources: Ninety One and FactSet, 31.12.2020. Re-weighted excluding cash and equivalents showing metrics of the constituent companies, since inception. Return on invested capital has been restated on a pre-tax basis to account for the 2017 introduction of the ‘Tax Cuts and Jobs Act’ in the United States.
Our Quality focus means that we do not always buy market favourites – if they do not meet our strict investment criteria. We typically like companies that have material barriers to entry, the ability to compound growth over times, strong balance sheets and reasonable valuations. We require a high degree of resilience from the companies in which we invest. Our investment team has successfully managed clients’ money through many different market conditions and economic cycles. So, we do not get sucked into the market hype of chasing stocks when valuations are stretched. Instead, we stick to our investment philosophy and process, which has enabled us to create long-term wealth for our investors on a consistent basis.
Tesla is now one of the top ten stocks in the world in terms of its market capitalisation (market cap), and benchmark index huggers may feel compelled to own the share. The company has no doubt done an amazing job in launching the electric battery car. While Tesla will likely take substantial market share over the next decade, it won’t have the marketplace all to itself. We believe other vehicle manufacturers will participate strongly in this segment and that the market will become quite fragmented. We think the current market cap of $375 billion is overdone, given the company’s lack of profitability, high debt levels, and questions around volumes and future market share. Essentially, investors are already paying for a de-carbonised world where the internal combustion engine is extinct and Tesla batteries have dominant market share.
Figure 3: Do profits actually matter to followers as long as the share price goes up?
Tesla in USD
Source: Bloomberg in USD as at 15 January 2021. Daily data over the last five years.
Apple has also enjoyed a fantastic stock market performance. We believe its valuations are stretched. Apple is still a hardware company – close to 80% of its revenue comes from hardware. How long will the 20/80 principle persist? Can the high-quality services business revenues (20%) keep on supporting its premium priced hardware products (80%)? To ensure more sustainable earnings, we believe Apple will have to transition its business model so that it earns a much bigger chunk from business services. It’s not clear how the company will achieve this.
Amid the current market exuberance, many investors are not paying heed to regulatory risks. We believe Amazon’s stock price does not reflect the material regulatory risk that the tech giant could face in 2021 and beyond. One of the biggest issues is whether regulators will demand that it separate out its first-party and third-party e-commerce businesses. The way Amazon runs its e-commerce platform can be likened to an environment whereby a fund manager controls the entire stock market, with the ability to see all the positions of every single participant, providing both products and pricing.
This is the kind of advantage that Amazon enjoys in the e-commerce space. The biggest reason why it has been able to get away with this, is because the antitrust and monopoly laws are not yet at a point where they address such a degree of monopoly power. We expect regulators across the world to play catch-up in 2021 and beyond, so this is an area that investors need to watch carefully. Will every single large-cap tech business be broken up? We think that is unlikely, but investors need to consider which companies are vulnerable to a regulatory shake-up and be very studious about what they own in their portfolios.
Global tax reform is another area to watch. Some global businesses could find themselves paying more tax as governments devise ways to get their slice of revenue from large multinational corporations. We believe global giants with unsustainably low tax rates may be particularly vulnerable to tax hikes. Importantly, the weighted average of the tax rate of stocks in the Ninety One Global Franchise portfolio is a healthy 26%, which is well above that of the MSCI ACWI.
Our exposure to the information technology sector has grown over time and currently comprises more than a third of the portfolio. While some technology companies are overvalued and may be vulnerable to regulatory risks, we are still finding excellent businesses in this sector. We have allocated the portfolio’s tech exposure to capitalise on some of the most exciting structural trends to develop within the sector over the past decade. Most notably, the rise of digital payments and cloud computing, which we access via our positions in companies such as Microsoft, Visa, Intuit, Autodesk, and more recently, Alibaba.
Intuit provides tax-filing and accountancy software to small businesses. As the recovery gains momentum and additional stimulus enters the real economy, small businesses should benefit, which in turn, will be positive for Intuit. Autodesk, which we added to the portfolio last year, produces computer-aided design software to the manufacturing, architecture, building and construction industries. We expect these sectors to enjoy a recovery in 2021 and beyond.
We recently initiated a position in Alibaba, a leading ecommerce and cloud computing services giant in Asia. Ecommerce in China is expected to continue its strong growth, reaching 30 trillion renminbi over the next five years. This expansion is being driven by the offline to online shift, an increased spend per user (thanks to a growing middle class), high-density living and superb delivery infrastructure. China’s cloud computing industry is expected to grow 26% over the next five years. Alibaba has the first mover advantage and enjoys a leading market share in both these long-term structural growth industries.
It is interesting to note that our direct stock exposure to China is the highest it’s ever been, amounting to a portfolio weighting of more than 8%. For long-term investors, more opportunities to access excellent businesses in Asia are emerging. The universe of quality stocks in the region has become much more diversified by geography and sector than it has been historically. This has enabled us to obtain exposure to long-term structural growth, with limited exposure to cyclical sectors dependent on the economic cycle.
We remain comfortable with the balance and positioning of the Ninety One Global Franchise portfolio. Besides exposure to structural growth trends, we maintain a material holding in more defensive areas of the market. Global equity remains a key driver of asset class returns for our flagship Quality SA multi-asset funds, namely the Ninety One Cautious Managed and Ninety One Opportunity Funds.
Figure 4 shows the strong cumulative outperformance of the Ninety One Global Franchise portfolio over time with short-term periods of relative weakness – driven in part by stimulus-induced reflation trades.2 These can be short-lived, if led more by sentiment than fundamentals and not supported by long-term sustainable growth. This has been the case on several occasions historically, and current uncertainty again gives us reason for caution. Our Quality investment approach has a proven ability to outperform over the long term, and the current opportunity remains attractive in both absolute and relative terms.
Figure 4: Ninety One Global Franchise alpha cycle
|1 year||3 years p.a.||5 years p.a.||10 years p.a.||Since Inception p.a.*|
|Global Franchise A Acc||15.3%||11.8%||11.6%||10.6%||7.9%|
|MSCI AC World NR**||16.3%||10.1%||12.3%||9.3%||5.8%|
Past performance is not a reliable indicator of future results, losses may be made. Source: Ninety One, 31.12.2020. Performance is net of fees (NAV based, including ongoing charges, excluding initial charges), gross income reinvested, in US dollars. *Inception date 10 April 2007. The performance is based on the OEIC Ninety One Global Select Equity Fund from 10.04.07 which then merged into Luxembourg-domiciled Ninety One Global Franchise Fund on 4.07. 09. **Fund Benchmark: MSCI AC World NDR (pre Oct-11, MSCI World NDR). Highest and lowest returns achieved during a rolling 12 month period since inception: Feb-10: 54.4% and Feb 09: 38.7%. The Fund is actively managed. Any index shown is for illustrative purposes.
1 Morningstar, dates to 31.12.20, NAV based, (net of fees, excluding initial charges), total return, in US dollars. Highest and lowest annualised returns during a rolling 12-month period (10 years): May-11: 27.5% and Dec-18: -4.5%.
2 “The term is used liberally to define an uptick in growth and price pressures after a broad contraction.”, Bloomberg, “What’s a reflation trade, and who wins and loses?”, 8 January 2021.