Clyde Rossouw, Head of Quality at Investec Asset Management, explains his outlook for 2015.
What has surprised you most in 2014?
In terms of market performance the biggest surprise in 2014 has probably been the strength of the US stock market compared to most other markets around the world. In fact, it has been the only game in town; we have had a strong dollar and a great performing US stock market almost at the expense of everything else. We know that at the margin people have had the expectation that the US was getting better and that looks like it is running its course now.
How will ‘quality’ companies fare in 2015?
The ‘quality’ businesses we target have typically been able to create dependable, meaningful earnings growth in difficult market circumstances such as we have now, i.e. falling bond and commodity prices. Therefore, we would expect to see a similar consistency of earnings in 2015. In the past, when market participants have started to look for more dependability, quality assets have moved back into focus. As a result, we would expect a relative re-rating of such assets and that is typically the type of business in which we would look to invest in our strategies.
Where do you see the greatest opportunity in 2015?
We are focusing on two distinct categories: Companies that have pricing power and business models that are able to embrace ‘disruption’ risk.
Typically, businesses that have pricing power are able to put through inflationary or above inflationary rates of increases in their product prices. Tobacco is an obvious example: every year excise duties go up all around the world and even though the incidence of smoking is declining, tobacco companies have this pricing power mechanism built into their business model and are able to put up prices.
The other opportunity that we believe investors should focus on is businesses that have very strong market shares or business models that are able to embrace disruption risk. Technology is changing the way in which businesses have to operate. Therefore, investing in companies that are part of the disruption, but at the same time have very strong cash-generating business models, such as Microsoft, is, we believe, one way of offsetting some of the pricing risks that are at play in the market place.
What are the biggest risks to these views?
The biggest risk to any equity-based investment strategy would be if markets were to be just dismal and disappointing. We have had various episodes in the past, such as the financial crisis in 2008/9, where there was no obvious tailwind for stock market performance, and also in 2011, when there was a fear the euro zone might implode.
The biggest risk for us, therefore, is that even though we are invested in businesses that we think are more dependable in terms of their earnings, there could potentially be a significant drawdown because they are part of the equity markets.
How are you positioning your portfolio?
The businesses we invest in are typically of high quality. We also have sector preferences and have done a considerable amount of work looking at which parts of the market are able to produce companies that have intrinsically high quality characteristics. So, in terms of the natural leanings in our portfolio, we will always have a relatively high weighting in consumer staple names, certain parts of the pharmaceutical market and also within areas of technology. This does not mean that other parts of the market do not interest us, but generally they will have smaller weightings.
A cornerstone philosophically of the way we construct our portfolios is what some people would conceive to be inherent biases. But, based on academic evidence, we would rather invest in parts of the market where we believe we can maximise our probability of investment success.
In terms of individual stocks, our top ten holdings comprise a technology company, three pharmaceutical companies, a non-bank financial stock and a range of consumer staples companies with a specific focus on beverages, food, tobacco and home & personal care products. We still see opportunities across the board, but it is very much motivated by bottom-up opportunities and looking for superior businesses that have those key characteristics.