Last updated: 16:15 / Wednesday, 11 December 2013
Investec Asset Management

Quality Franchises: Four Investment Themes to Close 2013

Quality Franchises: Four Investment Themes to Close 2013

Five years on from the onset of the financial crisis and reflecting on the evolution of markets in 2013, there has been general optimism. This has been reflected in fairly buoyant equity markets so far this year. As the world economy recovers, in our view, we expect markets to continue following the path of least resistance – upwards. That being said, there is always the risk that expectations rise too rapidly and stocks rise too quickly. We believe that investors should still be rewarded from holding equities, however, but to avoid shares of businesses like most banks that rely on a continued strengthening of the global environment in the event that these trends prove over-optimistic.

Below, we outline four top themes informing our portfolio construction now as we move to the close of 2013:

  • Positioning to cater for a broadly positive environment ahead - Whilst our portfolios are constructed on a bottom-up basis, we are mindful of the environment in which we operate. We hold  29 high-conviction ideas in the portfolio, which consist of time tested businesses that are steady compounders of cash flows.
  • Defensive tilt - Our high quality portfolio with its defensive tilt has limited exposure to industrials, consumer discretionary, financials, telecommunications and materials. These sectors are typically highly capital intensive, and thus names in which we would not have exposure through any market cycle. Informing our investment process is a belief in moving away from highly leveraged and capital intensive industries, preferring industries which are low in leverage and capital intensity, generate high free cashflows, with strong balance sheets and capital independence. We own only one direct Emerging Market share, Samsung Electronics, where the value in the share price is inconsistent with the dominance of the Franchise and the growth the business is producing and the investments it is making to extend its advantage over its peers.
  • Investing in quality global franchise businesses - Over the year to date, all companies in our portfolio have increased dividend payouts, nine companies have re-purchased shares and five have increased repurchases of shares. In addition, steady compounding of cashflows provides ongoing comfort with a compound growth rate of 11.4%. For example, Microsoft remains one of the best performing shares in the portfolio, up 26% year to date. In our view, Microsoft remains one of the few technology businesses that has managed to evolve and stay relevant in its market, and is in the midst of doing it again. We believe Microsoft remains attractively valued with a free cashflow yield of 10% and dividend yield of 2.9% as the market underestimates the growth prospects.WPP is a further example, as it continues to deliver robust performance. The proposed merger of its two biggest competitors, Omnicom and Publicis, sparked WPP to increase its focus on digital media and faster growing emerging markets, notably increasing its sales target. Capital allocation is also set to improve given the increase in the dividend payout ratio target from 40% to 45% over the next two years.
  • Companies with persistent returns, but receiving scepticism from the market - We maintain that quality is just as important as safety and safety just as important as price, making it crucial to consider strong durable franchises at attractive valuations. We have found that a strong franchise is a product or service that is able to resist the incursion of competition and consistently meet the needs of customers for decades. To us, businesses whose competitive advantage or franchise is dominated by intangible assets that will lead to high sustainable returns on capital and strong free cashflow are the definition of ‘quality’ companies. Our investment philosophy remains focused on low volatility, steady compounding of profits and consistent share price returns over time.

Column by Clyde Rossouw, Portfolio Manager, Investec Global Franchise strategy, Investec Asset Management

About Clyde Rossouw

Clyde is Head of Investec AM’s Quality Team and a portfolio manager. He focuses on multi-asset absolute return and low volatility real return equity investing. His portfolio manager responsibilities include our flagship Opportunity Strategy that he has run since 2003 and our two equity-oriented Global Opportunity Equity and Global Franchise strategies. Clyde joined the firm in 1999, initially as an asset allocation and sector allocation strategist.