This has been reflected in fairly buoyant equity markets so far this year and as the world economy recovers 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 though we would look to avoid shares of businesses that rely on a continued strengthening of the global environment in the event that these trends prove over-optimistic.
Out top-four themes influencing our portfolio construction now as we move to the close of 2013 are:
1) Positioning to cater for a broadly positive environment ahead
While 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.
2) Defensive tilt
With its defensive tilt our portfolio has limited exposure to industrials, consumer discretionary, financials, telecommunications and materials. Typically these sectors are highly capital intensive, and thus names in which we would not have exposure through any market cycle. We are moving away from highly leveraged and capital intensive industries, preferring those that 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.
3) 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.
4) 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 the potential for consistent share price returns over time.
This article was written by Clyde Rossouw, portfolio manager, Investec Global Franchise Fund
