U-WEN KOK, CFA 09-Jan-2019
Equity investors endured a bumpy ride in 2018, and looking ahead most pundits expect the elevated volatility to continue in the near term. After all, looming trade tensions, rising interest rates, and the possibility of multi-regional economic slowdowns continue to create headwinds. For global investors there are added hurdles as well. In fact, global equity investing is viewed by many as challenging, confusing and perhaps even downright intimidating.
We remain undeterred. As global investors who pursue opportunities across 196 countries in eight distinct global regions, we fully acknowledge the potential currency, cultural and sovereign policy obstacles posed by investing across borders. Yet we believe that the diversification and growth potential far outweigh any added risks. Adhering to strong risk protocols that stress quality-oriented companies at a reasonable valuation gives us the confidence to navigate any added obstacles we face as global investors.
But what, exactly, is “quality?” It can be a nebulous concept that holds different meaning for different investors. For us, it’s a simple belief that quality companies are those that should outperform over time thanks to three key attributes:
- Deploy capital at a high and sustainable rate of return
- Generate strong and predictable cash flow
- Demonstrate stable earnings growth, especially in a market downturn
So while some investors remain dubious of making a global allocation and others prefer a passive approach to the global equities universe, we believe that focusing on the above three quality attributes is a viable means to identify companies that may create shareholder value consistently. We think that stock selection based on these fundamentals will generate higher returns predictability over time. Consequently, we focus much of our efforts in understanding how businesses of these companies could perform under various market scenarios.
But don’t just take my word for it. Consider what the historical data shows for the MSCI ACWI Quality Index.* Of the 15 years in which the MSCI has tracked its quality factor data, quality companies have outperformed broader MSCI ACWI Index in ten of those years. Perhaps even more telling are the four down years – 2008, 2011, 2015 and 2018 – where the MSCI ACWI Quality Index has outperformed its broader parent index.
Thus, we think it’s hard to argue against using some sort of quality screen as a key ingredient to building a portfolio of global stocks. To find such companies, we score and rank every stock in our universe on many metrics, including those that assess company financials for their track records of efficient capital allocation, gross and net income profitability, earnings volatility and cash flow return on invested capital, among other items. Only then do we proceed to validate that these quality companies have sustainable, not transitory, prospects.
Looking across the global landscape, we see thousands of great companies to choose from without the hindrance of borders. The key is to have a solid stock selection methodology supported by a robust underlying risk management framework to help navigate the challenges. Any market volatility and economic dislocations in different regions and at different times simply present viable opportunities for active management. Moreover, we believe that making correct top down allocation calls or specific “country calls” can be immensely challenging and require unbalanced and unnecessary risk-taking. Therefore, we do not forecast sector and regional performance. In our view, stock selection—and specifically quality stock selection—can be far more impactful to overall fund performance than macro allocation.