12 May Fund Manager Focus – Walter Scott Gbl Equity Fd
Our Fund Manager Focus Newsletters focus on a fund manager within our investment portfolio and provide information to help our clients understand their investment philosophy and outcomes.
This newsletter focuses on The Walter Scott Global Equity Fund.
Introduction
As you may be aware we spend considerable time trying to create portfolios that will help you meet your long term financial goals. There are two parts to this i) ensuring maximum returns and ii) minimising risk. The definition of risk often depends on the conditions in which it occurs i.e. the risk that returns will not be enough, the risk that your capital may depreciate. There are always trade-offs in this regard, however we believe that building a portfolio on strong foundations can mitigate risk in the long term. Over all sectors, we try to pick investments that reflect this approach. The price of assets go up and down for various reason in the short term, however where a portfolio is made up of quality assets long term value should be recognised. We can think back to 2008 and see many companies were priced for disasters that never arose. To be fair, some never came back, but quality companies that kept growing and making profits, are in some cases trading at all time high prices.
The global equities sector is no different. While this sector lacks some of the tax advantages available to Australian companies, the range of companies and industries available for investment dwarfs the Australian market. Our approach to investing in this sector is, as suggested above, focussed on quality. Nevertheless we appreciate that different managers have different capabilities in term of the individual sub-sectors of global equities i.e. small companies, emerging markets, etc. We are also aware that there is a risk of overlap in respect of the holdings of various managers i.e. Nestle may be held by large company managers, yield driven managers, European focussed managers etc. In this respect owning three funds in this manner may just increase your exposure to the same company, albeit for different reasons. For the record Nestle earns nearly 40% of its revenue from emerging markets, making it even more difficult to ‘pigeon hole’ this company.
For these reasons our global equity portfolios tend to comprise a range of managers concentrating on specific sectors or themes. We have also tended to position a range of concentrated funds around 1 or 2 more broadly based funds. This helps to minimise stock overlap and provide exposure to a wider variety of companies. A concentrated fund will generally hold between 20 – 60 stocks with relatively high exposures to each company. A concentrated fund will thus tend to vary in performance relative to the relevant index or benchmark. In such a portfolio there is additional pressure to ensure quality research as stock selections that do not succeed will have a greater impact on overall performance.
About the Manager
Walter Scott is an Edinburgh based investment company that was established in 1983. While the company is now owned by BNY Mellon (a U.S. bank) the manager remains operationally independent. The fund is distributed in Australia by Macquarie Investment Management.
An investment team of 37 is led by Roy Leckie and Charles Macquaker, who have 17 and 21 years’ experience respectively.
Investment Philosophy
Walter Scott targets absolute long term real returns of 7% – 10% p.a. and believe the best way of achieving this is by investing in companies with high rates of internal wealth generation – that is companies that can grow their business in a profitably and sustainable manner. The manager will construct a diversified portfolio consisting of 40 – 60 stocks. These will be drawn from a pool of potential candidates that appear capable of generating strong internal rates of return. Risk is managed by focussing on companies that, amongst other things, have sustainable earning and strong free cash flow generation and avoiding companies with high gearing levels.
The portfolio will generally display considerable deviation from sector and geographic benchmarks. This is a result of the purely company driven focus of the portfolio construction. For example the fund has exposure to Spain, not because of the Spanish economy, but because the fund holds Inditex (the name behind Zara, amongst other brands). An overweight position in the IT sector is not a bet on the future prospects of the sector, but arises from research generated exposures to the likes of Adobe Systems. Interestingly, the fund does not hold investments in market heavy weights such as Apple Inc and Exxon Mobil, at this point in time, as they do not meet the manager’s criteria for inclusion in the portfolio.
Since inception (31 March 2005 in Australia), the fund has produced an annualised return after fees of 3.6% p.a., compared to the relevant index return of 1.00% p.a. over the same time period.
The following table illustrates the performance of the fund to 31 March 2013 (after fund manager fees):
The returns over the past year have lagged the relevant benchmark. However we believe this is a cyclical factor driven by the out-performance of lesser quality companies leveraged to global economic recover. We are comfortable in this regard as it provides us with confidence that the portfolio consists of higher quality companies with long term operational capabilities. The outperformance over the longer term is instructive when you consider the impacts of the events of 2008.
The following table indicates the current top 10 holdings of the fund. These represent a total of 21.3% of the portfolio:
We expect that while markets remain generally buoyant, this fund will tend to underperform the relevant benchmark. During down markets we would expect the fund to outperform as the broader market tends to ‘retreat to quality’ during market uncertainty. The fund will tend to have little overlap with the companies held by other funds in this part of the portfolio.
For most, the table above will contain a number of names that are unfamiliar (Novo-Nordisk may be familiar to Diabetics, Essilor to those of us wearing corrective lenses). Nevertheless we are confident that the rigorous processes of the manager will provide strong risk adjusted returns over the longer term.
We believe the fund blends well with other Global Equity funds by providing a concentrated exposure to companies with significant growth potential.
For further information regarding this or any other investment, please contact this office.