Defining what constitutes ‘quality’ companies can be difficult for investors, but even fund managers can make mistakes, according to BlackRock’s Andrew Wheatley-Hubbard.
While Wheatley-Hubbard’s BlackRock Global Income fund has been a top quartile performer during the past three years and since launch in 2011, the manager said there have been times when he has mistaken a value company for a quality investment.
“Quality is one of these wonderful phrases that has no definition to it – it’s like saying someone is a good bloke – you can take that to mean whatever you like,” he said.
The most recent example was in the oil sector, which he believed had a number of attractive features, particularly among the lowest-cost producers.
“We asked ‘how do you get an advantage in those sectors?’ It has got to be through cost advantage,” the manager explained.
He had exposure to a couple of companies including a smaller commodities company that was attempting to diversify more into the oil industry – an area he liked for a number of factors.
“[Firstly] we felt that with OPEC in the market there was more a price setting mechanism to try and keep the oil price [stable],” he said.
“If you were to talk about commodity prices in general we felt that they were there as a commodity stabiliser – that was a mistake with hindsight.”
However, the oil price slumped from 2014 to March 2016, losing 75 per cent of its value and falling from more than $100 per barrel of Brent crude to just $25 per barrel at one point.
Performance of index over 5yrs
Source: FE Analytics
“Secondly, you had a lot of management teams who were very aggressively trying to get their costs down and really thinking about where their capex was going to go,” he added.
He said that the team took the view that once these companies had made their large outlays to get production on stream, their costs should be relatively low and therefore that gave a good entry point into the market.
These were two mistakes, he said, as first, the oil price was less stable than he thought and secondly, what he then discovered was a lot of the costs which he believed were going to be able to fall were not as flexible as he had originally thought.
“So once that became obvious we got out of about half our oil names completely and held onto the lowest costs ones and again with hindsight we held on too long,” Wheatley-Hubbard noted.
“The issue with investing in the way we do is that we tend to be a little bit slow to sell stuff because by nature you have to be focused on whether I am confident that this company is going to be able to sustain its dividends for the long term.
“The companies that we sold last are still paying the same dividends it is just that we now look at them and say I am not confident that the dividend will still be being paid in five years and at that point it doesn’t matter how cheap the stock is.”
The manager has learnt from this and is now focusing on three main themes when assessing companies – operational strength, financial resilience and cash returns.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
“Operations strength is basically whatever happens in the world you are going to be able to generate growth,” Wheatley-Hubbard said.
“Within that operational strength bit we think about what it is you want [and for us] we need to have growth and you can get that in many ways.
The first is through reasonable revenue visibility, with a premium put on companies with high recurring revenues from well-established long-term clients.
The other is pricing power which he said is particularly useful as it doesn’t cost companies anything. “You just put pricing up,” he noted.
The final concept is of growth opportunities. “You could be a brilliant business with phenomenal returns and massive market share exposed to a bit of the market that doesn’t grow and at that point it doesn’t matter,” the manager explained.
Turning to financial resilience, he said that he looks for companies that have good balance sheets and low levels of leverage that should help to sustain dividends through downturns.
“We don’t want stocks where we like them unless there is a recession, we want to own this company for the long term.
“So, when a downturn does happen, can they still maintain the cashflow to support the dividend? And secondly, having generated all that wonderful cash during the good times and the bad times, what do you then do with it and do you have to give it somebody else first? So that means sensible leverage and no expensive M&A.”
The fund is now mostly invested in consumer staples, which makes up almost 30 per cent of the portfolio, with 0 per cent in energy.
“We only want to invest in high quality stocks and within consumer staples there are some brilliant companies in there,” Wheatley-Hubbard said.
“Despite all the noise recently, we really like tobacco, we really like some of the food and HPC [home and personal care] companies that are exposed to emerging markets.”
Indeed, over the last decade the MSCI World Consumer Staples have outperformed the wider MSCI World index by 98.22 percentage points, as the below shows.
Performance of indices over 10yrs
Source: FE Analytics
“Quality to us is this idea of regardless of what is happening in the outside world can you just do you own thing and play your own game rather than being influenced by all these external factors,” Wheatley-Hubbard said.
“Within staples there are some that look expensive relative to the market but in aggregate staples have always been expensive relative to the market as they are better quality companies.
“We are happy to own great companies at a fair price because what we are trying to get is that dividend yield and growth.”