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Two top managers share their ‘quality stock’ secrets

Two top managers share their ‘quality stock’ secrets

The hunt for yield has dominated discussions in fixed income circles, but what are leading equity investors after? Citywire Selector sat down with two top-rated managers to find out.

In this article, Investec’s Clyde Rossouw, who is Citywire + rated, explains why quality counts, while Citywire A-rated Wim-Hein Pals of Robeco argues that it is worth going outside of your comfort zone to uncover surprise outperformers.

Compounding champions

Clyde Rossouw, who is co-head of quality at Investec, says stock market prices remain stretched but a valuation discipline can unlock solid opportunities without over-paying.

As quality investors, we are focused on those rare companies with hard-to-replicate enduring competitive advantages, typically derived not from physical assets, but intangible ones such as brands, copyrights, licences, patents or distribution networks.

Quality companies are capital-light, financially strong and highly cash generative, with low sensitivity to the economic and market cycle. These attributes provide the potential for above-average long-term returns at below-average levels of risk. Importantly, in the current uncertain environment, these stocks provide defensive characteristics that can give some downside protection in the event of a market correction.

Given the unpredictability of the numerous factors at play, we continue to focus on these businesses, which are most prevalent in the consumer staples, technology and healthcare sectors. Our analysis shows that current free cashflow yield valuations are not out of line with longer-term history.

From a similar starting valuation 10 years ago, quality sectors were able to deliver around 9% per year total returns over the subsequent decade, more than double the wider market, and through a period that encapsulated the global financial crisis.

It is the compounding of cash flows that has enabled this, and we believe quality companies remain well placed to continue to benefit from this. The attributes of these types of companies have allowed them to compound shareholder value consistently through time at high rates of return and we see little reason to believe this will change dramatically.

EM opportunities

Robeco’s head of EM equities, Wim-Hein Pals, who is Citywire A-rated, believe it is too early to go fully on the defensive and brave investors can unlock quality investments in the developing world’s more robust markets.

Global growth and the inflation environment remain benign and, more importantly, traditional safe havens are very expensive. The euro, gold, US treasuries and German bunds, are all overpriced. One of the most attractive asset classes is the new safe haven ‘emerging equities’.

The equity markets of China and Russia are the most attractively valued in this space and the most unloved. In addition, the macroeconomic fundamentals of India are the strongest in the world, thanks to Modi’s reforms.

One common denominator in the bullish EM stock markets is accelerating earnings growth. China, in particular, witnessed a remarkable comeback after a period of earnings undershooting and this market is likely to become more important from a fund flows perspective.

Recently, MSCI decided to include domestic A-shares in their benchmark, which initiates a flow of billions of dollars to that market over the years to come. It is the combination of expected fund flows, superior earnings growth and still low valuation parameters, that make us most enthusiastic for equities in China, India and Russia.

This article originally appeared in the October edition of Citywire Selector magazine.

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