An excerpt from an interview with Matthew Benkendorf, Vontobel’s chief investment officer and portfolio manager of the Virtus Global Opportunities Fund.
The Global Equity strategy outperformed the MSCI All Country World Index in the second quarter. Can you discuss what drove returns?
Our long-standing overweight to the consumer staples sector was a significant contributor to returns over the quarter. The stability and consistency of earnings of tobacco companies were well sought by investors after the risks and uncertainty that resulted from the Brexit vote. Our investments in Altria, British American Tobacco, Reynolds American, and Philip Morris International were drivers of both absolute and relative performance.
We are also finding growth in the financials sector, but not in big banks. Our stock selection has been critical in this space. Avoiding global “systemic” banks, where returns have been weak, and focusing on non-bank financials, has helped our Global Equity strategy. For instance, American Tower Corporation, a real estate investment trust (REIT) with 67,000 cell towers located in the U.S., India, and Brazil, has done well this year and we expect to see growth from its international exposure. We also own companies such as Progressive (insurance) and CME Group (derivatives exchange) which have seen only limited revisions to earnings per share estimates this year, while traditional banks are suffering sharp downward revisions.
Our Indian financial holdings, Housing Development Finance Corporation and HDFC Bank, performed well this quarter. We continue to maintain our conviction in these holdings, which have been long-term investments in the Global Equity strategy. HDFC Bank, with a conservative approach to lending, has outperformed its state-owned peers. With low non-performing loans and consistent loan growth, it is continuing to take share of the market. Housing Development Finance Corporation’s (HDFC) share price also increased over the quarter as the market was relieved to see that its loan growth remained solid around 14%, as well as being reminded of the value of HDFC's other businesses following the sale of a 9% stake of HDFC Standard Life Insurance to its JV partner Standard Life and announcing plans for a possible IPO of this unit. We believe HDFC’s future growth will benefit from the long-term demand growth for mortgages as India urbanizes and incomes rise.
Sometimes what you don’t own can hurt the strategy from a relative standpoint. How has your lack of exposure to telecommunication services and utilities impacted the Global Equity strategy over the quarter?
Bond investors are gravitating to higher-yielding equities, particularly to the safe-haven utilities and telecommunications sectors, as a substitute for bonds that have paltry or even negative yields. These sectors were particularly strong in the first quarter and rose further in the second quarter. Our Global Equity strategy has no exposure to these two sectors and we continue to find better opportunities in consumer staples names, select financials, and elsewhere. Our lack of exposure detracted from performance as a result.
Energy and commodities continued to strengthen over the quarter, which for the most part negatively impacted the Global strategy. What is your view on these and other cyclical sectors?
We maintain the same view as we have in the past. We find that most cyclical companies, mainly in the energy, materials, and industrials sectors, are known for their commoditized businesses, high capital intensity, and some of them may be heavily impacted by movements in commodity prices. They typically have volatile, unpredictable earnings and pose a greater risk to absolute returns. Given their attributes are generally inconsistent with our investment approach, we currently do not have any energy or industrials exposure, and less than 2% of the strategy is invested in the materials sector.
What changes have you made to positioning of the Global Equity strategy?
We are finding some new companies, but at the same cadence that we've found names historically. These moves are more glacial, and evolutionary, as we try to optimize our capital. We initiated a position in TenCent holdings, a Chinese information technology company sometimes referred to as “China’s Facebook.” We’ve held this position across some of our other strategies. Consistent with our bottom-up approach, we are not taking a view on China, but rather buying a strong business that we believe will benefit from increased trends in consumer spending and online advertising, despite persistent negative headlines on the Chinese economy. We expect Nike, another stock we purchased, to also benefit from high growth potential in China. Nike is an American household name that designs, develops, and sells athletic shoes, plus a host of sports clothing and accessories. It’s a multinational corporation that we believe is poised to take advantage of a shift in distribution from wholesale to B2C (business to consumer). And, we like that it continuously innovates its manufacturing processes. Lastly, we exited our position in health care company Bayer over the quarter due to its proposed merger with agro-chemical company Monsanto. We generally tend to shy away from large, transformative acquisitions and this deal in particular appears to be dilutive to earnings for at least the next few years.
The Global Equity strategy has been successful over the last five years, in terms of alpha generation and low standard deviation of returns. To what do you attribute this consistent performance?
Our Global Equity strategy, which represents our highest competition for capital among all of our strategies, has performed well historically. While it represents the broadest geographic exposure, it is not simply a conglomeration of all the underlying geographic strategies because it is managed in a very concentrated style. We compare each company, name for name, to find the best businesses to gain entrance into the strategy, so it truly encompasses the best ideas across our regional strategies. That said, over every quarter or year, it won’t necessarily be the highest performing strategy because at different times there can be market gyrations in different parts of the world. So, emerging markets may perform well for certain periods of time, Europe might do particularly well, or perhaps the Far East or the U.S. but, over a long period of time, for it to be successful, certainly our Global Equity strategy needs to have those attractive, consistent characteristics to it.
Given the competition for space within the strategy, what makes for a higher weighting among stocks, e.g., a five percent weighting versus a one percent weighting?
First and foremost, it's our conviction in the company. What is our conviction based on? When we think about strategy position sizing, we visualize three points of a triangle, with the top point being quality. We always weight the most capital behind the best business we can find, all else being equal. We will allocate more behind a business with better fundamentals, a wider moat, and higher economic returns. To us, that's just common sense. Second, we look at the underlying growth of the business. We aim to translate the growth potential of the business into strategy returns. And third, we consider the company’s valuation, which is, of course, connected to its growth. We ask ourselves: how fundamentally undervalued is this business? We believe the first two points are the most important. Quality companies make a strategy more durable and sustainable over time. Growth levels should not be underappreciated. Only great businesses grow at an attractive rate.
Approximately 61% of the Global Equity strategy is in the U.S. market, 11% in Switzerland, and 9% in the U.K. Is that a fallout of where you find stocks with sustainable earnings growth?
Yes, it also speaks to the multinational nature of businesses in those countries. Switzerland is a very small economy and naturally a lot of businesses long ago had to find markets outside of Switzerland for growth and survival. The U.K. has a similar story given its history of positioning British brands and businesses around the world. And, the U.S. is clearly the epicenter of innovation, in technology and across other business models. It's natural that those businesses tend to be very global in nature as well. Global, diversified businesses with multiple growth drivers tend to have higher elements of predictability and stability over economic cycles. That said, everything we own does not have to be global. We do own some very market specific or geographically focused businesses so long as they are quality growth companies.
The way you look at risk is rather simple, where you focus on the business first. Can you elaborate on that?
As bottom-up, fundamental equity investors, our approach to risk management is primarily to focus on investing in companies that are dominant franchises in stable, predictable growing businesses with pricing power, strong balance sheets, steady demand, low leverage, low capital intensity, and transparent accounting practices. These types of companies tend to have growth, with less volatile earnings and share prices. Based on the business characteristics we seek when making an investment, we tend to find more of these types of companies in the consumer staples sector, historically as well as today. Consumer staples represents a very meaningful exposure across all of our strategies.
By investing in stable businesses, we believe we can effectively control risk in our strategies. But, we further mitigate risk by evaluating the correlation that exists among the stocks in our strategies. We seek to reduce overall strategy risk by meaningfully diversifying the earnings streams of our holdings, as opposed to making nominal allocations across sector or regional buckets.