ROIC and concentrated portfolios – An Antidote to Short-termism

By Pirkko Juntunen, NordicInvestor

Long-term investing is somewhat of a buzzword nowadays. Yet few investors or companies are immune to the prevailing quarterly-reports culture. The Global Equity team led by Nadim Rizk at Fiera Capital, the Montreal-headquartered asset manager, however, believes that his team’s long-term buy-and-hold strategy is one of its main competitive advantages.

Investment guru Warren Buffet has famously said that if you are not prepared to hold a stock for 10 years you should not be thinking about owning it for even 10 minutes and Nadim Rizk, Fiera Capital’s head of global equity team and lead portfolio manager of the US, international and global equity strategies, cannot agree more.

Rizk said he has been an investment nerd since he was a child and read Buffet’s ideas before university. “Once I graduated I went back to some of the books and it all made sense,” he quipped.

In a nutshell we are looking for good-quality companies at an attractive price that we can hold for 10-20 years or longer,” he said, giving Moody’s, a credit rating agency as an example of a stock that has been in the portfolio since 2009. Moody’s is one of two companies in an industry with high-barriers to entry, it is a well-run company with consistent high return on invested capital (ROIC) and cash generation. “Investing is owning great companies for the long run, the rest is speculation,” according to Rizk.

In Fiera’s global equity strategy there are approximately 35 positions and only two or three positions change per year; a 5-10% turnover in other words. Rizk and his team manage over US$24bn with over US$14bn in the global strategy. In total Fiera Capital has US$111bn in AUM with offices across Canada, the US, Europe and Asia.

Rizk continued explaining that the team initially takes small positions, typically about 1%, which is gradually increased as the investment thesis comes through and conviction solidifies. Stocks are sold if the investment thesis no longer holds or there are better long-term opportunities elsewhere.

Typical companies that Rizk and his team are interested in are companies in industries with high barriers to entry where the company typically holds a market leading position, often in growing industries with low capital requirement and with strong pricing power. Another key aspect is demonstrated track record in consistently generating high ROIC with superior operating excellence and capital allocation discipline. In addition, strong management team and sound corporate governance, commitment to shareholder value, low debt and high cash-flow generation combined with the stock price at or below intrinsic valuation are vital.

 “Many only look at cash flow but that is not enough or the full story. We are interested in the efficient use of capital combined with predictable free cash flow,” Rizk said.

These types of companies tend to compound returns over time and preserve capital and with lower probability of permanent value destruction. “The market will often misprice those assets, enabling us to buy them at attractive valuations,” Rizk added.

 “The constituents of the MSCI World Index have an average ROIC of 9-12% whereas Fiera’s Global portfolio consistently shows ROIC of 25-30%,” he said, adding that focusing on ROIC goes against passive investing. And it´s hard to disregard the track reckord Rizk and the team has built; Fiera’s global equity strategy has returned 8.12% YTD as at end of September, compared toMSCI World’s 5.43%. Since launch it has outperformed its benchmark index by 4.78% annually.

Fiera does not really have any specific sector or country biases. “However, we do not like companies that are capital intensive and cyclical which tend to be industries that dig stuff out of the ground such as mining, oil and gas,” Rizk said, adding that the ideal is companies that are less capital intense and generate a lot of cash. Typically Fiera avoids IPOs or companies with short track records. There are also corporate red flags such as ESG concerns, tax and legal issues among others, he said.

Sectors that are prominent in the portfolio are Financials, Industrials, Healthcare as well as Consumer Staples. Compared to the MSCI World Index the portfolio is overweight in Emerging Markets and the UK, neutral in the US and Europe and underweight in Japan, Asia and Canada.

Rizk said the high-conviction strategy, with a focus on best-of-breed companies, combined with a low turnover enables him and his team to spend more time with each individual company as well as more time making the decision. “Analysts typically spend between two to five weeks on one company,” he noted.

Rizk explained that the strong stock-selection process combined with the team-based compensation structure aligns incentives with clients’ interests. “Each member of the team has a vested interest in participating in the selection and construction of the portfolio,” he said.

Idea generation comes from multiple sources such as company meetings, existing holdings, as well as through internal proprietary screens which screen on such factors as high and consistent ROIC and stable profitability. Decision-making is a team effort and debated by the entire team. “The concentrated portfolio forces a discipline to own only the best ideas,” Rizk said.

The Global equity team’s short-list of candidates of 25-35 companies go through comprehensive modelling and fundamental bottom-up analysis where the team looks at industry dynamics and attractiveness, scrutinise the management culture, business strategy and ESG considerations. In addition the team uses full proprietary financial models and long-term projections and assess fair value and expected target return range. The final step is grading companies based on assessment of quality through Fiera Global Equity team’s proprietary T.I.M.E (Track record-Industry attractiveness-Management quality-Economic moat) score.

The T.I.M.E. scoring, which is standardised and repeatable, enables the team to grade and compare a company’s business practices and characteristics within different industries and countries in accordance with the investment team’s philosophy. The team targets companies with high T.I.M.E scores, reflecting the high quality of these businesses.

In the past few years various efforts such as OECDs long-term investment project and FCLT Global are focusing on how to facilitate long-term investments and how to encourage longer-term focus in businesses and investment decisions.

FCLT Global and McKinsey analysis also show that companies with a long-term approach delivered US$7bn more in market cap per company between 2001 and 2014 than their short-term peers.

In addition, the rise of environmental, social and governance (ESG) concerns has further pushed long-term investing to the fore.

There are a variety of approaches to sustainability and Rizk said that while Fiera is not a traditional ESG manager it sees the E, S and G from a risk perspective with a particular focus on governance. “Companies with strong governance culture tend also be strong on the E and the S parts with a clean corporate culture such as honesty with minority shareholders,” he said, adding that poor scores in any of the three ESG areas trigger further analysis. The team integrates ESG factors directly within their investment process as well as their proprietary T.I.M.E score.

“As long-term shareholders we hold regular meetings with company management and key board members. By raising ESG awareness and conveying our strong conviction on ESG matters, we have historically been successful in positively influencing management at these companies,” Rizk said.

Fiera has been a signatory to the United Nations Principles of Responsible Investment since 2009.

Rizk said the majority of Fiera Global Equity team’s clients are US and Canadian simply because of proximity whereas appetite for concentrated investment strategies is now greater in Europe.  “With the rise of passive investments many see our type of strategies as a complement to that, whereas others prefers a concentrated portfolio for their entire global equities allocation,” he concluded.

2018-11-17T10:43:37+00:00By |Categories: Equities, The Nordic Brief|