By Hamlin Lovell, NordicInvestor

Patient cashflow compounding from unique companies

The Fiera Atlas strategy has outperformed global equities by a massive margin: a mid-teens annualized percentage since March 2017. Around two thirds of this has come from companies growing and compounding cashflows and dividends, while one third has come from valuation multiple expansion – mainly because a bias to quality and growth factors has been a benign tailwind over this period. After stripping out the multiple expansion, fundamental alpha of 10% per year remains. For simplicity Atlas show their outperformance as “added value” but strictly speaking “alpha” would have been even higher since the beta happens to have been below one over the past five years. Indeed, the returns have been attained without taking on additional volatility: drawdowns have been shallower than in MSCI World and have been recovered more swiftly. The Sharpe ratio has been double that of the broader market, and the Sortino ratio (penalizing only downside volatility) has been higher still.

Whether double digit annual alpha is sustainable throughout a market cycle is open to debate but Atlas are happy to project strong and sustained profit growth for their portfolio: “we are confident about double digit earnings growth across the portfolio, almost irrespective of the economic climate: our companies are generating non-cyclical growth with drivers very different from the index,” says Simon Steele (pictured left above), Head of Fiera Atlas team, and one of four portfolio managers on the strategy, which was conceived at AMP in 2016 and spun out into Fiera in 2021, which essentially won a beauty parade. “We spent months talking to potential partners before deciding on Fiera, who shares our long-term perspective, are assisting us with ESG data and integration and can help with asset raising in North America. Culturally Fiera puts the client first,” says Steele.

Sectors, sub-sectors and idiosyncratic cashflows

In big picture terms, the strategy has been overweight of the US, technology and healthcare but has only owned one of the FANGMAN (Facebook, Apple, Netflix, Google, Microsoft, Amazon, Nvidia) mega cap complex. Themes are much more granular, pinpointing small segments of traditional sectors that are carving out powerful trends: “they include robotic surgery replacing laproscopic surgery; drugs moving from large molecules to biologics; and computing moving from on premise to the cloud,” says Steele.

But even these sub-sector classifications are too meta-level for the bottom-up Atlas process: “Sectors do not tell us much about where rents are coming from and there is massive dispersion between end markets in terms of customer types. This concept of diversification can be obtained within a single sector. In software, we own companies serving the energy, pharmaceutical, and research and development sectors,” points out Steele. He is therefore confident that the portfolio of 25-35 holdings is diversified by the uniqueness of companies: “idiosyncratic company cashflows lead to an aggregate portfolio level cashflow journey that is stable and diversified”. The strategy looks at traditional correlation measures for share prices, but finds it more useful to dig deeper in looking for diversification of companies’ cashflows.

Long term growth

This has been substantially a buy and hold strategy, though Atlas have found an average of four to five new companies to invest in each year. Average portfolio turnover of 20% means that the average holding period is five years, though neither figure is a target; turnover could be higher if more holdings disappointed on numbers or indeed lower if they all continued performing and remained at reasonable valuations. Turnover did not increase around the Covid crisis, partly because the team had confidence in the defensive qualities of the portfolio and trends such as digitization were clearly accelerated. Turnover has however increased much more in the first quarter of 2021, when a violent rotation from growth and quality to value and cyclical names resulted in a brief window of opportunity to pick up long-term compounders at attractive valuations. These sorts of cyclical rally episodes (which can also be dubbed a “dash for trash”) can cause brief spells of underperformance which have been rapidly recovered. Having started 2021 lagging global equities, strategy had regained its lead by September.

Outperformance is arguably a function of some other investors’ short-sighted approach. Some fund managers are under pressure to produce returns over short periods, and broker research might also be myopic in some cases: “sell side research analysts often only publish earnings estimates one or two years ahead. They often anticipate mean reversion in earnings power that has not occurred for the Atlas portfolio,” says portfolio manager, Neil Mitchell (pictured above right). Atlas are disciplined about valuations, which need to stack up over an expected five year holding period, and some compounders are too expensive for the strategy.

The Atlas research process emphasizes deep dive interviews with experts throughout companies’ ecosystems, including former employees, suppliers, competitors and customers. The team members are spread across the UK, Australia and Hong Kong, which broadens out the dialogue. All are generalists covering all geographies and industries, and increasingly doing non-traditional research as part of ESG.

Expanding ESG policies

ESG is a separate heading but it is very much integrated into the investment process. ’’We firmly believe that ESG factors (opportunities and risks that may impact long term cashflows) should form part of an integrated and holistic investment appraisal touching all aspects of the investment case and should not be treated as a separate bolt on at the end of our research process,’’ says Steele.“’Companies that better manage and nurture their environmental, social, shareholder and outside stakeholder capital are less prone to destroy financial value over the long term; thus ESG considerations are inextricably linked with our stated investment objectives of stable, long term wealth creation,” says Steele.

ESG applies hard exclusions to tobacco, controversial weapons, oil sands and coal, but not alcohol, where Atlas has owned a Chinese spirits maker. Climate is clearly a top priority: “Fiera is committed to a net zero target at the corporate level,” says Tina Soderlund-Boley.‘’ As long-term investors we are acutely aware of the risks that climate change presents to society, the global economy and to long term investors, consequently we explicitly target a lower level of aggregate portfolio carbon intensity compared with the investment universe from which we select,’’ says Steele. Avoiding fossil fuels naturally helps to reduce the carbon footprint, and will make it easy for Atlas to demonstrate a lower carbon footprint than global equities in general. Long term Atlas hope that data quality will allow for best in class benchmarking of companies versus sector peers. Fiera is also helping with ESG data providers, using its size to access more databases

Styles and factors

Strong corporate ESG credentials often have some overlap with the more traditional “quality” style factor, which is also embedded into the fundamental research process. Style and factor analysis would place the strategy in the “quality growth” category but hundreds of other managers invested in thousands of different equities could also be grouped under this umbrella. “Quality growth disguises a multitude of sins. First and foremost, enduring value creation and expansion drives share prices, long term compounding, and better risk adjusted returns. Exceptional companies offer superior capital appreciation through a full cycle, and a lower risk of loss of capital,” says Steele.

Benchmark agnostic

The strategy is benchmark agnostic, with respect to both broad benchmarks and “smart beta” indices that highlight growth and quality. It clearly has geographic, sector, and sub-sector exposures that are very different from both sorts of indices The universe of 2,300 stocks excluding banks and cyclicals comes down to about 150 names after various quantitative and liquidity screens are applied. “Cyclical sectors such as banks and commodities are avoided, since they do not lead to stable wealth creation. Measures such as active share, tracking error or sector over-weights and underweights can all quantify the degree of active management, or benchmark-relative risk, but they do not reveal much about true risk, which is permanent loss of capital. The companies define whether we preserve and grow capital or lose it, not the sector, geography or style,” says Mitchell.

Though there is a hefty technology weighting the managers do not view the Nasdaq as a useful benchmark. “We were happy to underperform technology in 2019 when hope and pray stocks were driving the index. We invest in stocks with predictable revenues and cashflows. We are not investing in firms that are valued as options on a large future market,” says Steele. The spectacular performance of unprofitable technology companies in 2020 had no bearing on Atlas performance.

If the economic and equity market cycles are maturing, investors’ focus could shift away from cyclical growth and towards the sorts of structural and secular growth trends that Fiera Atlas seek out. “We cannot control short term share price volatility but we are confident about identifying persistent long term earnings growth. Our companies are increasing their intrinsic value at a healthy rate, irrespective of the market backdrop. Since inception, 85% of our holdings have grown their earnings by a double digit annual percentage,” says Steele.

“Ultimately the strategy can be summarized as:

  • Finding exceptional companies
  • Not overpaying for them
  • Diversifying the portfolio’s cashflows

In our opinion, these are the long term determinants of risk-adjusted return,” concludes Steele.