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What lies beneath and why “QARP” is the new “Value” in Global Equities

Ned Bell
Chief Investment Officer & Portfolio Manager
September 2019
Ned Bell
Chief Investment Officer & Portfolio Manager

 

Research Coverage

Primary: Materials & Telecommunications 
Secondary: Healthcare, Industrials

What lies beneath and why “QARP” is the new “Value” in Global Equities

September 2019

One of the most important considerations for global equity asset allocators is the role that a manager will play in their portfolio. 

In light of the rising volatility in markets, many investors would be asking themselves the questions - a) who is playing the downside protection role in my portfolio? and b) have they managed to provide downside protection?

Q4 2018 arguably gave a snapshot of what’s to come.  

While asset allocators adopt different approaches to ‘style’ mix in their portfolios, it’s fair to say that many would have some exposure to the Value and Growth extremes. The ‘hope’ being that Growth plays the upside capture role and vice versa for Value. 

We are not launching into a missive about the ‘death of value’ - but rather putting forward a case for Quality at a Reasonable Price (QARP), a distinct alternative to Value for the downside protection role in a style neutral portfolio. What this means is that investing in high quality businesses while not overpaying for them should help investors avoid investing in value traps. Additionally, quality businesses, typified by stable companies with strong management, sustainable moats, distinct competitive advantages and high returns on capital without excessive leverage, if invested over the long term are likely to have less downside risk.

Bell Asset Management’s (BAM) overarching philosophy to investing predicates around investing in high quality businesses and not overpaying for them whilst being very patient when buying and very disciplined when selling. 

Typically, the characteristics of the portfolio’s we manage exhibit far superior profitability and financial strength metrics with comparable valuation attributes to the benchmark. We would argue such an approach is in stark contrast to those who reside at the extremities of the Value / Growth see-saw. Value portfolios often come with meaningful fundamental risk and Growth portfolios come with meaningful valuation risk.

As we look across the global equity landscape in early September, the overall risk environment has escalated quite meaningfully. Against this backdrop, there is an argument that Growth’s stellar run in recent years is running out of steam and the risk of valuation de-rating is meaningful. There is also an equally worrisome argument around earnings risk / sensitivity with the Value cohort. Such companies often come with a combination of elevated regulatory risk, capital intensity, little pricing power, leverage and economically sensitive earnings.  

If we focus our attention back to the downside protection role in portfolios, recent history has demonstrated that Value investing, by and large, has not achieved its objective of protecting capital in negative markets.

The table below shows the three negative years over the last 10 years, and that the excess return or value-add from “Value” has been poor at best.

While it should not be discounted that “Value” may well have a rebound at some point, we believe it is important for investors to consider alternatives such, as QARP, particularly for the downside protection role in a well-diversified portfolio.

BAM’s investment approach has stood up extremely well in both up-and-down market conditions since 2003. More specifically, our Global Core portfolio’s upside capture of 108.87 and downside capture of 89.80 is indicative of our ability to outperform in up-markets and provide strong downside protection in down-markets - the combination of which sets us apart from the vast majority of active global equity managers.

Additionally, several other relevant highlights of our Global Core portfolio, since inception to 30 June 2019 (in USD terms):

1. We have outperformed the MSCI World index (Benchmark) by 2.5% p.a.;

2. 93% of our rolling 3 year periods have been above benchmark;

3. Our information ratio has been 0.69; 

4. We have only lagged the Benchmark by more than 2% in one calendar year since 2003;

5. While we lagged the Benchmark in three calendar years, we rebounded the following year in each instance.

In those same years when “Value” did poorly, our Global Core strategy outperformed the MSCI World Value index and MSCI World Index by an average of 7.69% and 5.65% respectively.

We point out these metrics as they represent factual information that, as an active fundamental bottom-up manager with a strong discipline of investing in high quality businesses at the right price, will serve the downside protection role well for our clients over the long term.  

Looking at overall performance and volatility, the Global Core strategy has outperformed the MSCI World and MSCI World Value indices, while exhibiting lower volatility than the respective indices over the short, medium and long-term.

 Cumulative return comparison, BAM Global Core, MSCI World Value and MSCI World Indices

Volatility comparison, BAM Global Core, MSCI World Value and MSCI World Indices

 

 

 

 

 

Important Information: This has been produced by Bell Asset Management Limited (BAM) ABN 84 092 278 647, AFSL 231091. This has been prepared by BAM for information purposes only and does not take into consideration the investment objectives, financial circumstances or needs of any particular recipient – it contains general information only. Before making any investment decision, you should consider your needs and objectives. No representation or warranty, express or implied, is made as to the accuracy, completeness or reasonableness of any assumption contained herein. To the maximum extent permitted by law, none of BAM and its directors, employees or agents accepts any liability for any loss arising, including from negligence, from the use of this document or its contents. This document shall not constitute an offer to sell or a solicitation of an offer to purchase or advice in relation to any securities. Any such offer shall only be made pursuant to an appropriate offer document. Past performance is not necessarily indicative of expected future performance. 

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