PGIM Keynes Systematic Return

downward trend (chart 2), should therefore not blind investors to the cumulative effect that a resurgence could have on the value of their wealth, even at relatively low levels. But what can they do about it?

Chart 2: World Consumer Prices (% change)

1983 1985 1987 1989 1991 1993 1995 1997 1999

Source: World Bank.

2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Building defences

From a portfolio perspective, businesses with strong pricing power (the ability to raise prices without sacrificing demand) can offer protection over long holding periods. Investors need to be ready to weather increased volatility, however, particularly amongst highly rated stocks, as market assumptions about the value of future cashflows are recalibrated. Aside from equities, other assets that have proven their worth in the past, albeit to an extent that is determined by the prevailing backdrop, include; property, infrastructure assets, commodities, inflation-protected securities (such as TIPS) and gold.

The success, or failure, of investments in each of these areas will depend on a number of factors, including the specific drivers of inflation over a given period and how the response from monetary policy makers impacts real yields (the nominal yield on bonds minus the rate of inflation). Building a combination of differing strategies, therefore, seems to us to provide the best protection against a range of inflationary scenarios. These are exhibited, to varying degrees, by the four funds highlighted in the table opposite. ●

Key fund data and charts

The table below summarises four funds from our coverage list, which are also constituents of our Alternative Allocation and Alternative Income Managed Services. These aim to provide protection against future inflationary scenarios within portfolios. Please speak to your Investment Manager for more details on any of these strategies.

Income & Growth LondonMetric Property (LMP-LON) Fund Type Real Estate Inv Trust Asset Manager Self-Managed Manager(s) Andrew Jones & team Market Cap £1.95bn Historic Yield 4.0% LondonMetric’s strategic focus is on owning desirable real estate, aligned to sectors that are supported by structural trends. The portfolio is principally invested in distribution assets, from small urban logistics units to regional and mega distribution assets located on major arterial routes. Around two thirds of the related income is subject to contractual uplifts, with the remainder coming largely from urban logistics assets where constrained supply and strong demand is driving strong open market reviews.

Risk Rating: 6

Growth Trojan Fund Fund Type Manager(s)

Open Ended Inv Co Sebastian Lyon Fund Size £5.28bn Ongoing Charges 0.87% Historic Yield 0.5% The Trojan Fund aims to achieve capital preservation and growth, in real terms, over the long term. The Fund can invest globally in equities, fixed interest securities and cash, as well as cash equivalents, including gold. The current allocation to inflation-protected government bonds and gold remains high as the management team believe that the fiscal and monetary tools used to stimulate the economy will become increasingly unorthodox. This suggests that real yields will continue to drop.

Risk Rating: 4

Share price, total return (last five years)

200 180 160 140 120 100 80

2016 2017 2018 2019 2020 2021 NAV, total return (last five years)

135 130 125 120 115 110 105 100 95 2016 2017 2018 2019 2020 2021

Income & Growth 3i infrastructure (3IN-LON) Fund Type Investment Company Manager 3i Group Market Cap £2.63bn Ongoing Charges 2.24% Historic Yield 3.3% This London-listed Investment Company aims for income and capital growth through a portfolio of unquoted infrastructure businesses and assets. The portfolio is focused on businesses that have a strong market position. This means they have an asset base that they own in perpetuity, operate within regulatory frameworks, or provide essential services and generate stable cash flows underpinned by long-term, often inflation linked, contracts. Risk Rating: 6 Absolute Return PGIM Keynes Systematic Absolute Return Fund Type Open Ended Inv Co Manager QMA Wadhwani Fund Size £113m Ongoing Charges 0.94% Historic Yield 0.0% This absolute return fund aims for an attractive return on capital while attempting to limit the risk of loss. The strategy has a targeted return of LIBOR plus five percent, with volatility of seven percent and is one of the more agile and nimble we have under our research coverage. A focus on monetary policy and economic signals indicates that the fund is alert to emerging inflationary pressures and is positioned accordingly. Risk Rating: 5

Share price, total return (last five years)

210 200 190 180 170 160 150 140 130 120 110 100 90 2016 2017 2018 2019 2020 2021 NAV, total return (last five years)

140 135 130 125 120 115 110 105 100 95 90

2016 2017 2018 2019 2020 2021

All chart data source: Bloomberg. Chart data to 31 March 2021. For details of the Killik & Co risk rating system, please refer to page 15. Figures stated gross. Past performance does not guarantee future results.

Getting started

Svenja Keller, Will Stevens and Dan Fellows

At a client webinar earlier this quarter, our Head of Wealth Planning discussed why we all need a financial plan and how to pull one together with two of her colleagues. Here are the highlights. For more information about future events, please email events@killik.com

What is planning all about?

Svenja: I split our role into two parts – understanding the big picture, and then mastering the detail. The former involves trying to help our clients to identify what they want from their lives, and how a financial plan can help them to achieve it. Key stages include; making long-term projections, setting an overall strategy and then creating a roadmap. Only then can we delve into the detail and decide on the right products and structures that will move them along it in a tax-efficient manner, taking their personal circumstances into account.

Typically, we will be looking at how they can effectively use tax wrappers such as pensions, ISAs, or some of the more complex options, such as offshore bonds and trusts. It is important that we understand how each component within their overall strategy will be taxed so that we can reduce the total burden. As part of this process, we will carry out a review of any existing products and wrappers they may have so that we can clearly set out our views on their current position and make personalised recommendations for the future.

Sadly, new clients are not helped by the fact that the industry we work in has not evolved in the most straightforward way. For example, some advisers can provide everything a client might need, whereas others are limited to either planning or investment advice. As a result, people that approach us for the first time have often previously been faced with a confusing array of independent financial advisers, or specialists connected with a larger firm. The simple truth is that not every firm in the market offers the same type of advice. At Killik & Co, we strongly believe in a two-specialist approach. The complexity of some aspects of the financial advice world means that it is nigh-on impossible for one person to know everything. That is why we have separate Investment Managers and Financial Planners (which we sometimes label “Wealth Planners”) working closely together to offer a broad range of services under one umbrella. Their skill sets are very different, but in combination they bring a huge amount of knowledge and experience to the table. Naturally, I am a big believer in this approach, but I always remind people that our way of doing things is not the same as everyone else in our space.

When do people tend to seek your advice?

Will: Different planners will have their own take on the answer to this question because what we do can be applied in many diverse situations to resolve a wide variety of challenges. Most of my clients are trying to balance multiple financial objectives. For example, they may be saving long-term to fund themselves once they reach the point at which they decide to either stop full-time work or dial it down. This increasingly includes funding the later phases of life, when they may need to make major adjustments in terms of the way they live. In the meantime, they also need to be sure that they are sufficiently liquid, in cash terms, to meet their current commitments, which could be anything from school fees and university costs to property renovation or travel.

There is clearly a balance to be struck and we can help to clarify what can be quite a complex financial picture with different objectives all competing to be funded at multiple points in time. We can steer clients through the various trade offs they may need to weigh up to ensure that their short, medium and long-term goals can be covered without incurring a shortfall or depleting their lifetime savings. For example, they may not fully appreciate the impact that a decision about a property upgrade, or private school fees, could have on their current lifestyle (if it means, for example, that both partners need to work full time) or the timing of their full, or partial, retirement. On a brighter note, I also meet people who have worked and saved hard all their lives, but have not yet realised that their goal of reducing the time they spend working is closer to hand than they think. Dan: My phone often rings when people suddenly come into a

large sum of wealth. The most obvious example is an inheritance. This can be quite intimidating for someone who has not had to manage a substantial sum in the past. It can also create mixed emotions – in the absence of a specific stipulation from the deceased should they, for example, use it to accelerate their departure from full time work, plan to leave it to their own children, or a bit of both?

Business owners are another example. They may have done a fantastic job in growing a firm and managing dividends and other withdrawals with the help of an accountant. However, when it comes to dialling down their involvement, perhaps through a full, or partial, disposal of their interest in a business, they will seek our guidance when it comes to deciding what to do with both the rest of their lives and the capital they are about to receive. A third situation where a sizeable lump-sum may be involved, is divorce. We are sometimes brought in early in the process for pre-divorce planning, where a couple are seeking to split their combined household assets as tax-efficiently as possible. Alternatively, we might be engaged further down the line once a decree absolute (the document that legally ends a marriage) has been signed and the relevant assets are being shared out. For some people, this may be the first time they have taken control over their own finances, either fully or at all. Suddenly, they need to start providing an income for themselves and perhaps their children, while making decisions about where they will live and how much they can afford to spend on setting up a new home. Svenja: I would echo Will and Dan, in that we are asked to advise clients in a very wide variety of circumstances. That is one of the things I love most about the job. Another area that I often get involved with is intergenerational planning. Many people are fortunate enough to be able to provide not just for themselves, but also their children and grandchildren. The challenge is minimising the tax leakage that is created by the need to pay inheritance tax on each generation’s wealth. There are specific things we can do to help here, but the starting point is often just a conversation around the assets someone has and how they plan to pass them on. There are also decisions to make about how and when they would like their assets to be received by any beneficiaries. Some grandparents, for example, are keen to see money they give away used during their own lifetimes. Others worry that gifting large sums too early will take away the motivation from subsequent generations to work hard. Since these are personal considerations, our role is to try to facilitate a constructive dialogue between the different generations within a family as early as possible, and to help the relevant parties to put a plan together that everyone understands and is comfortable with.

This can involve some challenging conversations at times. For example, I may push back against someone making gifts too early, if I am not sure that they have thought hard enough about their own financial security, or given themselves enough of a runway to fully enjoy money that they may have worked very hard to acquire. Some people live a lot longer than they expect and underestimate the amount they may need for themselves. Whatever the situation, the key is starting the process early. That way we can, for example, make the most use of the smaller, regular allowances that make quite a difference to the tax-efficiency of a financial plan over the long-term.

Is there a difference between when planning is used, and when it should be?

Will: I would say “yes” in a lot of cases. People are often unsure about whether, or not, they should engage with financial planning and that is exactly when a planner would recommend a conversation. The result may be a simple review of their current position, a few steers and an agreement to just keep in touch until they need more support. The pity is that, on other occasions, people come to us later than we would have liked because the opportunity to maximise their use of certain allowances has passed and we then need to move at speed to make sure that they don’t miss out in the future.

That is why I urge people to at least check in with an adviser as early as possible. Even if they have only just started saving money, it gives us the opportunity to signpost things they should be aware of when it comes to being tax-efficient in the future. Sometimes these are quite simple if they are connected with, say, someone moving up into a new income tax threshold, from basic to higher rate, or higher to additional rate. For example, if they are fortunate enough to see their annual income hit £100,000, then they should look at ways to minimise the impact of their personal allowance disappearing, as otherwise it can result in some eyewatering marginal tax rates. Where these changes in income coincide with a promotion, or even a job move, the planning side of things may get forgotten unless we are kept in the loop. I have also had quite a few people talking to me about starting their own businesses over the last few years. The reasons vary, from fulfilling a lifetime dream to solving the problem of losing a full-time job and needing to generate an income. I find that although entrepreneurs may be very good at getting a business off the ground and nurturing its assets, they

often leave gaps when it comes to their own personal protection and that of their families. We need to ask questions about whether all the business revenue is recycled, or if any of it is being used to provide some degree of future personal security. Relying solely on the eventual sale proceeds from a start-up can be tempting, but also very risky. Dan: I agree with all of that and would urge anyone who is taking on financial commitments of whatever sort for the first time to come and talk to us. These may include signing up for a mortgage, getting married and having children – all are examples of important “tipping points” where someone’s financial circumstances may change quite radically as they begin to carry financial responsibility for other people, rather than just themselves. Children bring lots of big decisions into play around when, and to what extent, parents choose to help them financially. For example, I have some clients that offer support through the school and university years, but then leave them to fend for themselves. Others are keener to help them onto the property ladder as a priority. Then there are the families that can afford to do both, and also want to cushion them financially further out, perhaps through the use of trusts. In all cases, the key to a good financial plan is to identify core goals and then break down the “big picture”, that Svenja referred to earlier, into more detailed and specific action points. For example, if children are to be offered help with school fees paid as a lump sum, we can review the timing and amount involved and then work out how to build it up in the most tax-efficient manner. We will often discuss this with one of our colleagues on the investment side of the firm to ensure that a client has the right growth strategy in place.

Are people intimidated by advisers?

Svenja: I think they often are, yes. That is, in part, down to a misconception about what is involved. Some people assume they will be bombarded with complicated spreadsheets and cash flow models from the off. But whilst modelling can be a very useful way to frame choices, it is the broader background research we do that most of our clients really get value from. Well before we get into the financial detail – a lot of which we can work on behind the scenes while they get on with their lives – we act more like coaches. A key part of our role is to ask the right questions and to not be afraid to deal with strong and differing opinions. For example, I meet young people sometimes who feel they have been conditioned to do what is considered right for them by their parents or peers – marriage, children and a steady job are often on the list. However, when we dig down a bit, we often unearth the fact that their real dream is to start a business or enjoy the trip of a lifetime well before they settle down. Whilst I would never want to come between different members of a family, I think it is important to properly understand what each person really wants to achieve. Otherwise, any plans and fancy models that are formulated later will rest on unsound assumptions.

What is the secret to successful planning?

Will: To build on Svenja’s last point, I think it is all about people being honest with themselves and with their planner and not just telling us what they think we want to hear. The old life plan, whereby someone goes to university, gets a steady job, has a family and then retires aged 65 just isn’t relevant to many people anymore. Take the decision to go to university. It is not always clear cut now, given that most people who do so will clock up a huge debt that their parents may have avoided. As for a conventional retirement, that is a pipedream for many young people, not just financially but also in terms of how they want to live their later lives.

Conversely, when we drill into the expectations of older generations, around spending money once they dial down work or sell a business, we sometimes find we can deliver a pleasant surprise by advising them that they can afford to spend more money than they thought, and sooner too. The fact is that we need to be able to properly test some of the assumptions we come across, so that we can do the best job for our clients. The more honest they are, the easier that becomes. A good adviser will try to identify not just what someone’s objectives are, but also the underlying drivers. This sets us apart from the firms who seem to start from the solution and work backwards. Personally, I have yet to meet anyone who wakes up wanting to consolidate their pensions, even though a chunk of the industry’s advertising suggests that many clients are desperate to do just that. It’s an approach that sends the wrong message that financial planning is just a one-size-fits-all administrative exercise. Done well, it is far more wide-ranging than that. Dan: One obvious, but often overlooked, secret that lies behind both successful investing and planning is harnessing the power of long-term compounding. The earlier someone starts saving, and the less of their hard-earned money they give away to HMRC, the better off they will be. Tax leakage can occur in all sorts of ways, so it is important that income and capital gains tax allowances and shelters are used effectively too. We also encourage all our clients to carry

out regular reviews as the rules have a habit of changing and therefore financial plans need to be adaptable. Another aspect of good planning is to recognise that whilst tax-efficiency is a vital component, decisions must always be taken with an end-goal in mind. So, for example, if we know the level of what we call “peak savings” a client will need before they can start enjoying their wealth, rather than just building it up, then we can aim to get them there via the quickest but safest possible route. It is important that people keep their eye on this end goal and do not get drawn into the trap of thinking “if I just worked five years longer, I could add so much more to my savings”. They may be right about the amount, but why sacrifice that time unnecessarily when they could be enjoying themselves or spending more time with their children or grandchildren? I accept that a lot of people no longer want to fall off the job cliff into full retirement, but they need to be clear about when they will reach the point where they are working through choice, rather than necessity. Svenja: Adding to that last point, one of the secrets to successful planning for me is flexibility. Over a 20, 30 or 40-year horizon an awful lot can change in someone’s life and circumstances. Too often I have seen people boxing themselves into a corner by trying to be super tax-efficient and snapping up every new product as it becomes available. The problem is those same products might be quite rigid and tricky to unwind later. Better to keep things simple and to avoid any arrangement that is difficult to understand or subsequently unwind. It is also important that our clients accept the trade-off between flexibility and tax-efficiency and therefore strike the right balance between the two.

What would be your single tip for someone new to planning?

Will: If in doubt, ask for advice. The initial conversation with a reputable planner probably won’t cost you anything and it is a good chance to start building both a relationship and the confidence to seek help later when things get more complicated, financially or emotionally. In short, people shouldn’t wait until they feel they have to throw themselves in at the deep end because something has gone wrong. Dan: Be wary of the quality of information on the internet. Beyond some very simple things, such as setting up an ISA, planning can get quite nuanced and the key to doing it successfully often lies in the detail, particularly when it comes to interpreting legislative changes. Once people realise that they don’t know what they don’t know, our job becomes easier as they are less likely to cut corners and make mistakes. If I had a pound for every scheme I have had to try to unwind for a client who was lured into it on the promise of some creative tax savings, I would be a wealthy man! Svenja: My top tip would be not to be put off by the word “wealth”. It means many different things, a fact reflected in its origins in the concept of wellbeing. It is therefore important that people don’t assume that they need to start with lots of cash in the bank before they contact a wealth manager or planner. We deal with many types of individuals and, as we have hopefully explained here, we can help them in many ways, whether simple or more complex. Everyone has to start from somewhere, and we would rather be able to offer support from the beginning of their financial journey. ● Killik & Co Security Risk Ratings

All research recommendations are issued with a security-specific risk rating, represented by a number between 1 and 9. Assessing the relative risk of any security (specific risk) is highly subjective and may change over time. The Killik & Co Risk Rating system uses categories which are intended as guidelines to the specific risks involved, as follows:

1. Restricted Lower Risk Securities in this category are what we believe to be lower risk investments such as cash, cash equivalents and short dated gilts, and the collective investment vehicles that invest in those instruments.

2-3. Restricted Medium Risk Securities in this category are what we believe to be medium and lower risk investments including medium and long-dated gilts, investment grade bonds and certain collective investment vehicles investing predominantly in these securities.

4-9. Unrestricted Securities in this category are what we believe to be higher risk and are drawn from across the United Kingdom and international markets. These are normally direct equity investment and collective investment vehicles which predominantly hold securities other than investment grade bonds and money market instruments. The vast majority of the Killik & Co Research recommendations are likely to fall in the unrestricted/ higher risk category (4-9) above.

For further details on the Killik & Co Risk Rating system please see the Killik & Co terms and conditions.

Terry reflects on the impact of the pandemic and explains why it has not altered his core investing approach.

What conclusions should investors draw from the last 12 months?

The period after the Spanish Flu of 1918/19 offers some insights. A terrible death toll triggered a big reduction in the workforce. That, in turn, led to the widespread adoption of the assembly line for mass production. The result was a huge increase in productivity – all sorts of household items became a lot cheaper to make and were therefore made more widely available. Post-war spending completed a virtuous economic circle and ushered in the “roaring ‘20s”.

Fast forward and whilst there are grounds for pessimism when it comes to sectors such as hospitality, travel and traditional retail, the sheer pace and breadth of recent digital transformation, encompassing cloud technology, online business products and e-commerce across many others, is staggering. The impact has been obvious on everything from digital advertising, online retailing and electronic payments, to the way we work and access services ranging from medical advice to education.

If I had to pick an economic “letter” to sum all this up, it would be a “K”. Some areas of the economy will continue to power ahead whilst others seem destined to languish. The key, as an investor, is to therefore ensure you are positioned correctly.

Moving on

Terry Smith

CEO and CIO of Fundsmith

How helpful is the technology label in 2021?

Not very. Take the so-called “FAAANS” – Facebook, Apple, Alphabet, Amazon, and Netflix. Although they are often lumped together, they are all very different businesses, spanning online entertainment, e-commerce, distributed computing (“the cloud”), social media, digital advertising and consumer devices. Each has its own distinct profile in terms of predictability, product longevity, returns and valuation. Equally, there is a world of difference between the payment services, accounting software and airline booking companies we own, yet they are often loosely badged as technology firms by some investors. A more useful approach is to look at how well firms have innovated, regardless of their sector classification. Look at retailing. Management teams that have failed to grasp the importance of developments such as digital advertising, the “social influencer” method of marketing, and e-commerce order fulfilment have been left behind. Meanwhile, the likes of L’Oréal went through ten years’ worth of change in ten weeks last Spring. They have grasped the importance of attracting a younger generation in key new markets such as China – to do that they cannot remain a pure bricks and mortar operation.

Are we in a stock market bubble?

After a bull run that has lasted over a decade, it is something that people undoubtedly worry about. However, I am more sanguine for two reasons. Firstly, in a world where the equity benchmark, the long bond yield, remains so low by historic standards, we cannot compare today’s higher share valuations to those 20 years ago. In the absence of a step-change move in that yield, I do not therefore foresee an imminent cliff edge for share prices. Secondly, the shift in the percentage of the average US firm’s assets that are intangible, as opposed to tangible, since the mid-1990’s raises a separate important point around valuations. As a fund, we have always favoured intangible assets (whether intellectual property, goodwill, or unique licenses) as we think they can generate higher future returns than their tangible peers (plant, machinery and buildings). Yet, because the latter can be pledged as security to underpin bank loans, firms often borrow against them with the result that their balance sheets take on lots of debt relative to equity. That drives their returns and valuations because the associated interest expense, and often the asset depreciation cost, do not touch the profit number analysts focus on. Intangibles, on the other hand, need to be funded with equity. Moreover, the costs of building and maintaining intangible assets, whether research and development, product development or digital marketing and promotion, are usually expensed against profits and operating cashflow rather than being locked into the balance sheet.

The net result is you simply cannot compare two firms using a conventional price to earnings (P/E) ratio, when one has adopted technology and e-commerce to build, say, a branded consumer goods empire whilst the other has stuck with a classic manufacturing and selling model. The adjustments required to make a valid value comparison will be subjective, but I agree with Sir David Tweedie who once said, “it is better to be roughly right than precisely wrong”. The net result is that I think you can ascribe bigger multiples to businesses that carry a higher proportion of intangible balance sheet assets.

Is value investing “dead” as some claim?

Far from it. We do not believe that the type of growth investing we do can ever be fully separated from value principles. The misperception that it can arises, in part, because traditional value investing has been bent out of shape. In today’s market, asking “is this business trading on a low valuation?”, without considering what you are comparing it to (for example, its ability to deliver future growth and returns on capital) is pointless. Pure value investing will have its time in the sun again but only once we enter a period of strong postrecession economic recovery, something we are not yet seeing. It will also require some sort of runway for share prices. At the moment, even stocks that took a huge pandemic hit, such as IAG, are trading not too far off their all-time highs which does not leave much room for undiscovered upside.

Have your favourite financial metrics changed at all?

No, not really. Number one has always been the return on capital employed (ROCE). It was US investor Warren Buffett’s favourite as far back as 1979 and I agree with him that it is fundamental to stock selection. You need to know what level of return you expect on a pound invested in anything, whether a bank account, bond, share, or something else. For me, it comes way ahead of earnings (or “EPS”) growth, something other investors get distracted by in my view. This happens because they focus too hard on making a quick profit – buying today and then flipping a share onto someone else.

My perspective is different. I want to know whether a firm can generate consistently high returns on capital over the very long term. As Buffett’s investing partner Charlie Munger noted, if you hold a stock for long enough, the return will gravitate towards a firm’s ROCE regardless of the price you pay. I also don’t worry too much about how far this number is above a firm’s cost of capital because the latter is far too subjective. If I achieve a 25% ROCE, on average, across the firms in our portfolio then I can be confident that we are delivering value. By contrast, we have looked at the average ROCE for some of the major car producers over the last five years. At just under five percent, I don’t need a rocket scientist to advise me not to invest.

The next metric on my list is gross margin, which is also one of the most overlooked. Companies combine components, ingredients, commodities and people to make a product or service that they then sell to clients – gross margin measures the mark-up. For our average portfolio company last year, it was 65%, meaning that they made things for 35p and sold them for a pound. For the FTSE index, the equivalent number is about 40%. I know which I would rather hold!

Aside from its clarity, there are two other things I like about the gross margin. Firstly, it is the single biggest indicator of pricing power in a business. It tells me an awful lot about market share, brand strength and competitive position. As such, it also reveals something about the strength of a company’s defences against inflation, in terms of the extent to which they can pass on cost increases. Further, I use it to get an insight into a firm’s resilience. A high gross margin acts like a shock absorber. Take L’Oréal as an example again – their gross margin is about 80%, largely because cosmetics don’t cost much to make, even if they cost a lot more to package and advertise. So, if the firm suddenly hits some price competition that erodes the gross margin by 2-3%, it will not suffer a big hit to its operating profitability (see below). Contrast that with a general retailer such as Walmart, where the gross margin might be more like 25% with an operating profit in the low single digits. A 2-3% hit to the former could wipe out the latter. That is why it makes sense to monitor both numbers.

Cash conversion is another key metric – the percentage of profits that turn into cash, which we calculate at the operating profit level. Some businesses convert more than 100% of their profits and some significantly less. For us, a number much below 90% is a potential red flag, given that a typical company in the main index might average 80%. Ultimately cash conversion reflects a firm’s ability to manage its suppliers and customers. Even today people still ask me why profitable businesses run into trouble, to which the simplest answer is often, “profits are not cashflow”. One more ratio I want to mention is interest cover. A company might offer terrific returns on capital, wonderful margins and great cash conversion, but I need to know if this has been achieved via a debt binge. My method takes operating cash flow as a multiple of interest charges and rentals (to reflect the fact that some firms rely heavily on leased assets). Our portfolio companies have historically offered about sixteen times interest cover, against an index average of more like six.