INVESTING
31 August 2020
CLYDE ROSSOUW Co-Head: Quality, Ninety One & Manager: Ninety One Global Franchise Fund
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arkets and the economy are likely to remain fragile for some time to come. The case for quality investing – building a portfolio of companies with competitive advantages, strong market positions, healthy balance sheets, sustainable revenues and low sensitivity to the economic cycle – is obvious when markets are stormy. Less discussed is the potential for quality companies to grow robustly in a recovering market. Amid the wreckage of weaker businesses as the dust settles, they often get a head start on growth that can propel them through the next cycle. A key attribute that helps quality companies not only survive a downturn but continue to expand in the aftermath, is their strong cash positions; or, more specifically, the fact that they tend to be both cashflow resilient and have cash on hand. They say cash is king. After a crunch, possessing these twin cash advantages can be a kingmaker, helping quality businesses increase their market dominance. History suggests they have helped some quality companies
Why cash flow can be a kingmaker after a crunch
outperform as a recovery gets underway. Whatever the economic backdrop, revenues usually keep flowing for quality companies – or, if extreme circumstances do interrupt them, the hiatus would be expected to be brief before structural growth resumes. This is partly because they offer products and services that people need, which may sometimes be sold via subscription or as recurring purchases. They also tend to operate in growing industries where they have competitive advantages. Consequently, they aren’t as vulnerable when the economy slows. Because they often have dominant market positions, quality companies may have pricing power, which gives them additional protection in a downturn. Quality companies tend to have low operating expenses, especially low fixed costs. They are also capital light, meaning they don’t need to spend a lot on maintaining, say, factories or sophisticated machinery just to stay in business. Strong balance sheets are another feature of quality companies. As well as having relatively little debt,
they typically have significant levels of cash and ready access to liquidity/ funding on good terms, due to their strong credit ratings. Together, these attributes give quality companies more flexibility in allocating capital – that’s an advantage not only in challenging times, but also when the storm passes. During a crunch, quality companies can make productive use of share buybacks or temporary dividend cuts to ensure they remain resilient and to prepare for a changed economic environment. That is to say, they can suspend buybacks if required, as they have not been reliant on borrowing to buy back shares in order to drive earnings-per-share growth. When conditions improve, they can spend on growing their businesses or on acquisitions – at what may be a very advantageous time to do so, as some weaker rivals may have been eliminated or may be available for purchase at a low price. With a clearer field, the potential for robust growth is higher, which is why quality companies can be quick out of the blocks in a recovery. They are also likely to restore dividends sooner, if
they reduced them at all – something income-seeking investors will particularly appreciate. Simply put, after a shake-out, the strong tend to get stronger. The performance of Ninety One’s Global Franchise Fund – which seeks to identify quality companies through in-depth research – suggests as much, with generally above-benchmark returns in the year immediately after a market downturn. Or course, those seeking to follow a quality investment style need to maintain valuation discipline, buying shares in quality companies at reasonable prices. With an active, research-intensive approach, that can be done at any time. But it is at times like the present, after largely indiscriminate sell-offs when shareprice moves detach from fundamentals, that the opportunity to build a quality portfolio at low valuations is often the greatest. And whether what follows the current turmoil is a prolonged slowdown or a swift bounce back, a quality portfolio’s combination of resilience in hard times and strong growth potential in recoveries could stand investors in good stead.
Investing in gold through ETFs
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n times of uncertainty, investors typically flock to safe-haven assets like gold. This year alone has seen the price of gold soar around 19% as investors seek diversification from more traditional assets like stocks, bonds, or property. Buying gold for many investors is a daunting prospect – one which is too often believed to be the sole purview of specialists, fund managers and banks. This is, however, not the case and gold is a lot more accessible to investors through avenues like gold coins, gold mining shares (which have the underlying performance risk), or ETFs. 1nvest – backed by Standard Bank, STANLIB and Liberty - offers investors access to 15-unit trust vehicles and 13 ETFs, including a range of precious metals ETFs with strong and impressive track records. “Precious metal ETFs are designed to offer investors alike a secured, simple and cost-efficient way to procure direct access to the precious metal market. Because the precious metal ETFs hold the actual underlying metal in secure vaults, gold in the case of the 1nvest Gold ETF, it provides investors a return equivalent to the movements of the rand gold price less the management fee. As each ETF represents about 1/100 of an ounce of gold, it provides investors the opportunity to acquire gold exposure for as little as R300 per ETF, allowing you to take large or small investments,” adds Johann Erasmus, Executive Director at 1nvest.
Advantages to adding a precious metals ETF to an investment portfolio include: • Convenience: An easy way to gain exposure to rand spot returns of the underlying precious metal in small or large quantities • Liquidity: Liquid and traded intraday during exchange hours with Standard Bank providing intraday market making • Minimal tracking error: Returns of the ETFs are equal to the rand spot return of the underlying metal priced in rand minus low management fees • Physical ownership: Each ETF unit is secured by the corresponding physical metal held in a custody vault • Transparent to value: Precious metal prices and the USD/ZAR exchange rate is published daily • Segregated: The physical metal is stored in secure vaults and each ETF is guaranteed and has security over specific metal held by the custodian • Costs: The precious metal ETFs have some of the lowest management fees in the market. “1nvest Gold ETFs are backed by physical gold, stored, and insured in secured custodian vaults. Each gold ETF will have recourse to good delivery gold bars. The gold is segregated, individually identified, and allocated. 1nvest ETF is not allowed to introduce any outside risks into the gold ETFs, including leasing of the precious metals,” explains Erasmus. He adds that by adding gold to a larger investment portfolio, investors will gain wider
diversification of their assets, which ultimately works to offset market risks. “Gold and other commodity ETFs are risky but are generally good alternative asset classes to add to your portfolio because they often perform at an inverse correlation to more tradition assets like securities and add another liquid asset class that can easily be transacted.” The recent growth of the 1nvest Gold ETF highlights the staying power of gold in volatile climates. From 2019, the fund has grown from holding 5,912 oz of gold valued at R112m to holding 111,674 oz of gold valued at R3,4bn, in less than a year.
Johann Erasmus, Executive Director, 1nvest
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