As the current market cycle perhaps draws to a close, two of the investment boutiques at BNY Mellon Investment Management try to avoid such ‘blanket’ shifts in approach, preferring to invest in a style that will stand up in both rising and falling markets.
Since the global financial crisis, we have seen loose monetary policy offer support to the corporate world, with record debt levels having built up indiscriminately as businesses have taken advantage of cheap borrowing. High growth stocks, bound by large amounts of leverage have enjoyed the heady heights of one-directional travel for almost a decade. But things are starting to change.
In a downturn, we often see investors take the oft-cited “flight to quality”, and it’s easy to understand why. In more difficult market conditions, companies with stressed balance sheets, facing competitive pressures and struggling to capture new business have less room to breathe. Certain companies are simply cyclical in nature and (the better ones) learn to adapt to the ups and downs over their lifetime.
Yet where Walter Scott, which manages both the BNY Mellon Long-Term Global Equity strategy and the Global Leaders strategy, and Newton, particularly with its Global Equity Income franchise, share some common ground, is in their shared preference for the long game.
Walter Scott and Newton favour quality; even in rising markets, despite sacrificing some relative possible gains at the top end during very strong bull runs.
When a bull market comes to an end, the opportunity to find value stocks becomes prolific. But a long-term focus on high-quality, defensive growth stocks should not only deliver positive, steady returns over time but will also offer some downside protection in falling markets. Over a full market cycle, quality growth should offer/be a win-win.
Seven key traits to quality
So, what defines quality? Generally, quality companies will have strong balance sheets with low debt and high levels of free cash flow, resilient business models and consistent profitability, whose performance is agnostic to external market conditions. They might have high barriers to entry, so rivals are fewer and farther between and tend to demonstrate characteristics that are diametrically opposed to cheap ‘value’ stocks, whose business models may be vulnerable to a downturn or may be highly indebted. Both Walter Scott and Newton’s teams work hard to avoid falling into these ‘value traps’.
According to Walter Scott, there are seven key characteristics of global “leaders”. The team prefers to seek out the rare beasts with these characteristics focusing their attention on a smaller number of higher-quality holdings.
These seven traits are: pioneering; innovative; adaptable; differentiated; sustainable; visionary management; and with financial results that consistently stack up.
Together, these characteristics aim to help global leaders create value over the long term. In the words of the investment team: “We are convinced that patiently investing in a highly select and focused portfolio of these companies, with due respect to valuation, should yield robust investment results over the long term.”