Mawer Investment Management Commentary on Manulife Global Equity Class
February 1, 2021
Clients should understand there is trade-off to a portfolio that tends to preserve capital when things get tough. The underperformance in 2020 stems primarily from the fourth quarter when our style fell out of favour. Our investment philosophy demands that we invest in companies that are wealth-creating, i.e., that earn a return on capital above their cost of capital over an economic cycle. To do so, companies we own need to have durable competitive advantages and able management teams. The result is a portfolio that prioritizes resilience and that is less exposed to many cyclical, lower-quality, and value-oriented industries, often those which had been beaten down by the pandemic, in favour of higher quality.
The market rotation prompted by the COVID-19 vaccine releases led aerospace companies like The Boeing Co. (+24%), European banks like Banco Santander S.A. (+65%), and mining companies like Vale S.A. (+53%) to standout performance during Q4 … none of which meet our investment criteria. By contrast, while the majority of the companies we own delivered positive returns over the period, the returns of many of our top holdings were much less spectacular. Companies such as professional services provider Wolters Kluwer NV (-6%), insurance brokers Aon PLC (-2%) and Marsh & McLennan Cos., Inc. (-2%), industrial gas producer Air Liquide SA (-1%), and certification and testing company Intertek Group PLC (-10%), were fundamentally sound, yet furnished modestly negative returns. While stock selection drove underperformance, this was not due to fundamental issues within the companies we own.
We were not caught unaware of the potential for the reopening trade. But at Mawer, our focus isn’t on positioning the portfolio to “bet on” different market environments. Rather, throughout the pandemic, we have stuck to our long-term philosophy. Recent activity has focused on prioritizing those companies that best meet the three components of our investment criteria: wealth-creating businesses, excellent management teams, and priced at a discount to intrinsic value.
This third element, valuation, factored into a number of investment decisions this past quarter. We reduced our position in several companies where our valuation work suggests that returns have outpaced fundamentals. We trimmed our weight in industrial gas company Air Liquide SA and exchange operator Deutsche Boerse AG, while exiting our position in acquisitive software company Constellation Software, Inc., which had been in the portfolio for over a decade and generated a cumulative return of more than 6,000% over our holding period. We continue to hold Constellation Software, Inc.’s management team in extremely high regard but can no longer justify the valuation in light of concerns we have around their runway for continued acquisitions.
Several other companies were eliminated from the portfolio due to low return potential supplemented by a reduced assessment of quality. We exited our position in Comcast Corp. as we believe the company’s high debt may exacerbate the financial impact of heightening competitive intensity brought on by cord-cutting and substitution from 5G. We eliminated our position in PepsiCo, Inc.: in most of the scenarios we considered in our discounted cash flow modeling, we do not believe the company can sustainably achieve the growth levels needed to justify its valuation, especially since many of its products are on the wrong side of health and wellness trends. And we eliminated Brookfield Asset Management, Inc. amid uncertainty with its office and retail real estate exposure.
By contrast, we initiated in companies in which the odds of more attractive return potential were much better, in our assessment. One example is Admiral Group PLC, a UK-based motor insurance company. While the company operates in an admittedly competitive industry, Admiral Group PLC has a demonstrated cost advantage relative to its peers derived from their scale, focus on online sales, and strong reinsurance relationships cultivated over many years – critical for earning excess returns on capital in a more commoditized business. Management has fostered an exceptionally strong corporate culture and have steadily gained market share over the past two decades. We believe the investment has attractive return potential, even with conservative growth rate assumptions, given the company’s high dividend payout and current valuation.
During the quarter, we exited Verizon Communications, Inc. and Rogers Communications, Inc., a continuation of a recent trend that has seen a decreasing exposure to telecom companies in the portfolio. Increasing competition and a deterioration in pricing power, often encouraged by governments, have made the business model less attractive, in our view. Rational competition, scale, and a low regulatory intensity are key factors in converting demand into high returns on capital. We believe the Japanese market offers this backdrop conducive to wealth-creation and as such, we initiated a position in KDDI Corp., one of Japan’s leading wireless providers. KDDI Corp. boasts among the highest customer retention rates and return on assets globally while also exhibiting a low degree of leverage relative to other wireless service providers around the world.
Finally, we introduced Novo Nordisk A/S to the portfolio, a pharmaceutical company that has taken a different approach than many of its peers by having a very focused development pipeline for new drugs. The company specializes in medications and devices for diabetes, where it is the dominant player globally, and exploits the common mechanisms behind diabetes and other diseases like obesity and cardiovascular disease to repurpose their R&D on more complex molecules. This focus allows the company to attract talent, develop hard-to-match manufacturing competence, and has resulted in strong relationships with the endocrinologists who prescribe their drugs. We believe the valuation is attractive in the context of demographic trends globally and given that only an estimated 40% of diabetes cases worldwide have been diagnosed.
While the reopening trade may persist for some time, we continue to believe that investing in a portfolio of sustainably wealth-creating businesses remains a rational approach for investors looking to protect and compound capital over long periods of time.