PM Magellan’s Global Strategy
PM Magellan’s Global Strategy
PM Magellan’s Global Strategy
PM Magellan’s Global Strategy
Matthew: Nikki, you and Arvid have been working together closely on the portfolio for six months now. How has it been going?
Nikki: It’s wonderful being back at Magellan. Arvid and I worked together when I was Head of Research, and we have complementary skills. There has been good input from Arvid into the process to help with stock selection and consideration of macroeconomic issues.
Arvid: Complementary is a great way to describe our relationship. Nikki has a significant amount of experience looking at stocks and markets and, while I’m a stock analyst at heart, I spend most of my time looking at risk and macro. Bringing those things together is really important – more so, given what’s been going on in the world right now.
Matthew: Have there been many changes to the investment team?
Nikki: The existing team is made up of about 30 analysts who have been doing great work with Magellan for a long time and continue to engage in deep research that sits behind the Magellan philosophy and process.
We’re engaging with them every day, digging through different stocks and issues confronting the markets right now. They’re supporting new and different ways to position properly for volatility across global markets. The experience of our investment team is a great asset for us.
Matthew: What about your experience with Magellan co-founder Hamish Douglass who has returned to the firm in a consultancy role?
Nikki: We’re looking forward to that – I think it’s a real win-win. He understands how Magellan invests and I’m looking forward to being able to tap into the mind behind the strategy to enhance our offering going forward. He’ll be a wonderful addition back into the team.
Matthew: Arvid, I’ll ask you a few questions about the macroeconomic environment and then we’ll turn to Nikki for the impact on the portfolio. The last 12 months have been a tale of two halves – the “growth at any price” mentality ended in December. But while markets overall have fallen, energy indices have rallied by 50%. Are energy companies going to be a good investment?
Arvid: It has certainly been an unusual year. When we look at companies, we have an intense focus on quality. For our strategy, pricing power is almost a prerequisite for a company to be considered a quality investment opportunity. That isn’t generally found in the energy industry.
Take the oil industry, for example. Generally, oil producers don’t have the pricing power that OPEC has. There are also many government restrictions and regulations that can limit pricing changes. Because of this, energy industry companies don’t have the level of quality that we look for.
Oil markets are a good example of the cyclicality of the industry. Oil prices are more than $100 a barrel now. Just two years ago, in some places oil prices were actually negative. You had to pay people to take oil off your hands.
While energy industry returns are up almost 50% in the last six months, it’s an aberration. Over the last 10 years, the sector has only generated returns of around 5% per year – including the 50% returns from the past six months. Looking to the future of energy prices, while they’re relatively high at the moment, I don’t think they’re going to continue to increase at this pace. When they level off, the energy sector is probably going to underperform the broader market.
Matthew: How have quality companies performed in the bear market?
Arvid: Quality companies tend to be defensive, which means they provide reliable earning streams. They have low leverage and high returns on capital. So, it’s fairly unusual to see quality companies underperforming in a bear market.
I think the biggest consideration about why has to do with higher interest rates. Growth-focused quality companies tend to have profits further into the future than most other companies. That means their valuations are more sensitive to higher interest rates, which have gone up significantly this year. While we still consider these quality companies, this mechanical link between interest rate hikes and valuation has dragged down the overall quality index.
The question now is, “where are interest rates going to go?” Looking at the 10-year bond yield in America, which is probably the key interest rate here, the Federal Reserve has already told people that it is going to raise rates to a level that is going to start constraining activity. If they did more than that, people in the bond market would say that growth is already going to be constrained.
I think the chance of recession will go up even more if rates continue to increase. But as recession risk rises, yields on the 10-year bond may come down; think of it as an average of interest rates over the next decade.
The point is that it is getting harder for the 10-year bond yield to go up materially from where it is right now. And so, the drag from higher rates on the performance of quality companies is unlikely to be as strong as it has been so far this year.
Matthew: How should investors think about geopolitical risks like the war between Russia and Ukraine and interest rate increases, as well as new considerations about inflation or stagflation?
Arvid: While there is a lot going on in the markets right now, there is a normal sequence of events that we’re seeing. The first step is higher inflation that causes the second step, which is central banks raising interest rates to keep inflation under control. This is when investor sentiment starts to weaken, which I think we’ve already seen. In the third step, higher interest rates start to do their work and reduce economic growth and profit growth. This is where I think we are right now as people are reducing their expectations.
This slowing in growth is going to make it hard for bond yields to move higher. I think the market is going to perform in a very similar manner to the sequence I just described. In the first six months of the year, the rise in interest rates was the dominant reason why returns were negative. At this time investors were focused on what companies and sectors were most sensitive to interest rates.
Looking forward, we’re expecting an environment with slowing economic and profit growth. I think investors are going to start focusing not on interest rate sensitivities but earning resiliency. The companies that will hold up the best in this environment are quality companies with defensive or more reliable earnings. While they have been hit in some places by higher interest rates, I think they’ll do a lot better in the future.
If you can find a quality company that has a strong, long-run industry thematic, then you’ve got a real winner. They’re the type of companies that we’re looking for.
Matthew: Nikki, how are you incorporating these broader macro trends in the portfolio?
Nikki: Broadly speaking, we’re looking for the things that are working right now. We want to have pricing power. We want to have protection from inflation and, if we can get it, to be able to leverage inflation. That means we’re looking for companies that can make more money on the back of inflation.
We want to stay with the high-quality options that Magellan is known for, finding businesses that we think will outgrow GDP year in, year out for the next decade.
We’re confident in the companies that we have in our portfolio, which is very concentrated – it’s only ever 20-30 stocks. We have high representation from businesses like Visa and Mastercard, which are largely inflation protected and, in fact, leverage inflation.
Strong exposure to Microsoft and Alphabet – both with strong tailwinds around enterprise software, global digitalisation and digital advertising – provide a strong base.
We’ve also leaned on reliable earnings generators like McDonald's and Yum! Brands that clip the ticket on top-line sales that come from franchise operators. They don’t get the headwinds of commodity costs to the same degree as a typical restaurant chain. We believe these brands will perform well and will be resilient if we go into a period where economic growth is challenged.
They’re the sort of companies that we’re looking for and leaning on in this difficult market. We’re starting to see some opportunities appear where the market’s oversold and we find brands that have strong tailwinds, in our opinion. We’re looking for opportunities like these in these difficult markets.
Matthew: What are some of these new opportunities?
Nikki: Some of them are new and some are stocks that have been reintroduced to the portfolio that have history with Magellan. Stocks like Diageo, the world’s largest spirits manufacturer. It is very leveraged to the end of lockdowns and reopenings happening around the world. Its last results saw a 20% organic growth in its business; that’s an example of an economically resilient business that has extraordinary pricing power.
Others may be new, like ASML, the leading supplier to the semiconductor industry. It’s probably the least-known monopoly in the world. When you think about the growth in semiconductors in this digitalised world – everything from your dishwasher and fridge to your phone and car are all connected – you need semiconductors for that. This is a business we had an opportunity to pick up and put into the portfolio.
Another one is Chipotle Mexican Grill, a high-quality Mexican food chain with store roll-out opportunity giving it at least 8% to 10% per annum growth for the next decade due to an efficient operating model. Restaurant margins are very strong and returns on capital as they roll out these stores are extraordinarily good. It’s a classic Magellan-type of investment, but we've been able to start acquiring this at what we believe are bargain basement prices.