Global equity markets, and the world in general, are struggling to find a new equilibrium as we work through the COVID-19 pandemic and economies slowly reopen. The length and depth of the recession is unknown and predictions about the strength and sustainability of the economic upswing remain challenging. This uncertainty may lead investors and advisers to ask how their investments are managed and whether these strategies are appropriate given the rapid change we are experiencing. Questions arise such as: Can my global equities portfolio grow over time even if the economy does not fully recover? Is my portfolio dependant on a certain economic outcome or investment theme?
At Loomis Sayles, we construct portfolios on a company-by-company basis, centred on bottom-up fundamental research and a long-term perspective. This approach enables us to focus on the merits of individual companies, rather than chasing themes or forecasting economic conditions. We seek to invest in businesses that meet the criteria of three alpha drivers: quality, intrinsic value growth, and an attractive valuation. We look across geographies, sectors, and styles to find our best ideas and invest only where we have the highest conviction, typically around 40 holdings.
Three alpha drivers of security selection
The three alpha drivers focus the research process on companies with sustainable competitive advantages, the ability to grow free cashflow, and which present an attractive discounted cashflow valuation. The following are key examples of the companies currently held in the portfolio.
MasterCard, a brand likely to be familiar to many consumers, maintains a crucial role in the global payments system, enabling credit and debit transactions between merchants and purchasers. The firm operates an extensive network with nearly universal acceptance in most developed markets and possesses a powerful network effect: the more consumers on MasterCard’s network, the more attractive it is to merchants, and vice versa. Global payments processing has an attractive market structure with MasterCard differentiating itself with a growing business services segment.
We have followed the company on our tracking list for several years. It had met the first two alpha drivers, quality, and intrinsic value growth, but fell short on the third, an attractive valuation. Price volatility in the first quarter of 2020 drove MasterCard shares down and presented the valuation opportunity we had been waiting for.
At first glance, MasterCard’s business appeared badly affected by the pandemic. Indeed, at its nadir, MasterCard’s card spending volumes were down over 30%. However, we felt MasterCard could comfortably withstand a short-term drop of this magnitude, buffered by a business model with low capital requirements, a solid balance sheet, and its growing, less cyclical business services segment which offers clients important tools such as data analytics and cyber-security.
We also believe MasterCard could emerge stronger as behaviours borne out of the pandemic were accelerating the shift from cash to digital payments, particularly contactless payments. There is also the possibility that the environment could create attractive acquisition targets, which would feed into MasterCard’s opportunistic and disciplined bolt-on acquisition strategy.
Nomura Research Institute
Nomura Research Institute (NRI) is a Japanese IT services provider that specialises in serving banks, asset managers, and retail chains. The firm has been a longstanding holding in the strategy since 2013. NRI provides strategy consulting, system integration, and business process outsourcing, as well as software. While largely concentrated in its domestic market, NRI is expanding into global financial markets, recently acquiring AUSIEX (better known as CommSec Adviser Services). NRI has strong relationships with enterprise buyers across Japan, formed over decades of consistent execution and superior services. NRI’s vertically integrated business model creates a more stable and profitable revenue stream by allowing the firm to charge customers for packaged solutions rather than billing hourly.
We believe NRI’s resilience stems from its asset-lite business model and entrenched position with clients.
NRI is involved in critical business functions such as supply chain management systems for all 7-Eleven convenience stores in Japan. The company also has a high degree of recurring revenue stemming from its cloud computing capability, where offerings such as its back-office solution for retail brokerage firms are very sticky.
With most of its business concentrated in Japan, NRI has successfully navigated a low growth environment for decades. The company maintains a strong balance sheet and has grown revenue at a rate well above Japan’s GDP growth while achieving a profit margin and return on equity that compare favourably with leading global players.
Moreover, as with MasterCard, we believed the long-term potential of this company has perhaps improved in this new environment. The digital transformation in enterprises driving NRI’s long-term potential has accelerated. Enterprises without best-in-class digital technologies are likely to find it increasingly hard to compete, as their peers have leveraged technology to improve existing business processes and created more relevant products.
IQVIA Holdings is a relatively new company, formed in 2017 by the merger of leading clinical research outsourcing organisation Quintiles and IMS Health, a leading healthcare data provider. The company provides clinical trials, like the ones currently being undertaken for a COVID-19 vaccine. Through its healthcare data and analytics business, IQVIA provides data (such as on prescription trends) which enables biotechnology and pharmaceutical companies to successfully launch new drugs. The combined company offers a one-stop shop for the life sciences industry.
IQVIA has a high degree of recurring revenue from subscription-based products and a durable client base, as well as potentially attractive end markets as pharmaceutical companies increase spending on drug development and outsource more of their clinical development work.
IQVIA’s business was greatly affected by the pandemic, particularly within its contract research segment. Its shares came under pressure as the COVID-19 environment delayed drug trials (as patient populations are typically measured at medical facilities) and its 2017 founding merger (of Quintiles and IMS Health) left the company with somewhat elevated debt levels.
We remain confident that IQVIA will successfully navigate this period of uncertainty, aided by its variable expenses within clinical research services and strong revenue visibility of the data business. Importantly, the company’s long-term drivers of intrinsic growth remain intact.
Loomis Sayles’ global equity offering is being distributed by IML here in Australia. If you would like to learn more about our capabilities hit the 'contact' button to get in touch or visit their website for more information.