When markets are unreliable, invest in reliable companies

When volatility is cranked and the index is unreliable, look for reliable companies. 

That was the key takeaway from a recent sit-down with Iain Fulton, Portfolio Manager, Yarra Global Share Fund. 

What does reliability look like? For Fulton, it's companies with improving return on capital.

There's a long history of empirical evidence that shows that if you can, over five years, improve your return on capital through enhancing margins and enhancing profitability, through the capital expenditures that you make, that's a great way to add value for shareholders over time.

In this interview, Fulton also discusses the current outlook for global markets, and the upstream artificial intelligence (AI) play he's recently added to the portfolio. 

Note: this interview was recorded on September 7, 2023. 

Edited Transcript

LW: What’s your outlook for global markets?

We're cautiously optimistic on markets. 

We see a pretty strong disinflationary pulse coming through, particularly from traded goods coming out of Asia, bringing headline prices down. 

The flip side of that is we've still got tight labour markets and the service sector is still seeing some inflationary cost pressures there. But we're probably at or around a peak in the interest rate cycle, and that's usually supportive at some level for markets going forward.

LW: Have markets been too quick to claim victory against inflation and higher rates?

I think it's possible. I think we've definitely got a slow-down in parts of the economy and a lag to the impact of monetary policy. But fewer households in the US, the UK and economies like that have mortgages these days relative to 10 years ago. More of those households are on fixed rates so have been less interest rate sensitive up until now, but they’re beginning to reset.

We will see some of that demand weakening while we've got disinflation happening. I think that's a sensible scenario that, as long as it doesn't go too far, can lead us to that soft landing outcome. So I don't think markets are too quick. I think they're pricing in what is the most likely scenario today. There can always be outliers to that, but that's probably what's most likely right now.

LW: What type of opportunities are you looking for in the current environment?

We look for businesses that have an improving return on capital. 

There's a long history of empirical evidence that shows that if you can, over five years, improve your return on capital through enhancing margins and enhancing profitability, through the capital expenditures that you make, that's a great way to add value for shareholders over time. 

So we think in times like this where we have volatile economic conditions, a range of possible outcomes in terms of inflation and growth, companies with solid competitive advantages, with great margins and great cash flows that also have strong balance sheets and sensible valuations give you that kind of all-weather idea that can manage through difficult economic periods.

LW: Can you talk to a company that you have recently added to the portfolio?

We've recently added Synopsys (NASDAQ: SNPS) to the portfolio and it's really around the AI arms race and their new high-end chip design. 

The software that Synopsys provides to semiconductor manufacturers and semiconductor design companies is really critical in the development and the advance of high-powered and high-functioning semiconductors in markets like automotive and in high-end server architectures, and really across a whole range of applications which are expanding as the need for these products develops into new and more interesting areas of the economy.

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