The market seems to be dominated by the twin beliefs in the invulnerability of the U.S. economy and the massive impact of GenAI. This is not the easiest environment for an investment philosophy that seeks established winners with resilient earnings in tough times. However, high expectations generally, and increasingly for one company in particular, make us nervous about the market’s prospects. We remain steadfast in following our quality process and focus on absolute, long-term compounding.

While active versus passive is a well-worn debate, it needn’t be an either/or decision. We would argue there’s a strong case for both index investing and active management to co-exist in portfolios. While passive funds provide broad-based exposure and nimble, cheap access to tactical themes, there is still an opportunity to be selective – particularly given indices’ biases. When stock prices become disconnected from fundamentals, skilled stock pickers can take advantage if they have the luxury of a longer time horizon and a lopsided multiples-powered bull run still has momentum.

In a market obsessed with chasing the next big thing, we make sure that companies’ valuations look justified by the underlying fundamentals, building a portfolio of those rare companies with the ability to compound at a high and sustainable return over the long term. Because while multiples have accounted for 85% of returns this quarter, over 20 years this falls to 4%. Meanwhile, earnings growth counts for much more – as much as 71% over 20 years. Compounding requires discipline and patience.

A combination of ebullient and concentrated markets makes for a challenging investment environment, particularly in relative terms. The International Equity team’s response is to continue to think in absolute terms, be fussy on both quality and valuation, and look to compound over the long run.

From understanding how to pick great companies to the secret of longevity in the investment business, William Lock shares 10 lessons learned from 30 years of investing in high-quality companies that are able to sustainably compound capital over the long term—providing clients with attractive long-term returns.

Compounding is a powerful force—but what tells us whether a company might be a high quality compounder? We focus on return on operating capital employed (ROOCE) and gross margins. Companies with high ROOCE typically have high-margin and asset-light operations, while high gross margins generally reflect pricing power. These attributes indicate to us which companies are worth looking at more closely, and where we ought to be spending our time evaluating franchise durability.

After a year that suggested nobody knows anything, we’re entering 2024 with good arguments for both sunny optimists and cloudy pessimists. And while we can’t be certain where the world economy will land on the sunny/cloudy spectrum, the market is clearly pricing in a sunny outcome. Combined with high multiples, that creates an unfavourable asymmetry with limited upside and plenty of downside. The trick—as always—is to hold on to the healthy long-term absolute returns when markets take a knock.

GLP-1 agonists have been heralded as game changers in treating obesity, with the drug manufacturers seen as the immediate market winners, and medtech and U.S. food & beverage stocks as losers. As they explain, the International Equity Team remains sanguine about the overall effects on their portfolios and believe that the medium- to long-term impacts are likely to be minimal.

As long-term investors, we want our companies’ pay plans to encourage longer-term thinking over short-term opportunism. We favour incentive schemes that align goals with shareholder interests, structured on sensible and disciplined performance-based targets. And we take the compensation process seriously, with our proprietary Pay X-Ray scoring system and established principles based on 20 years of talking to companies about executive pay.

Alongside the early winners of the AI gold rush, the International Equity Team believes there are others for whom the benefits of GenAI will take longer to emerge but will be significant over time. These “slow burners” will not only generate value from AI, but also have the pricing power to hang on to the resulting benefits. This challenge is easier in relatively closed systems, or “Walled Gardens,” that include proprietary data.

Financials is a value sector – typically cheap and quite frequently not so cheerful. Or is it? We believe that select high quality companies within financials do exist and make excellent candidates for our portfolios. Well-managed companies with strong intangible assets in balance-sheet light subsectors such as exchanges, payments and insurance niches can achieve the combination of high returns, moderate cyclicality and recurring revenues that we favour.

While society may be driven by immediate rewards, the International Equity team would argue that patience in investing leads to enduring results and positive long-term investment outcomes.

As artificial intelligence enters its next chapter, the early winners of the “AI gold rush” have been the semiconductor and cloud computing providers. But the surge in generative AI also included two surprises: the speed of consumer adoption and the lack of barriers to entry. While the full impact of AI remains unclear, the International Equity Team continues to invest through its high-quality lens, focusing on further opportunities in cost reduction and value creation, and with an eye on risks.

In the world of M&A, not all acquirers are equal. The International Equity Team is cautious of M&A, typically a high-risk choice for a company’s capital allocation. But there are companies out there—some of which they own—with a track record of relatively low-risk acquisitions that add meaningfully to shareholder returns. Good acquirers are a rare breed, but there are common characteristics to their strategies that suggest it is a repeatable process.

Which companies are well placed to capitalize on the long-term behavioral and lifestyle changes that a multi-stage life might bring about? The International Equity Team discusses.

As higher interest rates make it harder to engineer growth through debt, we think the relative value of businesses that can grow organically should only go up. Learn how our companies are better placed to use their balance sheet resilience to enhance their competitive positions, increase the sustainability of return on operating capital employed (ROOCE) and drive steady, predictable growth.

In the current climate of rising prices and a global squeeze on the cost of living, do big brands face the risk of consumers “trading down”? The International Equity Team discusses why price perception matters, and the power of cues to influence decision making.