FOR INVESTMENT PROFESSIONALS ONLY LOOK TO EUROPE S LEADERS FOR SUSTAINABLE RETURNS COLUMBIATHREADNEEDLE.COM
LOOK TO EUROPE S LEADERS FOR SUSTAINABLE RETURNS David Dudding Portfolio Manager Mark Nichols Portfolio Manager THREADNEEDLE EUROPEAN SELECT FUND: 30 YEARS OF STRONG PERFORMANCE In the past few years, high-quality growth stocks like Anheuser-Busch InBev, RELX and Unilever have delivered strong returns to shareholders. They have done so even though other companies have reported volatile and poor results, and stock markets have at times failed to perform. What these European champions have in common is a competitive advantage and a robust business model that allows them to sustain high returns over long periods of time. Without this advantage, it would not take long for competitive forces to drive down their returns. By investing in these market leaders, the Threadneedle European Select Fund has generated attractive long-term investment returns. In the past 30 years, the fund has generated an annualised performance of 11.2%, compared with the FTSE World Europe (ex UK) index s 8.1%. 1 Over the three decades, the fund would have turned 100 into 2,204.82, more than twice the index s 902.35. The fund has delivered impressive long-term returns and the focus on building a highconviction portfolio provides the potential for strong and sustainable future returns. At a time when less predictable returns from equities in general seem likely, these high-quality stocks may well prove to be among the stock market s most sustainable performers. 1 All returns are gross of fees and include gross reinvested income. Covering period from 31.10.1986 to 30.4.16. From 01.04.2014, the fund returns are calculated using global close valuations and daily cash flows. From 01.01.2008, the returns are based on global close prices (prior to this date official noon prices have been used). 3
The market underestimates the sustainability of returns Returns Additional shareholder value Actual Fade Cost of capital Assumed Fade Time SUSTAINING HIGH RETURNS In a free market economy, capital seeks the areas of highest return. Whenever a company develops a profitable product or service, it attracts competition. A company must possess competitive advantage to avoid or defeat such competition and to sustain high returns. Strong management and great products are advantages for any business, but they are not enough. Only exceptional companies possess sufficiently powerful competitive advantage to protect their positions and pricing power. In order to maintain the pricing power needed to grow profits while maintaining high returns on investment for a long period, a company typically boasts one or more of the following factors:- 1. Strong brands Brands often lead to industry dominance, and act as barriers to entry 2. Patents Patents prevent competition for a company s products 3. Cost advantage Low costs can enable a company to limit the attractiveness of a market to existing competitors and new entrants 4. Network effect Where current users of a good gain when additional users adopt it (a classic example is the telephone) Porter s Five Forces (see diagram below), the business strategy tool, is useful for showing the competitiveness of different industries. Developed by Harvard s Professor Michael E Porter, this helps to reveal a company s sustainable competitive positioning and sources of pricing power. 4
Anheuser-Busch InBev (ABI) is an example of a European company with powerful competitive advantage. ABI s beer brands are among the world s best known Budweiser, Stella Artois and Corona are stocked across the world and it has a powerful distribution network. Furthermore, its suppliers have little power to push up prices as they produce commodities. Additionally, ABI s proposed takeover of SABMiller will create a global beer company, and enhance its position in Africa s fast-growing markets. ABI: the world s best known beers 180 160 Rebased = 100 140 120 100 80 Mar 14 Sep 14 Mar 15 Sep 15 Mar 16 Anheuser-Busch InBev Anheuser-Busch InBev relative to FTSE W Europe Index Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Bloomberg 2016 Unilever, the Anglo-Dutch consumer goods company, is another company with strong competitive advantage. It has more than 400 brands, including Ben & Jerry s, Dove, Lynx, Persil and Vaseline. It is gradually moving from food to higher-growth, higher-return areas such as personal care. Unilever: powered by consumer brands 140 120 Rebased = 100 100 80 Mar 14 Sep 14 Mar 15 Sep 15 Mar 16 Unilever Unilever relative to FTSE W Europe Index Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Bloomberg 2016 5
RELX, a specialist publishing conglomerate, also has competitive advantages. It has scale from the number of legal and scientific publications it controls, and power because of their importance and longevity. It benefits directly from the move to online (rather than paper-based) access as it can offer its clients more, become more important to them and therefore charge them more. Its databases gives it unique access to risk data which is in increasing demand in the insurance world. RELX: strong intangible assets 180 160 Rebased = 100 140 120 100 80 Mar 14 Sep 14 Mar 15 Sep 15 Mar 16 RELX Group RELX Group relative to FTSE W Europe Index Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Bloomberg 2016 THE PROCESS OF PICKING WINNERS The process of picking companies with strong competitive advantages has been in place for 30 years. The managers have significant experience of managing portfolios across various market conditions, and can draw upon a range of different perspectives from within our multidisciplinary European equity team and across the wider investment platform. Dave Dudding has managed the fund for nine years and has recently been joined by Mark Nichols as co-portfolio manager. They are supported by a team of 13. The stocks selected aim to deliver high returns over the long term. The size of the fund s position in a stock depends primarily on how great the managers judge the potential gains to be, as it is also matched to liquidity. Sufficient liquidity means a holding can be trimmed if it becomes expensive and added to if it gets cheaper. Typically, the companies in the portfolio have large, established collections of products and services. Many of them come from Europe s consumer discretionary and pharmaceutical sectors, with strong brands and patents respectively. By contrast, there are few holdings in the oil & gas, financials and utility sectors, where there is little pricing power. 6 But even the strongest competitive advantage does not always last forever, especially at a time of rapid technological change. Every portfolio holding s investment case and price is closely monitored. While stocks are generally held for long periods, they can be sold for example, if there is a deterioration in their industry s prospects and an erosion of their competitive advantage.
30 YEARS OF STRONG PERFORMANCE The fund s 30-year performance illustrates the long-term gain of investing in Europe s high-quality growth stocks. Since inception in 1986, the fund has generated 11.2% annualized performance. By comparison, the FTSE World Europe (ex UK) Index has returned just 8.1%. 2 Analysis of the past five years demonstrates steady performance during an erratic time for European stock markets. The fund s annualised performance of 13.6% is in excess of the FTSE World Europe ex UK Index s 7.1%. 3 The main difference between the two came in 2011, when the index fell -12.5% but the fund protected investors capital, declining just 0.1%. An Information Ratio of 1.17 illustrates its solid balance of return and risk. The team has managed the fund for the past seven years, so this performance illustrates their medium-term track record. LOOKING FORWARD High-quality stocks can generate sustainable capital growth for investors at a time when weak economic growth and other factors are putting pressure on equity performance. While many stocks are highly dependent on the prevailing conditions in the economy and stock market to drive their returns, the best high-quality growth stocks should be able to carry on delivering high returns on capital, and earnings growth, almost regardless. The fund has delivered impressive long-term returns and the focus on building a highconviction portfolio provides the potential for strong and sustainable future returns. All over the world, investors are looking for ways to achieve capital growth in a challenging market environment. A select portfolio of high-quality European stocks stands out as a way of achieving this. 2 All returns are gross of fees and include gross reinvested income. Covering period from 31.10.1986 to 30.4.16. From 01.04.2014, the fund returns are calculated using global close valuations and daily cash flows. From 01.01.2008, the returns are based on global close prices (prior to this date official noon prices have been used). 3 Source: FactSet, as at 31 March 2016. Fund returns gross of tax and TER for comparison with indices. All data is quoted in EUR. 7
PORTER S FIVE FORCES 1. Degree of rivalry The intensity of competitive rivalry is the major determinant of a company s competitiveness 2. Threat of substitution Substitute products can shrink the size of a market for example mobile phones have reduced the use of landline phones 3. Buying power The bargaining power of customers affects a company s ability to increase prices, its pricing power 4. Supplier power The bargaining power of suppliers affects input prices. If there are not many suppliers, they can increase their prices 5. Barriers to entry Profitable companies that yield high returns will attract competition, unless there are barriers to entry Porter s Five Forces Supplier power Barriers to entry Degree of rivalry Threat of substitution Buying power 8
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