Publications

Global Equity Strategy 2Q 2021 Commentary

Jul. 15, 2021

“A thoughtful investment process contemplates both probability and payoffs and carefully considers where the consensus, as revealed by a price, may be wrong” — Michael Mauboussin, Expectations Investing

Like most things in life, writing quarterly commentaries has its plusses and minuses. On the plus side, it is a great tool to communicate with all of you and share some insight into how we’re thinking about the world. However, on the minus side, one fraction of a year tells us very little about returns that are forecast to be delivered over several decades. So, while every small chunk of time always has an element of noise, some quarters just seem to be noisier than others.

On the bright side, a handful of things played out better for us during this quarter than the prior two. In homage to our first quarter message, perhaps quality was in fact — “on sale?”

During the quarter, contributors to performance were broad-based and indicative of our more bar-belled portfolios, balancing sectors like technology and communication services with more cyclical areas such as materials and financials. We also saw a higher degree of breadth across equity markets: on a sector basis, every sector is positive on a year-to-date basis whereas last calendar year, several sectors were negative, like energy and financials.

While we believe many sectors are currently performing well, as denoted by an increase in price, it is important to remember that not everything is worth owning. We continue to remain very selective and focused on the underlying fundamentals of our portfolio companies across the globe. While this has been a noisy quarter, this noise has allowed us to uncover some less obvious sources of forward-looking quality. Below, we will highlight some of those examples we came across during the quarter.

AN EXPECTATIONS FRAMEWORK

Last quarter, we highlighted the reality of large, unexpected events that can cause a whole host of problems, which can then be exacerbated by the way our brains process information. This quarter, the world ventured beyond the unexpected things in reality, going straight into the imaginary, with someone paying around US$18,000 for a “sculpture” that literally does not exist, as highlighted nicely in Exhibit 1.i

Now, it is hard to pin a cause on everything, and it is even harder to pin a cause on individual motivations. It is puzzling to us what value the buyer saw (pun intended) in the white space of the suggested placing area, but as we are always looking for insights, maybe there is something to be gleaned here in the white space.

There is a two-dollar phrase called stochastic resonance that is often deployed in statistical filtering. While we don’t need to overly focus on all of the applications of “randomness,” it is an important concept that is often misunderstood. We kicked this off, as we often do, underscoring how noisy short-term periods can be. What stochastic resonance refers to is when noise can actually illuminate the signal. Whether that noise comes from short-term periods or headlines around invisible sculptures, maybe the best way to highlight signal is through contrast. In Exhibit 2, we have highlighted consensus analyst expectations for one of the largest global hotel franchises by market cap, combined with both 5-year forward price-toearnings (P/E) ratios and price returns. The top chart highlights analyst estimates for the next four fiscal years (2021 inclusive), while showing what 2021 expected earnings were just 18 months ago. Think about this: just 18 months ago, this company was expected to earn more than US$7 per share in the current year. Now they are expected to earn roughly 30 per cent of that. In fact, estimates show this company is not expected to earn in excess of US$7 per share until the end of 2024. Now, look at the chart on the bottom of Exhibit 2. The orange line reflects the current price while the green line reflects the forward P/E for this company. While expectations for earnings declined and were kicked three years out, the price is basically at three-year highs! So, investors are paying an all-time high price, for all-time highs, in earnings uncertainty. Therefore, it should not be surprising that we have avoided these types of situations, which, in our opinion, are not unique to this company but in fact illustrative of a broader theme, of “pull forward” returns for certain cyclical, fully-loaded, reflation themes.

Contrast Exhibit 2 with Exhibit 3. Exhibit 3 is an area that we like quite a bit and is not commonly frequented by a quality growth manager — iron ore. We believe the setup for select companies in the iron ore space, where the largest producers control more than two-thirds of global production, is the opposite of Exhibit 2. Notice that while this iron ore producer has seen price appreciation, the company’s forward P/E has fallen substantially. Not only that, free cash flow (FCF) margins for the company are roughly 30 per cent, which is in software industry FCF margin territory. This is certainly unexpected for a company in the physical world with real costs and real machines. Unlike invisible sculptures, there is nothing imaginary here. While there is no doubt that this industry is full of noise and complexities, the supply/demand argument is compelling. In our opinion, even if spot iron ore prices were to retreat from their recent highs (a very possible scenario), FCF margins in Exhibit 3 are likely to remain in the mid-teens. Not bad for a company that posted near-zero FCF margins five years ago and once again, in our view, an illustration of our forward-looking quality approach.

Lastly, the expectations framework is not unique to iron ore, as depicted in Exhibit 4. In our non-US strategies, our allocation to emerging markets, particularly Brazil and Russia, have increased, generally at the expense of our China exposure. Why is this the case? We have always said earnings are like gravity — it matters — even if it is a bit cyclical! As evidenced in Exhibit 4, though in our view there is no doubt the world is full of “money printers going BRRRR,” we have another take on this where the B and the R represent Brazil and Russia. While we are not trying to resurrect the old BRICs moniker, it is impressive to see that the cumulative earnings growth over the last five years for Brazil has now surpassed that of China, with Russia not too far behind. Therefore, while China garners all of the headlines (for better or worse), once again noise has helped highlight the signal: bottom-up company fundamentals in both Brazil and Russia are far better, in our opinion, than many market participants are giving them credit for.

Does any of this guarantee that next quarter, next year, or the next five years will play out positively for our strategies? Of course not. Do we think that based on market expectations our global forward-looking quality approach gives us a higher likelihood of being correct than more dogmatic approaches? We do. Regardless, we continue to sift through the data (noise included) to find the signal, wherever it exists.

During the second quarter of 2021, the GQG Partners Global Equity Strategy’s Composite outperformed the benchmark MSCI ACWI (Net) by 358 basis points net of fees, posting a total net of fees return of 10.97 per cent versus the benchmark’s 7.39 per cent return (see Exhibit 5).

Among the largest contributors to relative performance during the quarter were stock selection in the United States and both the information technology and communication services sectors.

The largest negative contributors to relative performance during the quarter included stock selection in China, Germany, and France.

Contributing holdings over the second quarter included:

  • NVIDIA CORP
    Nvidia is the leading designer of graphics processing units that enhance the experience on computing platforms. The firm’s chips are used in a variety of end markets, including high-end PCs for gaming, data centers, and automotive infotainment systems. During the quarter, the company continued to benefit from positive momentum in the GPU market.
  • ALPHABET INC
    Alphabet dominates the online search market with Google’s global share above 80%, via which it generates strong revenue growth and cash flow. Google’s ecosystem strengthens as its products are adopted by more users, which was aided by the pandemic, making its online advertising services more attractive to advertisers and publishers and resulting in increased online ad revenue. During the quarter, the company continued to see positive momentum in its underlying business segments.

Detracting holdings over the second quarter included:

  • ABBOTT LABORATORIES
    Abbott manufactures and markets medical devices, adult and pediatric nutritional products, diagnostic equipment and testing kits, and branded generic drugs. During the quarter, management cut 2021 EPS guidance due to a softening in demand for Covid-19 PCR testing.
  • JD.COM INC
    JD.com is China’s second-largest e-commerce company after Alibaba in terms of transaction volume, offering a wide selection of authentic products at competitive prices, with speedy and reliable delivery. The company, and the Chinese E-commerce sector more broadly, were in our view all under pressure from a rapidly deteriorating regulatory environment during the quarter.

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DEFINITIONS

Earnings per share (EPS) is the monetary value of earnings per outstanding share of common stock for a company.
Price-to-earnings (P/E) is the ratio of a company’s share price to the company’s earnings per share.
Free cash flow (FCF) is the monetary value of cash a company generates after accounting for cash outflows to support operations and maintain its capital assets.

END NOTES
i https://news.artnet.com/art-world/italian-artist-auctioned-off-invisible-sculpture-18300-literally-made-nothing-1976181

GQG Partners Global Equity Total Composite includes all fully discretionary institutional portfolios, with consistent investment parameters, that invest in equity investments in companies whose securities are principally traded in, or whose principal revenues, operations or business risk are attributable to, in the aggregate across the entire portfolio, at least four countries. The Composite includes portfolios that contain client-directed restrictions that do not materially impact the management of the portfolio. For comparison purposes, the Composite is measured against the MSCI All Country World Index (net of withholding taxes). Returns include the effect of foreign currency exchange rates. The GQG Partners Global Equity Total Composite was created January 1, 2021 with an inception date of October 1, 2014.

GQG Partners LLC claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. GQG Partners LLC has been independently verified for the periods June 1, 2016 through December 31, 2020. The verification report(s) is/are available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards.

Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firmwide basis. Verification does not provide assurance on the accuracy of any specific performance report.

GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

GQG Partners LLC is an investment adviser registered with the U.S. Securities and Exchange Commission. The firm maintains a complete list and description of composites, which is available upon request. The firm’s list of pooled fund descriptions for limited distribution pooled funds is available upon request. The firm’s list of broad distribution pooled funds is available upon request.

Performance presented prior to June 1, 2016 was achieved prior to the creation of the firm. The account is a personal account of the Portfolio Manager who was the only individual responsible for selecting the securities to buy and sell. The prior track record has been reviewed by Ashland Partners & Company, LLP and conforms to the portability requirements of the GIPS standards. On June 28, 2017, ACA Performance Services, LLC acquired the investment performance service business of Ashland Partners & Company, LLP.

The US dollar is the currency used to express performance. Returns are presented both gross and net of management fees and include the reinvestment of all income. Gross and Net performance are calculated after the deduction of actual trading expenses and other administrative fees (custody, legal, admin, audit and organization fees). Net returns are calculated using the highest/model rack rate fee. Gross and Net performance are net of foreign withholding taxes.

The investment management fee schedule for the Composite is 0.70%. Actual investment advisory fees incurred by clients may vary.

The investment management fee schedule for the GQG Partners Global Equity Fund, a series of GQG Partners Series LLC, which is included in the GQG Partners Global Equity Total Composite, is 0.65% on all assets. The Fund’s qualifying expenses are currently capped at 0.15%, so the total expense ratio of the GQG Partners Global Equity Fund will not exceed 0.80%. This is not an offer to sell securities. That may only be accomplished by the issuance of a private offering memorandum/subscription documents.

Policies for valuing investments, calculating performance, and preparing GIPS composite reports are available upon request. GQG Partners calculates asset-weighted standard deviation. Past performance is not indicative of future results.

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