Dialling down the noise and investing in quality

Our next speaker is Hamish Tejal, portfolio manager at SG Hiscock & Co. His presentation topic is, dialing down the noise and investing in quality.

SG Hiscock is a fund manager specializing in high-conviction, actively managed investment strategies and managed discretionary portfolios.

The company is entirely owned by directors, staff and associates.

The focus of their funds is on identifying high-quality companies which are sustainably growing, free cash flow and returns at an attractive margin of safety.

Hamish has over 20 years experience in institutional equities research and investment management.

Prior to S.G. Hiepock, he worked at Goldman Sachs, J.B. Wu and Arthur Anderson.

Welcome Hamish to the presentation.

Thanks, Angelina.

And it's a pleasure to be with you today.

Just before I start, disclaimer for compliance purposes, this presentation is general advice only and does not contain investment recommendations or

provide investment advice.

Let's turn to the next slide.

As Angelina said, SG Hiscock is a boutique fund manager.

We were founded over 20 years ago, and we've got an experienced and dedicated team of 14 investment professionals focused on investing in Australian equities.

We're 100% owned by staff and co-invest in our funds, which

we believe provides our clients genuine independence and alignment.

Our investment approach is very much based on being active managers and high conviction research process focused on building concentrated portfolios that outperform the market over the longer term, which we've had a strong track record of doing.

In Australian equities, we have a broad range of funds across broad cap equities, small caps, emerging companies, and ARITs.

And today, I wanted to focus on two of those funds, two broad cap strategies, being the SGH High Conviction Fund and the XGH X20 Australian Equities Fund.

The two funds, as I say, High Conviction Australian Equities Funds, the X20,

tends to hold 35 to 45 stocks whereas the high conviction tends to be more concentrated investing in around 25 stocks.

Our investment process is very much based on a philosophy of active management and exploiting market inefficiencies through research insight and investing in high quality businesses which we believe are better positioned to grow earnings

and free cashflow and outperform over the longer term.

As investors, we also believe that the price you pay is important in determining the ultimate returns and focusing on valuation and an acceptable margin of safety is absolutely critical.

Another important aspect of our investment philosophy is that the future is uncertain and unpredictable.

That is to say, we should not ignore what's going on around us.

We spend a lot of time observing and understanding the external environment, but we think overly focusing on the macro can be a distraction and create a lot of noise.

The events of the last few years and the current mix of geopolitical, social, environmental, technological, demographic issues

are all creating a high level of uncertainty and extreme policy responses from governments and geopolitical realignment on a scale that many of us haven't seen in our lifetime.

It's also raised the question whether the deflationary trend of the last 30 years has come to an end and we are entering a new regime of higher interest rates and inflation.

This is clearly a source of great debate at the moment

but we also believe is providing opportunities for active managers and longer term investments.

We think dialling down the noise and focusing on investing in quality companies at a margin of safety is the right strategy for the times.

Quality companies in our experience tend to have more resilient earnings, better able to navigate the future,

have fewer tail risks, better downside protection, and in a holistic approach where we're trying to identify quality companies and including ESG risks and opportunities, also provides better longer term returns for investors.

So how do we define quality?

Well, as is shown on this slide, there's four key criteria we look at.

The first is business quality.

which really seeks to assess company's competitive advantage and opportunity to grow.

We look for companies with sustainable competitive advantage that ideally is a leader in the industry with attractive market structure and tailwinds that is allowing it to grow at above GDP growth.

The second thing is really focusing on the quality of the earnings and our confidence in the earnings predictability of the business.

We place a premium on earnings predictability in companies with strong free cash flow, good earnings transparency and strong balance sheets and seek to avoid unprofitable and overleveraged companies.

We also think it's critical to assess the management quality.

It's something we spend a lot of time thinking about.

We're really strong believers in the fish rots from the head, and it goes without saying it's critical

we're investing alongside management that are properly motivated, can demonstrate an ability to create value and aligned with shareholders.

And finally, as I've mentioned, we spend quite a bit of time thinking about ESG quality or the risks and opportunities that companies face in the uncertain times that I've spoken about.

If we move to the next slide, our research process is

a very disciplined one, with a bottom-up fundamental approach, as I've discussed, and it focuses on identifying the best quality companies through a quantitative and qualitative research process.

Our analysis results in us ranking companies across quality, growth, and valuation in constructing our portfolios.

This involves a rigorous debate

amongst the team to ensure we're paying a sensible price for the quality and growth prospects of the companies in the portfolio.

And we have a margin of safety which protects us against permanent capital loss.

A unique feature of the process and in building resilient portfolios is that we seek to provide exposures to different opportunities and earnings drivers.

to provide the diversification and resilience required.

One of the unique ways we do this is through this last company lifestyle diversification and in gaining the exposure to companies with different growth quality and valuation characteristics.

Our view is not all quality is created equal and the portfolio seeks to provide exposure to

faster growing companies through the structural compounders in companies like CSL and Aristocrat.

More defensive stalwart exposures with often monopoly type characteristics like chorus in Auckland airports.

Quality cyclicals that are positioned to capitalise on multi-year earnings momentum through a clear competitive advantage.

An edge like Woodside and Computershare

and emerging companies which are more early stage type businesses that are profitable and have a strong pathway to cashflow sustainability like Lifestyle Communities and Genesis Minerals.

In building the portfolios, we're also very focused on identifying tailwinds for those quality companies.

Amidst the uncertainty that I've discussed, we see that there's four

P or major tailwinds that are running through our portfolios at the moment and supporting a number of our investments being persistent inflation, surging migration, the energy transition and essential services and infrastructure.

This next slide provides more granularity around some of these themes and how we're linking those themes to stock ideas in the portfolio.

By way of example, you can see in the energy transition, we think this is an undeniable theme of strong growth where governments and policy is influencing strong investment.

We're playing this through the portfolios at the moment through a number of different ways.

Firstly, in renewables through companies like Whalley and Infotel, then through critical commodities that are being used in that energy transition like Woodside and BHP.

And then finally, through a number of the service providers that are helping support those companies in delivering on their projects.

I've detailed here the top 10 holdings of both the High Conviction Fund and the X20 Australian Equities Fund.

As I highlighted earlier, the High Conviction Fund is more concentrated and invests in around 25 companies.

and also in the top 20, so holds companies like BHP and CSL.

The X20 fund tends to hold a higher number of stocks, typically 35 to 45, and invests outside the top 20.

In conclusion and bringing presentation to summary, it's really three key messages I wanted to leave you with today.

The first is that

We do think macro uncertainty is creating a high degree of volatility in markets, but that's also providing an opportunity for active managers and long-term investors.

In navigating that uncertainty, we think it's important to dial down the noise and focus on stock fundamentals and investing in quality businesses.

And hopefully, I've given you two examples today

of portfolios within the SGH stable, which are doing that and offering the opportunity for investing in high quality businesses and outperformance over the longer term through managing risk adjusted returns and providing downside protection.

Thank you, Angelina, and I'll hand back for questions.

Thank you, Hamish.

Do you have time for two questions?

The first question is, how is inflation and higher interest rates impacting on how you are thinking about investing?

Angelina, I think it's a good question, and clearly it's one that everyone's asking at the moment.

So how are we thinking about inflation?

I guess there's a few ways.

First of all, as I mentioned earlier, we're seeing a clash between inflation and deflation, and we're very open minded as to where the rates have peaked.

We think it's hard at this point in the cycle given a lot of the other changes in terms of geopolitical events etc to be conclusive on that.

We are of the view that inflation and rates could remain stickier for longer and as I highlighted in the portfolio and one of the themes inflation persistence

and positioning the portfolio for more interest rate incentives, incentive, interest rate sensitive stocks and stocks leverage to that inflation thematic is something that we're currently doing.

But also the view that valuations need to be watched very carefully, clearly in a higher rate environment.

And at this point we are, I guess, cautious or more cautious around some of the longer duration stocks.

and have limited longer duration exposure through the portfolio.

Hamish, in managing a high conviction portfolio, that's what you're managing.

The sell side discipline is as important as the buy discipline.

So how do you manage this?

Another good question and something we spend quite a lot of time focused on.

There's really three main reasons why we will sell a company.

The first is that we just think the value cannot be improved, that it's hit our valuation target or company's been taken over, or we have a better idea to replace that in the portfolio.

The second really is that if there's been an impairment to the earnings power of the business,

that is there's been a regulatory change or some change in the competitive environment perhaps, that means that our investment thesis has been broken.

And lastly, we typically sell companies where we've lost confidence in management's ability to create value.

We do tend to be longer term investors, and therefore we accept volatility as part of the process.

And as I say, really only solve for fundamental reasons.

Thank you, Hamish.

What a presentation, the Q&A.

Great to see you.

Take care.