Exploring sustainable returns through quality growth investments

Our next presenter is Elisa DiMarco, Portfolio Manager, Magellan Core Global and Core ESG.

Elisa joined Magellan in 2015, and prior to that, she worked as an analyst at APRA and at Macquarie Group.

Her presentation topic today is exploring sustainable returns through quality growth investments.

Welcome to the presentation, Elisa.

Thanks, Angelina.

It's great to be with you today.

As Angelina just mentioned, today we're going to be talking about how to generate sustainable returns through investing in quality growth companies.

In doing this, we're going to be starting at the beginning, and that's really how we think about risk and return when constructing a portfolio.

Next, we're going to talk about the importance of investment process within this framework and really how to identify a quality company.

And then finally, we're going to put a spotlight on structural growth companies and how this enables sustainable returns.

A little spoiler, this is really how Magellan is thinking about constructing our global portfolios.

So when we're thinking about investing at Magellan, we don't do it from the lens of, well, what is the industry sector, be it information technology, financials, or healthcare.

what we're really thinking about is the investment attributes.

So an investment attribute is the consideration for a company's risk and return profile.

And we think that that is a lot more important than the sector that a company belongs to.

So at a high level, we break the universe down into five categories, deep value, cyclical, defensive, structural growth, and speculative growth.

Let's unpack what each of these represents.

So first onto deep value.

So deep value really has us asking the question of is the company a bargain or is that company cheap for a reason?

So deep value companies can be characterized as being higher risk given that uncertainty in future growth outcomes.

And given these attributes, these companies will often trade at a lower PE multiple.

eBay and Zoom are two such companies that we view to be deep value.

And these companies, in our opinion, have a wide range of potential outcomes.

Let's think about Zoom for a moment.

So we've just exited that work from home boom.

The question in front of us really is, can Zoom continue to defend its share and grow usage of its collaborating software when its largest competitor is the magnificent Microsoft?

So Microsoft has that 90 percent market share in the Office productivity software.

next is cyclical companies.

So these are companies that will benefit in different market cycles.

So for example we have the agricultural cycle which sees farmers increase their expenditure when prices are stronger.

John Deere is a leader in agricultural equipment and benefits from that stronger agricultural cycle.

Or perhaps it's the capital expenditure cycle that is related to travel which would see airlines then bring forward that refreshment of its planes and then that higher servicing level.

So this would benefit Safran which is a leader in jet engine manufacturing and servicing.

So the PE multiple of these companies will then move with the cycle and then the risks are a little bit higher given that uncertainty of when that cycle will bottom or top out.

The next bucket that we mentioned was defensives.

So for a defensive company, these companies have that higher degree of certainty in their earnings.

So they are typically then lower risk, but then often accompanied with slightly lower growth.

So some examples of these more defensive companies in nature are Costco, Nestle and Transurban.

So Costco is one of the largest food retailers in the world and Nestle one of the largest manufacturers of consumer staples.

Both of these companies we have a lot of certainty in their earnings so regardless of where interest rates are or what the economic cycle is I'm certain that we're all still going to be eating food and we'll be consuming food at home.

next bucket structural growth companies.

So these companies can grow their revenues at greater than GDP levels due to this structural tailwind.

Now the tailwind that's underpinning these companies is typically enduring and it's enduring because of the industry structure that it operates within which then gives us greater certainty of its growth profile

These companies will have a more moderate risk, but that higher growth opportunity.

So some examples of structural growth companies include MasterCard that's linked to the cash digitization tailwind, or Microsoft that is linked to the cloud computing tailwind.

These are enduring tailwinds and enduring growth.

These companies have that higher than GDP profile.

We'll unpack structural growth a little bit more towards the end of the presentation.

Now, the final bucket to unpack is speculative growth.

Now, these companies, as the name suggests, are likely to grow the fastest amongst the five buckets that we have spoken about, but we do have lower conviction within this bucket.

And this uncertainty in the growth profile

may be due to the tailwind or to the industry structure.

And then they typically come with a higher risk.

Tesla is an example of one such company.

So we have really high certainty in that transition to electric vehicles.

But we don't have the same certainty in Tesla's ability to deliver that continued exceptional growth that we've seen at current EV prices and given the increasing competition that we're seeing within the sector.

So let's bring all of this together now.

So we've introduced what these five attributes are on our investing menu.

And as we talked about, each of these attributes provides a different risk and return profile.

So on the ends of the spectrum, we have our deep value and speculative growth.

They are higher risk and potentially higher return.

Now, as you work towards the centre, you receive greater certainty in your return and it can be a lower risk profile.

So now that we know all of this, how do we then use this information to construct our portfolio?

So to construct our portfolios, in our opinion, you really need to set your investment objectives.

So that really is well, how much risk are you willing to take on to generate your returns?

And then what is your tolerance for potential capital loss?

So putting this into practice, let's look at Magellan's investment objectives.

So for Magellan's global funds, we have two primary investment objectives.

We want to generate attractive returns with consideration for risk.

And we want to protect capital in adverse markets.

Now hopefully from everything that we've talked about so far you can see why at Magellan we really play into that middle section of this investment menu.

That is the cyclical, defensive and structural growth companies.

This is what we view to be the lower risk section of the menu.

and these companies they give us greater certainty in earnings and then greater certainty of those shareholder and investor returns.

But importantly this part of the menu allows us to protect capital in adverse markets.

Now, an important layer that we add onto this filter in the investment set is quality.

So when we're investing in these quality, cyclical, defensive and structural growth companies, it enables us to generate those important sustainable returns for investors.

Before unpacking quality a little bit more, I wanted to really just touch on well, how is it that we're actually allocating across these investment attributes for our core strategies?

So Magellan's core strategies are actively researched and competitively priced at 50 basis points.

The core global and core ESG strategies that we have on the slide, approximately half of the funds is in the structural growth names, about a third in defensives and the remainder in cyclicals.

These funds have been able to deliver around a 10% per annum after-fee return since inception and a lower risk than the market, achieving our investment objectives.

Okay, back to quality, as we have alluded to, that's a really important part of generating those sustainable returns.

Firstly, what's our definition?

So when Magellan considers quality, we're looking for these unique attributes that will enable a company to generate attractive and sustainable returns over the long term.

So in summary, we're trying to find, well, what is that structural advantage that a company has?

that will enable it to protect but also to grow earnings into the future.

On the slide on the left-hand side, we have a few of the attributes that we're looking for in a company.

Let's go through some examples.

We're looking for companies that have high barriers to entry.

This could be in the form of financial cost to build infrastructure or perhaps the time to replicate a technology.

This is the case for the Cloud providers.

Think here, Amazon, Alphabet, and Microsoft.

they've spent billions of dollars between them building the infrastructure to support clients.

This takes both time and money to replicate what they've created with respect to Cloud computing services.

Another attribute that we look for is having a strong brand.

Think here about the luxury fashion groups of LVMH and Hermes.

These brands have history and quality and they've created a status symbol for their brands.

They're trusted, they're desired and it will take a decade, perhaps even a century to emulate what these brands have created.

The last one that we'll touch on today, but by no means least, and there's many other attributes that we're looking for, let's touch on scale.

So scale will enable a company to leverage its existing resources and its future investments across its broad customer base.

Netflix is a terrific example of a scaled company.

As Netflix invests in its content, that is shared across its leading network of subscribers.

The cost per view is much more expensive for your sub scale providers.

Now, whilst a company may not have every attribute that we've listed,

more attributes that a company has the greater certainty that it gives us in the future earnings.

Now this definition really is critical to our investment process however to find these enduring returns and that forward-looking aspect of well what makes a quality company you can't rely on historical data.

it's all about the research and it's our team of 23 investment professionals that really undertake this detailed fundamental research and then it's the oversight from our investment committee and then that continuous review on the thesis that gives us conviction that the companies that we invest in will generate those sustainable returns into the future.

finish up today let's put that spotlight on the structural growth companies as they're such an important part of the portfolios here at Magellan.

So as we introduced at the beginning, structural growth is an investment attribute that we look for.

And some of those thematics that we're looking for are listed on the slide today.

And it's these thematics that will enable a company to generate that revenue growth that is above GDP.

And it's when you combine that structural tailwind with a quality company, that strength of industry structure, that quality, it will enable that sustainable earnings growth.

Some of the structural tailwinds within our portfolio include AI usage and data growth, that digitization of cash, the shift of a Cloud, and the aging population.

As we alluded to, it's that power of quality plus structural growth that means that the risk profile of these companies is more manageable.

We have greater certainty in the future earnings and returns of these companies,

that will generate the sustainable returns.

So finally what does that then look like when it comes to the portfolio?

What are the types of companies that we're invested in?

On the screen here we're putting together well these structural tailwinds plus the investments that we have within the core ESG strategy.

So as we mentioned we are exposed to the cash digitization and that's via the duopoly that we see in Visa and Mastercard.

We're exposed to digital platforms and those strong platforms that I think most of us are using now in our everyday lives of Amazon, Apple and Netflix.

And then we're also exposed to the aging population through exposure to high quality names such as HCA Healthcare and Striker.

So these are really high quality companies and we continue to see great opportunities within these companies given their quality attributes.

This will enable these companies to protect and to grow their earnings into the future, generating those sustainable returns for our investors.

Thanks very much, Angelina.

It's been a pleasure to speak to you today about quality investing.

Thank you for your presentation, Elisa.

Do you have time for a few questions?

Yes, absolutely.

What makes Magellan's definition of quality unique?

That's a great question Angelina and quality is a term that as I imagine most hear quite a lot in the industry but what makes it hard is that there's no single definition.

So when we're implementing our definition of quality and really what makes it unique is that fundamental research that I mentioned and it's taking the time to really

understand a company in how it can protect and grow its earnings.

We can't just rely on that historical data.

It's our big team of 23 investment analysts that are doing that wide ranging research, debating key topics to ensure that companies can continue to generate strong returns into the future.

What structural tail wing are you most excited about?

Yes, well, we're looking at these quite often and we are really excited.

I think AI has to come to mind and no doubt the topic that will feature within the presentations today, but

thing that's really exciting about AI is that it's going to be touching so many of the companies within our universe.

So it's not just going to be your Microsofts of the world for example as it launches co-pilot into its office suite or we've got ASML that is manufacturing the tools that will be able to process these Gen AI queries.

It's

Also then about your other companies where they have the productivity uplift that will enable them to reduce costs and improve their margins all because of AI and the strengths that it will be providing.

So yeah, thank you.

Thank you, Elisa.

It's good to see you again.