When it comes to investing, sticking with what we know makes sense, especially in uncertain times (which seem to be all the time). As I am British, UK stocks seem familiar to me. The largest is AstraZeneca – everyone knows AstraZeneca. The second-biggest is HSBC, followed by GlaxoSmithKline. These are companies we can feel comfortable with, you might think; no need to look further.
In its 2018 European Asset Allocation Survey of institutional investors, Mercer, the investment consultant, found that UK investors keep 28% of their equity allocation in British markets (compared with the UK’s 4% weighting in global equity indices) and it’s the same for Europeans generally, with a 38% allocation to home equity markets.
A global footprint
AstraZeneca’s US revenue is 80% higher than its European revenue. Almost 50% of HSBC’s revenue comes from Asia, and it’s a similar story at GlaxoSmithKline. So we are more familiar with international markets than we thought.
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The problem is that the FTSE 100 is skewed away from highly profitable, or “quality” companies. The largest ten companies in the UK market have an average expected “post-Covid-19” return on equity (ROE, a key gauge of profitability) of 23%. The largest ten in the MSCI World Index, a broader global index, have an average expected post-Covid-19 ROE of 38%.
Over the last decade the MSCI World Quality Index has outperformed MSCI World by almost 90% and the FTSE 100 by almost 195%. For the ten years before that, MSCI World Quality beat MSCI World by 14%, but in the decade before that the gap was 309%. So buying “quality” works, but buying British doesn’t seem to be a “quality” buy.
The companies on the UK market are not generally of the quality that can generate good long-term investment returns. Unilever is listed in London and is a very good company, but how about looking at a company like Mastercard, which we are all familiar with?
“Quality” does not simply mean “growth”. Many of the top-performing funds over the last few years have focused on rapidly-growing companies but the inverse correlation of “growth” stocks’ returns with bond yields is clear. Should inflation come back, bond yields are likely to rise, reflecting falling bond prices. “Quality” has stood the test of time whereas “growth” is likely to suffer if bond yields rise (higher interest rates temper growth).
Three top tips
Here are three global stocks that we think are “quality”, but not necessarily “growth”. One is Inditex (Madrid: ITX). This is the Spanish company behind Zara. Naturally the pandemic has affected sales, but it has a strong balance sheet and a growing online business.
Then there is Novo Nordisk (Copenhagen: NOVO-B), a Danish diabetes-treatment maker with a terrific record on environmental, social and governance issues and a head-start on the competition in oral-diabetes treatments. Finally, Pepsico (Nasdaq: PEP) is a high-quality soft-drinks, snacks and foods maker whose brands include Quaker Oats and Pepsi Cola. Its ROE and history of dividend payments are both attractive.
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