Recent market turmoil has exposed the dangers of investing in lower quality companies whose fortunes are tied to factors they cannot control, according to Gerrit Smit, manager of the £1.7bn Stonehage Fleming Global Best Ideas Equity fund.
Markets have been roiled in recent weeks by a banking crisis that has caused investors to reconsider their portfolio allocations against an already testing backdrop of high interest rates, persistently high inflation and economic uncertainty.
“We have lately seen in markets that there is an inherent danger in investing in companies that are exposed to factors they cannot control,” says Smit. “Whilst banks are supposed to benefit from higher interest rates, this time it turned out the reverse. We have also seen weakness in energy and resources companies due to sharp oil and gas price falls. No matter how well these companies are managed, they are at the mercy of the underlying commodity prices. That is why we do not own companies that aren’t masters of their own destinies.”
While there was a broad market sell-off in 2022 as central banks began aggressive rate hiking cycles, Smit says many of the companies that outperformed during that period are unlikely to prosper in a more difficult economic environment.
“Some of the areas that performed relatively well are struggling now and could continue to underperform going forward,” he says. “The better quality companies – those that can deliver top line sustainable growth organically and through their own strategic endeavours – are performing much better and that is primarily because they are resilient, which is a desirable characteristic to have heading into a more challenging economic environment.”
Moreover, many of these companies can withstand the pressures the market could continue to face from higher interest rates in a weakening economic environment, with significant uncertainty around central bank policy going forward.
“I can sleep well at night knowing that if interest rates go higher and stay higher, then the companies in our portfolio will be able to cope very well,” says Smit. “Many of these businesses benefit from higher interest rates with net cash on their balance sheets, with the ability to grow sustainably irrespective of the challenges they face both now and in the future.”
Not only do these companies not require positive external factors to outperform the wider market, he adds, but they are now trading at much lower valuations, having endured a difficult 2022.
“Last year’s sell-off was more about a de-rating than fundamental economic weakness,” he says. “It was a painful period for quality companies but it is important to remember that many of these names are now trading at much more attractive valuations than they were 18 months ago, and they historically outperform during more uncertain economic times.”
