Fund Calibre interviews Morgan Stanley Global Brands portfolio specialist Candida da Silva, giving insights into the protfolio’s strategy of holding high-quality companies with defendable, visible future earnings and emphasising the long-term ownership of these businesses.
Why you should listen to the interview: With the mantra, “Don’t lose money” firmly in the forefront of the team’s investment approach, Candida comments confidently on the long-term holdings in the portfolio and their characteristics. She looks at the impact of inflation and also explains why patience is key.
This interview was recorded on 28 May 2024. Please note, answers are edited and condensed for clarity. To gain a fuller understanding and clearer context, please listen to the full interview.
Interview highlights:
Quality is worth the wait
“Charlie Munger talked about the big money is not in the buying or the selling, but in the waiting. And we look for high quality, well-managed companies, which can compound their earnings steadily across market cycles. But the art is being patient enough to allow them the time to do so and we have the luxury of a long investment horizon. As an illustration, over a third of the companies we hold in our Global Brands portfolio have been held for 10 years or more. In terms of our philosophy, it dates back 28 years and the companies we like have the following characteristics.
“First of all, difficult to replicate intangible assets. We also look for a sustainably high return on operating capital employed on an un-levered basis. High gross margins, pricing power – crucial in this inflationary environment – and low capital intensity and a reliably recurring revenue stream. In all of this, effective management is crucial. These are highly cash-generative businesses and we want to see a history of disciplined and efficient use of that free cash flow; that makes sure the franchise is protected and can grow.”
Managing competition risk to maintain moats
“The well established companies that we like have deep, well managed moats or high barriers to entry, thanks to their intangible assets. And these moats can offer long-term durable competitive advantages.
“For instance, we own a banking software business that’s so entrenched in its client’s infrastructure that its clients tend to be extremely reluctant to switch provider. A joke in the industry is that a senior bank manager would rather retire than oversee a core banking software transition. As a result, about 90% of their revenues are recurring. And a similar deep moat applies for a holding that’s the leading provider of proxy voting services – it has about 95% market share – and it’s such a complex and difficult area administratively, that its recurring revenue retention is an extraordinary 98%. It takes too much effort and cost for its clients to take on the work themselves or to switch provider. So intangible assets are a vital ingredient against those challenges in the first place.
“But we recognise that things can change and one of the key risks we look to manage on an ongoing basis is competition risk which is where management comes in. We want to see effective and sustained investment by management to maintain these moats. This can be in the form of advertising and promotion, R&D and innovation.
“Generative AI is a very good example of how companies adapt over time, and where we believe that the moats of many of our holdings are strong, thanks to what we call their walled gardens by which we mean the extensive proprietary data that they can mine for more customer insights to increase efficiencies and enhance customer service. We’re already seeing that at work today. These companies therefore aren’t standing still, but continue to invest in order to protect their high barriers to entry.”
The resilience of pricing power through exceptional headwinds
“Pricing power is a crucial kind of aspect of what we’re looking for in a holding. We look for these natural compounders that can compound through market cycles as they tend to be resilient because they’re more non-discretionary in nature, whether that’s mission critical software, must have medical products, or very strong brands that are often in everyday must have arenas such as washing powder or shampoo. This in itself sustains customer demand regardless of the market backdrop. And it also arms them with pricing power.
“Regarding inflation, if I take the the key sectors where we find high quality companies one by one. First of all, software and services; they tend to have incredibly high margins, so don’t need to put up prices that much. And the cloud transition has also provided them with that robust recurring revenue through subscription services.
“With staples, any prolonged inflationary environment shouldn’t be too difficult for them to handle. More challenging has been the short, sharp inflationary environment which we’ve experienced where everyone has put up prices and our companies have also put through price increases. Their top line overall has been strong and profit growth solid, even though there’s sometimes been a hit to volumes.
“And then finally in healthcare, many of our businesses are selling low margin products at the consumables end. For example, a company that’s a leader in supplying syringes and needles; for them, it’s been a bit tougher to put through price increases to hospitals, but they have succeeded, given the critical nature of their trusted products.
“So I think, all in all, the last few years have seen an exceptional set of headwinds for companies, whether that’s Covid-19, war in Europe, supply chain disruption or rampant inflation and tighter monetary policy. But through this we’ve seen remarkable resilience in our holdings along with continued investment to drive onward growth.”
Conclusion
Candida’s commentary explains how being an active manager that’s driven by bottom up research really can add value to this high conviction fund. The fund has returned over 218% for investors over 10 years, compared to 153% for the IA Global sector*.
*Source: FE Analytics, total returns in sterling, from 10 June 2014 to 10 June 2024
The fund mentioned herein is available to UK investors only. All investments involve risk, including the loss of principle. Full details and risks associated with the fund can be found in the fund’s Prospectus at www.morganstanleyfunds.co.uk. The fund is available through your Investment Adviser and applications for shares in the fund should not be made without first consulting the current Prospectus, Key Investor Information Document (“KIID”), Annual Report and Semi Annual Report (“Offering Documents”), or other documents available in your local jurisdiction. This content has been prepared solely for informational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy.
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