The Current Opportunity in
Global Quality Growth
The Fundamental Argument.
The Nutshell Growth Fund’s current portfolio is dominated by rare exceptional companies that have demonstrated their ability to continue to prosper over the long term regardless of the economic environment. They have high profitability, large moats, stable earnings and little leverage/debt. They have performed well in rate rising environments and have tremendous pricing power to pass on any exogenous costs.
Historically the market has sensibly rewarded these companies with a higher rating than the index in terms of earnings multiple. However, since the inflation/Fed tightening event there seems to have been what could be argued is an indiscriminate sell-off in companies with high multiples regardless of their growth prospects or quality factors. This trend has been accelerated somewhat by the current Ukraine conflict. We believe this is overdone and offers investors a very rare opportunity to gain exposure to some of the world’s leading companies at what amounts to zero premium to the market.
Current Factor Exposure: The Nutshell Growth Fund (March 2022).
Looking at the factor exposure versus the S&P500 (a tougher comparison than a world index) the Growth Fund’s current portfolio has a very high exposure to Size (Liquidity/Market Cap), Credit Strength (e.g. probability of distress, leverage, solvency), Quality (e.g. ROE, ROIC), and Profitability for a Neutral valuation premium. In other words, this week the Estimated P/E of the portfolio for the current year fell to 19, which is in line with the S&P500 index itself.
The market is demanding no premium for this superior set of fundamental characteristics. From a relative value perspective we think this is a great opportunity. (Similar to an AAA bond trading flat to an A, or an Audi flat to a Seat). There have been lots of recent examples of market moves which in the short term can defy reason and preconceived understanding such as negative oil futures or second-hand cars demanding higher prices than new ones. So, in the short run this irrationality could continue, however we think for the long term, patient investor the current environment could represent an attractive and very rare entry point.
The Technical Backdrop.
We created the above index in 2019 for our own internal benchmarking. It is composed of some of the largest and most widely held quality growth funds. Most are household names within the investment community and have won many awards, and all have at least 10 years’ track record. From the chart we can see in log space that the returns have been very lucrative, producing around a 500% return over the last 10 years. (approx. 17.5% pa). We can also see that the current drop is of a similar magnitude to the initial March 2020 Covid outbreak.
The 2nd chart shows the ratio of our custom index vs the MSCI World. We can see that there has been an underperformance of the quality index since April 2020, as the outperformance of profitability factors during the early Covid period dissipated. More recently the underperformance has accelerated since the Fed policy normalisation announcement, and then effectively gone into free-fall after the Russian invasion of Ukraine.
The above charts demonstrate the level of the current extreme drawdown the Global Quality Style is having relative to the MSCI World Index. Since 2020 this style has underperformed by around 25%. It is clear this level of underperformance is very rare. Even when we use a 200 day Moving average to take out the trend, the current period is the most extreme over the entire 10 years from 2012.
To conclude, we believe the current Quality Growth Style looks very attractive both from a fundamental and technical perspective relative to the market and its own history. In our opinion this is a rare opportunity for the patient long term investor.
By Mark Ellis
March 2022