Markets

There's only 25 businesses in the world that can generate returns of 10% p.a. today. Here are some of them

Thu 30 Mar 23, 9:58am (AEST)
Charlie Callan, BondAdviser

Key Points

  • How investors can avoid Value traps
  • Robertson: There are only 25 companies that can generate returns of 10% per annum
  • How the portfolio has changed over the past decade
  • A few examples of portfolio positions today

I don't know what I expected going into an interview with Lazard's Warryn Robertson. Perhaps, I anticipated the usual suspects - the macro environment, the micro, and everything in between. 

What I didn't expect, was a truly unique story - one that would see a young boy from a hobby farm just outside Canberra catapult onto the path he treads today. 

At his family farm near Lake George, Robertson learnt the importance of hard work and patience. But the biggest lesson he would learn during his childhood years centred around trust. 

When I was 12 years old, my parents got swindled by an insurance agent, who essentially was taking a 60% upfront commission on the contributions they made. 20% went to the insurance company, and only 20% stayed with them.

The insurance agent was being fed clients through a series of accountants. And in 1984, he earned $5 million in commissions. That's a lot of money now. It was an incredible amount of money then. 

All this came undone when my parents' accountant died, a new accountant came in place, brought in an independent financial planner and he uncovered this financial charade that was going on.

Thankfully, and after many a TV interview, Robertson's parents were able to get their money back. Hundreds of the insurance agent's victims did not. 

"It's now the reason that independent financial advisers have to disclose the commissions they are paid," Robertson said. After witnessing the stress this insurance fraud brought to his parents' lives, Robertson realised he would need to become financially literate. And so, in the school holidays, he interned with his family's new independent financial planner. 

I realised there will always be people who will rip others off. The reason I do what I do is because of what happened to Mum and Dad. And I really do think, if I can invest people's money for them, and we do as good a job as we can, we can make a real difference to someone's retirement.

And the rest is history. 

Today, Robertson is the co-portfolio manager of the Lazard Global Equity Franchise Fund. The Fund has generated a net return of 14.1% per annum since its inception in October 2013, far outperforming the MSCI World Index's 11.9%. 

Robertson is also a co-portfolio manager on Lazard's Global Listed Infrastructure team and a research analyst on the Australian Equity team.

He also likes a good yarn, and so, a 20-minute chat turned into an hour-long discussion on everything from Robertson's life, Lazard's unique local strategy, investment theories, and where he is seeing opportunity today. 

In part one of this interview, Robertson shares the traps that continue to plague investors (luckily, not the insurance scheme kind), as well as why he believes there are only 25 companies within the global investment universe that can achieve an investment return of 10% per annum. 

In part two, you can expect Robertson's take on the Golden Rule, as well as the top five stocks in the portfolio that he believes to have the greatest potential for upside, despite the market madness we are witnessing today. 

IMAGES FOR BODY OF WIRES (20)
Warryn Robertson, Lazard Asset Management 

How to avoid Value traps

While it's a truism of investment markets that Value outperforms Growth over the long term, there will likely be some traps along the way. 

What is a Value trap? Well, this occurs when an investor values a stock and realises, thanks to its current share price and fundamentals, that it is valued at a discount. They buy the stock, looking forward to the rerate that is to come, but it never eventuates - perhaps because the stock later releases disappointing earnings, or because the fundamentals weren't as strong as they thought.

For example, a stock is trading at $2. On valuation, you realise it's actually worth $4. Cha-ching! You buy the stock, earnings come out and disappoint, you reassess your valuation and it's now worth $3. Thanks to the stock being sold off on that pesky poor result, it's now trading at $1.50. So, you buy more. After all, that's 100% upside! But yet again, it disappoints. Now, your valuation is $2, but the stock is trading at $1. Maybe you buy more, maybe it recovers to $2, but you never get your money back on your $3 or $4 valuation. 

"Part of the reason those Value traps exist is we think that you don't look for the right types of investment criteria," Robertson said. 

 Instead of just focusing on undervalued businesses, Robertson and the Lazard team spend a great deal of their time identifying "economic franchises". 

These are a universe of predictable, long-established businesses. Typically, they've got market-leading positions, high free cash flows, high margins, and manageable balance sheets.

Now, when people talk about that type of business, you normally associate that with a Quality or Growth manager. What we dovetail into that is a fixation on valuation, and paying the right price for a business.

After all, even the greatest business in the world can make a lousy investment if you don't pay the right price for it, he added. 

So what isn't included in this universe? 

Surprisingly, banks, insurers, energy companies and miners don't make the cut - typically staples in a Value investor's portfolio. 

"Banks operate in competitive markets, and they are highly subjected to managing the net margin, and credit growth. There's a whole range of factors that are quite difficult to forecast, and investors can easily make mistakes on," Robertson said. 

"Insurance is all about trust. You've really got to trust what insurance companies say to you because you can't look at their accounts and back it with cash flow." 

Meanwhile, energy companies and miners as the prices of their underlying commodities can be incredibly volatile.  

Value investors can get trapped... but so too can Quality and Growth investors 

Don't let the Growth and Quality investors tell you any different - everyone can fall for the trap.

So what are Growth and Quality traps? Glad you asked. 

Robertson outlines Growth traps as businesses that disappoint on the earnings front, failing to achieve the growth ambitions that high-momentum investors search for. 

"For example, the stock isn't going to do 20% EPS growth anymore, it's only going to do 15%. And all of a sudden, the share price gets taken out the back," he explained. 

"Take Adobe (NASDAQ: ADBE), which is a really good business. They've moved to a user pay system. It's an interesting subscription system in that you've got to opt out." 

While Adobe is a "great business", it was expensive, trading on 50 times EBIT. 

"It didn't miss a trick. Its earnings kind of disappointed. It then went and bought a business, which made the market query what the long-term growth trajectory was, and now it's trading back at 18 times EBIT," Robertson said. 

"It's still expensive, but it's lost two-thirds of its value. And what changed? The market just went, 'Actually, hang on a minute, I need to think about this.' So, that's where the Growth investors can get caught out." 

Meanwhile, Quality investors can get "fixated on return on equity". 

Often, that could be a poorly executed acquisition that changes the return profile of the business. Or it could just be that all of a sudden, business is getting a little more difficult, and marginal returns are starting to fall.

What often happens in those types of scenarios is that the investors like us, that hunt for Value in what people would regard as a Quality universe, or what we think of as our economic franchise or predictable universe, that becomes interesting to us.

For example, Alphabet's (NASDAQ: GOOGL) earnings momentum has recently faltered and its share price has fallen with it. 

"We looked at it and said, 'Now that actually represents good value. It's still a great business. We think it's going to dominate a certain category.' And we've bought back into it in recent times," Robertson said. 

Why Robertson believes there are only 25 companies that can generate returns of 10% per annum today 

To identify portfolio opportunities, the Lazard Global Equity Franchise team start off with the MSCI World Index and filter it down to only include those businesses they would define as "economic franchises". This dwindles the investment universe down from more than 1500 stocks to just 250. 

"Essentially, the ones where the dislocation's the biggest, and where I think the value is well above where the share price is, that's what we own in the portfolio," Robertson explained. 

Stocks are typically chosen by the team thanks to the long-term ability to forecast their earnings, he added. 

"That's a stable return on assets, moderate gearing, and good margins," Robertson said. 

"We've got a proprietary criteria scoring system that we use to look at product lifecycle, industry structures, and leverage. We consider the environmental, social and governance risks. 

"But at its heart, our objective is simple identify businesses with more predictable and forecastable earnings and cashflows, thus making the job of valuation easier than many other businesses with much more unpredictable or varied potential outcomes. And then in determining what we own is equally as simple.”

In plain English - the bigger the difference between a stock's intrinsic value and its share price, the bigger position it will hold in the Lazard Global Equity Franchise Fund.

You've seen the bond market and equity market moving in sync for the latter half of 2022 and early 2023, but have just all of a sudden started to diverge.

The bond market thinks there's a problem; the equity market thinks there isn't. And it's all because the Federal Reserve may pause on interest rates. And that might mean that we can go back to the days of the great modern monetary theory experiment. We don't think that scenario is plausible.

Subsequently, of Lazard's 250 stock universe, the team only owns 25 stocks. 

"Not because we want to be punchy, but because they're the stocks that we think are attractively priced," Robertson said. 

"There aren't that many of them. 90% of our universe won't achieve the return objectives we want, which are greater than 10% per annum. And that's why we own 25 stocks. We would love to own 50, but we can't find 50 that offer a decent return." 

What does the portfolio look like? 

The Lazard Global Equity Franchise strategy has been running for a decade, and while some allocations are similar to those at the portfolio's outset, most have changed immensely. 

A few quick stats for you: 

  • Today, 20% of the portfolio is invested in IT. A decade ago, 25% was invested in the sector. Back then, the portfolio held stocks like Oracle (NYSE: ORCL), Microsoft (NASDAQ: MSFT) and Intel (NASDAQ: INTC). Today, it holds positions in eBay (NASDAQ: EBAY), Cisco (NASDAQ: CSCO), Visa (NYSE: V) and Alphabet (NASDAQ: GOOGL).

  • Today, 25% of the portfolio is invested in healthcare. This is the same as it was a decade ago. 

  • Industrials exposure was 15% a decade ago, and is still 15% today. 

  • In 2013, 15% of the portfolio was invested in consumer staples - they owned Coca-Cola (NYSE: KO)Kellogg's (NYSE: K), and Walmart (NYSE: WMT)

    . Today, only one consumer staple stock is attractive. And it's a small position, it's Anheuser-Busch (NYSE: BUD), the biggest brewer in the world.

  • 15% of the portfolio was invested in utilities in 2013, today the portfolio only invests in two stocks in this space. 

"We're trying to steer ourselves towards businesses that we think have economic moats around them so that you can make that call that in 15 years' time, this business is still going to be a market leader," Robertson said. 

"That is a big call, and it's one you are constantly going back to revisit." 

It's not what the bond markets are doing, or the volatility of equities markets, that should be keeping investors up at night. It's structural change, Robertson said. 

"If you go back 30 years ago, newspapers were a business that everyone thought was infallible. And the internet changed that. It didn't change overnight, it took longer than people thought, but today, newspapers are a dinosaur," he said. 

He points to a current portfolio position Medtronic (NYSE: MDT) as an example, an "800-pound gorilla of the medical device industry" which makes catheters, stents, defibrillators, and pacemakers. 

"If a pharmaceutical company comes up with a pill that reduces heart disease, that economic moat of 5,000 patents and billions of dollars a year in R&D could be under threat for Medtronic. So it's not infallible," Robertson said. 

You've always got to worry about that black swan risk. And it's structural change for businesses.

It's not that you will wake up one morning and the banking industry will be in crisis again. That's something you can't predict. That's a Rumsfeld unknown unknown. The known unknown is structural change, and that's what worries us.

This article was first published for Livewire Markets on Thursday, 30 March.

Written By

Ally Selby

Content Editor

Ally Selby is a content editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian Group, Your Money, Sky Business and Sky News.

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