Diversified global quality equity fund focuses on risk management
However, the Benguela Global Equity fund takes a different approach.
The portfolio, managed by Zwelakhe Mnguni with support from Grant Nader, typically holds between 60 and 70 stocks. Mnguni told Citywire South Africa the primary reason for this is Benguela’s focus on risk management.
‘A concentrated portfolio is highly sensitive to single stock moves,’ Mnguni (pictured above) said. ‘We always ask: “what if we are wrong?”. So we align our position sizes to the quality of the business. The higher the quality, the higher the weighting.’
He added that they don’t want to take any big geographic or sector bets in the portfolio.
‘That’s because that decision would be informed by the macro. But we allow stock selection to drive our performance. If we underperform it will be because our timing or our analysis was out, not because we’ve made a macro call.’
Valuation discipline
Benguela also pays a great deal of attention to valuation in building the portfolio, and Mnguni said this influences the decision to hold a broad selection of counters.
‘To strike a good balance between quality and valuation, you probably need to have a well-diversified portfolio,’ he said.
According to Mnguni, a larger portfolio allows Benguela to take positions in three ‘buckets’ of different types of companies. The bulk of the portfolio – around 60% – is allocated to ‘stable quality’, while 20% to 30% goes towards ‘cyclical quality’ and the balance to ‘emerging quality’.
‘Stable quality businesses have strong competitive advantages, pricing power, and operational leverage,’ Mnguni said. ‘That allows them to grow at higher rates for longer than the market is expecting.’
Cyclical quality businesses are those that operate in cyclical industries but have a quality advantage. For example, Benguela owns BHP Group but would not own Anglo American.
‘BHP has ensured that it has the best processes in the production of minerals, and it only owns the best ore bodies,’ Mnguni said.’ As their ore bodies decay or get to a point where they become too expensive to mine, they sell them.
‘It’s cyclical because it is a commodity business, but within that sector it is able to ride the waves a lot better because it is focused on being the low-cost producer.’
The final bucket is ‘emerging quality’, where Mnguni sees potential for higher returns.
Opportunity
‘As a quality manager, you might think we wouldn’t buy a company that doesn’t meet its cost of capital, but then we would miss out on companies that have a lot of potential. We do hold a few companies that, on a forward-looking basis, we see generating strong cashflows, even if that isn’t the case right now.
‘In such cases, the portfolio decision is anchored by the strength of the competitive advantage and a great opportunity for reploughing profits. An example would be AirBnB, which has incurred enormous capex to build its digital platform, enabling future product releases to cost less. It has improved its free cashflow generation to the point that it now yields 6% on enterprise value.
‘If we wait until companies like this prove their mettle, then the majority of market participants would recognise that too, and the trade would be crowded out and returns would be reduced.’
The Benguela Global Equity fund returned 14.8% last year, underperforming its benchmark of the MSCI Acwi, but Mnguni said that this didn’t surprise them given their price-conscious approach.
‘We remained disciplined against what we felt were valuations getting close to euphoric levels,’ he said. ‘So we got beaten quite badly by the likes of Nvidia. Even though we were holders, we were underweight.
‘Our first entry into Nvidia was right on the cusp of its takeoff, but when the valuation ran away, we didn’t chase it because we had modest assumptions. But those modest assumptions were maybe way too modest.’
Nader (pictured above) said that this focus on valuation also means that the fund is not only a buy-and-hold strategy but will trim even the highest-quality positions as valuations are reached or exceeded
‘The core of the portfolio is stable quality companies we want to hold for as long as possible,’ Nader said. ‘But there are times when even those core quality companies can have stretched valuations that don’t make sense to us. In that case we may sell or reduce the position with a view to buying it back if the price makes a bit more sense.
‘The cyclical quality stocks by nature will have ebbs and flows. And there we would be a bit more active in terms of entry or exit as cycles play out over two to three years.’
Overall, the average holding period for a stock in the portfolio is three to four years.
He added that while the portfolio aims to serve as a core equity holding, it does have a high active share – typically between 70% and 80%.
‘It sounds like we’re conservative, but at the same time we are taking significantly differentiated exposure to the benchmark,’ Nader said. ‘We aim to be a quality strategy that gives investors downside protection because if you own good businesses they should outperform in difficult times.’
CityWire article link : https://citywire.com/za/news/diversified-global-quality-equity-fund-focuses-on-risk-management/a2458138?re=127902&refea=1507487&link_id=1805436