Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and here with me today to discuss the power of stock picking is Morningstar's Senior Fund Analyst, Pete Brunt.
Hello, Pete.
Peter Brunt: Hi, Emma.
Wall: So, we're here today to talk about the power of stock picking. But to give the background of that I thought you could start by telling me what exactly quality growth investing is and why it's been such a success of late?
Brunt: Okay. Yeah. Well, I mean, quality growth is looking for companies – well, let's step back. So, quality growth funds generally are unconstrained in nature, so they are not following a benchmark and that allows them to focus on companies that are typically – they have little need for financial leverage; they have a very strong competitive advantage, so strong franchises.
We look at that in terms of the Morningstar economic moat. They will be looking for companies that have little need for capital, or not capital intensive. And these typically ends up with investments in sectors such as consumer staples, information technology and healthcare and it tends to avoid areas such as materials and commodities, energy, financials.
Wall: The cyclical stocks?
Brunt: The cyclical stocks, yeah. I mean, what they are trying to do is identify companies that are not sensitive to the economic cycle and have secular earnings growth trajectories.
Wall: And why have those types of stocks and indeed therefore these types of funds done so well in recent years?
Brunt: Good question. So, I mean, we've had economic conditions such as very low interest rates. There's been a fair amount of uncertainty in the markets. So, people have been looking for growth in a very low-growth environment. And these companies have ticked a number of boxes on that front. So, looking at a sub-group of those funds, they have all performed on the whole very well relative to a far broader opportunity set. We cover two funds that fall into that sub-group; the Fundsmith Equity Fund and the Investec GSF Global Franchise Fund.
Wall: And those funds have done very well. Could you argue that they have only done very well because of that supportive macro backdrop, and therefore, when bond yields start to rise, as we're told it will happen soon, these types of funds will stop performing well?
Brunt: Yeah. So, it's a good question and it's a one that I think is definitely in the back of our minds when we're looking at these funds. So, if you were to take – let's start with the Investec GSF Global Franchise Fund first and the performance profile of that fund over time would show that when markets are strongly rising, it tends to lag, which is what you would expect. And so, there are definitely periods where the investment style when it's out of favor the fund can suffer. A good example of that was in 2016 where we saw a strong rotation to value for various reasons, and actually the fund lagged quite significantly as a result.
Now, as you alluded to in the introduction, the things that we like to see in fund managers is strong stock selection and that was one of the – that's one of the key standout features of the Fundsmith Fund. By way of example, if we look to 2016, that fund didn't actually lag the market, didn't lag its benchmark or peers in 2016. Why was that? Well, because we believe the fund manager just has a very good ability to select stocks that can add value above and beyond the investment style.
Wall: And that presumably is why Fundsmith has a Gold and Investec has a Neutral rating?
Brunt: Correct. Yeah, that's right. That's reflected in the funds' ratings.
Wall: Pete, thank you very much.
Brunt: You're welcome.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
