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Sarasin International Equity Income - Q2/11

Mark Whitehead talks about navigating the Sarasin International Equity Income fund through global economic volatilty and also considers the positive aspects of recovering markets.
22nd June 2011
15mins 39secs


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Presenter: I'm joined now by Mark Whitehead who is Manager of the Sarasin International Equity Income Fund. Mark, if I could start by asking about the macro outlook, what's your take on the global economy as a whole?

Mark: Well, thanks Mark. There's a lot going on in the global economy at the moment as you're no doubt aware. We are quite constructive on equity markets, notwithstanding the sort of volatility we've been seeing of late. Certainly, there are concerns regarding whether the broad based economic recovery is going to stall. We believe that it is not and it's going to continue. We also think that a situation will be resolved with the peripheral sovereign debt crisis we're seeing at the moment. What is very interesting is that equity markets to us look extremely good value at the moment. If you think that this year's consensus is correct for the S&P 500, a hundred dollars of earnings gives us about 20% earnings growth this year, off the back of about 36% last year. So we think markets are very well supported at about 13.5X PE this year.

Presenter: It's been a really tough environment for companies over the last few years, how have they been restructuring, what's the outlook at the corporate level?

Mark: Well I think it's been rather fascinating actually. We've got to a stage where I think as a result of the financial crisis corporate management has really been restructuring very aggressively. So they've been taking a lot of corporate costs out but also improving margins as a result. This is fed to really quite astounding free cashflow generation, and corporate management has been quite reticent about actually deploying some of that cash through capex, really because they've been obviously not that happy about that extent of the financial recovery. But, as I think things normalise, corporates will be in a good position to increase capex. But also what is really key, they will be able to return quite a lot of the cash that has been building up on balance sheets to shareholders through stronger dividends going forward.

Presenter: Well, that's the situation today, but how have you been able year on year with your process to sort of keep that income generation going and building?

Mark: Well I think our process is very differentiated. As you know we are thematic investors, so we look for long term trends in markets. Those long term trends in markets we think will provide performance across the business cycle, and I think that's the first pillar of our success. Second I think is the sort of very strong proprietary cash flow modelling we do of the businesses that we invest into. So we try to stress test under different scenarios what happens to a company and its cashflows if earnings fall markedly, or perhaps they want to undertake a merger or acquisition, or perhaps suddenly have to see a large tax rise, for example. So we can if you like stress test those companies and really understand where the cashflows are going and then be very certain about the dividend return from those companies going forward.

Presenter: And how's the portfolio positioned today, what are the main regional and sector biases?

Mark: Well, as a result of our process, which is thematic, we tend not to construct a portfolio by industrial sector weightings or regional weightings. What we try to do is invest in companies that we think are going to win out across that business cycle. As a result, we've got some very strong companies, but we don't have to rely, as an income fund sometimes has to, on large weightings in utilities for example or telecoms. We have a nice diversified spread across lots of different sectors and we don't have to rely on any too heavily.

Presenter: Now I mentioned at the start this fund's just hit its five year track record. As you look back over that, what have been the key drivers of performance?

Mark: Well I think across the period what has been really satisfying is we've managed to increase the dividend to our shareholders and I think dividend instils a very strong management discipline when it comes to running companies and actually produces much stronger total return to clients, or shareholders going forward and over the long term. So investing in these types of companies certainly we think allows us to outperform. Now what has been extremely interesting as well is after the credit crisis, where we performed quite well against the market, the period where we usually get a strong rebound in lower quality companies, which was very aggressive this time round with about 18 months of sort of deep value companies performing strongly. Well we've managed to keep up with that and also now producing strong performance as I think the market broadens out in its recovery.

Presenter: This is very much an international fund Mark, how do you manage currency risk?

Mark: Well, we are investing globally of course. We have at the moment about 40% of the fund invested in North America, about 20% in Europe ex-UK, about 10% in Switzerland, so in the Swiss franc, and also some exposure to Japanese yen and some other Asian currencies. We tend not to hedge any of the currency exposure because we believe over the longer term that currency fluctuations tend to wash out. We do have a sterling hedged version of this fund, which does hedge all of the foreign currency risk back into sterling, and we target a 90% sterling weighting. So if you like there's a sort of barbell approach that clients can use by going in to the sterling hedged or the non-hedged depending on their view on currencies.

Presenter: We've mentioned before it's a very tough time for equities, it has been over the last five years, do you think there's a more settled future for the asset class over the next five years?

Mark: Well I hope so it's been extremely volatile as you know over the last 18 months. I think what we try to do is put together a portfolio that will produce alpha across the business cycle and we think our process can deliver that. That means that we can put up with some short term volatility because we believe over the longer term our companies will win out. Certainly at the moment the very high quality portfolio that we have we think will win out. Certainly it is at the moment trading on a discount to the wider equity markets. So at the moment our portfolio trades on about 12.5X PE and the wider MSCI World at which the Fund is benchmarked against is trading on round about 13.5X to 14X PE. So a nice valuation discount but a portfolio producing superior free cashflow generation which is leading to stronger dividend return.

Presenter: We've had a question in here. It says: "What have you learned over the last five years, from the turbulent time what have you learned from being a fund manager?"

Mark: Gosh, that's a good question. I think to stick to one's convictions is very important. When constructing a portfolio I think one needs to really obviously have full conviction in the stocks that you're putting together, and that's why we target just 50 holdings for the Fund. We don't like to have a tail if you like of stocks that perhaps one doesn't follow too closely from time to time; we really want to have high conviction about the portfolio. And across the business cycle what we need to or what we've been understanding from it all is that to stick to those convictions and back those companies that we really believe will produce stronger returns going forward from our thematic investment process.

Presenter: How long can you be right on a company and the market wrong? What's the discipline for cutting mistakes, if you like, because they must happen from time to time?

Mark: Of course they do and we have a strong sell discipline. The main driver of that will be a company that we own loses its thematic credentials, and we will therefore sell the holding. But it can be of course valuation, it can be of course a certain amount of asset allocation, perhaps if you know we're following more cyclically bias portfolio and the market turns against us, you know, we can use the thematic allocation of the Fund to try and institute a type of asset allocation if you like through the different themes. So we have pricing power, the strong get stronger, corporate restructuring. These types of themes across the business cycle will work, some better than others at different times, so we can actually institute that asset allocation.

Presenter: What constitutes a theme, what makes you decide that sort of the stronger getting stronger is definitely a theme?

Mark: Well I think a lot of the themes we have, we've got five in operation. Typically they're 18 months in length and a lot of work goes in to deciding why we think we should put those themes together in a portfolio, but the main thing is they don't all correlate. And so what we're trying to see from the likes of pricing power for example which is working at the moment, but those companies that can increase pricing against a backdrop of rising input costs. Now that's very important where we're seeing quite a bit of inflation in markets at the moment. Like for example corporate restructuring has been our longest running theme, we've had the running for over 14, 15 years I think now, and we've had it because there are always going to be companies that are going to be restructuring and increasing margins, and therefore the efficiencies of their businesses going forward, and that theme works particularly well for us and it did post the financial credit crisis.

Presenter: Another question in, it says: "a lot of income funds now are using derivatives to enhance yield, is that something that you do on this fund or would you consider doing it?"

Mark: We do consider doing it, and we do undertake some derivative use in the portfolio, namely to enhance income. Under the UCITS III because the Fund is UCITS III, we can use short call options for example to take us out of positions as part of that sell discipline I mentioned earlier. We can also sell put options when we want to get in to particular stocks, but we're not a sort of an income maximiser, if you like. There are some funds out there that are structurally using options, we use it purely tactically and we can't use any more exposure than 20% of the Fund when it comes to using derivatives.

Presenter: What's the USP, there's quite a lot of international equity income funds launching now, what makes you different?

Mark: Well I think you know our sort of two pillars to the investment process being our thematic investment, but also there are proprietary modelling if you like or the cashflow modelling where we can undertake scenario analysis and really become extremely convicted in the stocks that we own. I think that really is unique and I think very transparent for our clients as well. I think our clients can at any time understand where the portfolio is sitting, and so we're investing in companies that we think are going to grow their dividend, but they are doing that by growing their businesses, and that is really important. You know, the long term thematic credentials in the stocks that we own mean that they are businesses that are growing their businesses. They're not value traps if you like where they've got weak margins or using lots of leverage to return cash to shareholders. We want companies that are undertaking capex for future growth which will lead to a stronger dividend.

Presenter: And you're confident you can grow the dividend, the yield this year as well?

Mark: Yes I am and we're seeing a number of extremely interesting dividend increases coming through at the moment from our companies. Certainly, you know, we don't target a specific yield from the companies that we own, but a company must be increasing its dividend, and that is extremely important as I said earlier. But we're looking I think this year at somewhere around sort of 8-10% dividend growth for the Fund, and certainly we've been able to put through around about 4 or 5% for the last two years, which I think's been pretty impressive when you look at, you know, after the financial crisis certainly we were seeing in Europe and the S&P dividend cuts of around 15%.

Presenter: Now we've got another question in: "With the apparent flight of investors back to developed markets, where do you see emerging markets fitting in with the Fund from now on? Will you increase your current exposure of 7% to take advantage of these areas or perhaps take a more defensive position?"

Mark: Well I think what we've been trying to do actually is to access sort of emerging market growth through developed market companies. Those companies that have very strong balance sheets and can access the fast sales growth that we're seeing from the strong macroeconomic backdrop, albeit slowing somewhat because of tightening money and fiscal policy and the likes of China. We will continue to invest in developed economy stocks that will benefit from emerging markets. So I don't see that our weighting will go up too much higher in emerging markets companies specifically. What we tend to look at is emerging market companies, you know, they are selling their products back into the Western world, so actually their sales growth is more dependent on what's going on in the Western world in many cases. So we like to invest in developed companies that have the financial discipline to continue to pay a dividend, and we can rely on to continue to pay a dividend, and they are benefitting from some of the explosive growth that is coming from emerging markets.

Presenter: We talked a lot about reward, but to focus if I may for a minute on risk. I mean this fund has had historically slightly lower volatility than perhaps some of its peers. Is that just a by-product of how you run money or is that just happy coincidence? How important is low volatility?

Mark: It's very important to us, and I think it's not just a by-product; it's certainly something that we try to invest for. I think that investing in companies that are growing their businesses over the long term and producing strong dividend discipline, by its nature produces lower volatility when it comes to equity market returns. We've tried to really produce that over the long term and we've got to a stage where we're producing three year volatility number of about 18 versus 21 for the MSCI World index, with performance better than the market, and that's really the central tenet of the Fund.

Presenter: How much income do you derive from Europe and are you worried about the possible euro crisis?

Mark: Well naturally I think everyone's extremely worried about it and everyone who's involved in investment markets saw what happened yesterday. I mean we've got to a sort of political loggerhead type situation at the moment with Trichet obviously trying to defend his large holdings of peripheral debt that the ECB now has on its balance sheet. I think any more contagion into perhaps getting as far as Spain would be bad for risk assets as a whole. We don't think it will get as bad as that, we think that something will be sorted out. We're not sure when, but I think in the meantime if we're invested in high quality equities and you're prepared to put up with volatility, we still think that the broader economic recovery, globally, is set to continue and should continue to produce longer term, healthy gains for equities.

Presenter: Final question, why should investors be considering global equity income today?

Mark: Well as I mentioned I think putting together a high quality portfolio today means that you're putting together a set of stocks which are trading at a discount to the market. I think that's extremely important. If you have a sort of medium to long term view on markets, investing in high quality is extremely important, and we think that stronger dividend return of that discipline will produce much higher total returns to equity holders over the long term. So that's why we think it's a good time at the moment.

Presenter: Mark Whitehead, thank you very much.

Mark: Thank you.

Sarasin International Equity Income Fund

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