Global Franchise Equity Income Strategy
Global Franchise Equity Income Strategy

Global Franchise Equity Income Strategy

 
 
 
Summary

The Morgan Stanley Global Franchise Equity Income Strategy is a concentrated equity strategy which seeks to provide investors with attractive and sustainable income alongside long-term compounding of capital and relative downside protection. The International Equity team builds a portfolio of high-quality companies, in line with the Global Franchise portfolio, characterised by dominant intangible assets, high returns on operating capital employed (ROOCE) and strong free cash flow generation. The strategy seeks to generate income from a combination of dividends from these high quality stocks and index call option premiums.

 
 
Investment Approach
Philosophy

The team believes that a portfolio of high-quality companies, whose primary competitive advantage is supported by dominant, hard-to-replicate intangible assets, has the potential to generate attractive long-term returns. In the team’s view, this involves investing in companies that can potentially compound shareholder wealth at a superior rate over the long term, while offering a measure of downside protection. The team’s research shows that these high quality companies, or compounders, which exhibit characteristics such as strong franchise durability, high and recurring cash flow generation, pricing power, low capital intensity and minimal financial leverage, have generated strong long-term returns in both inflationary and deflationary environments.

The team believes that the strategy offers “income, the right way.” Many dividend strategies may seek to offer higher dividends but to the potential detriment of long-term compounding of capital. The Global Franchise Equity Income strategy’s high-quality bias offers a more robust approach to income generation. Rather than optimising the portfolio to ensure it pays out high dividends, the team focuses on the underlying company fundamentals and free cash flows, which in turn means dividends are more likely to be sustainable and growing. The companies the strategy invests in make a high return on capital and are capital light; this means that they can afford to pay out, and keep paying out, dividends to shareholders. This is high quality income.

 
Differentiators
An Attractive and Conservative Extension of a Proven Strategy

Offers clients access to the established Global Franchise investment process and strategy – with its 20 year track record of successful investing in high-quality companies – plus an enhanced income profile.

Quality Income with Capital Appreciation and Downside Protection

The high-quality bias in stock selection means that companies are more likely to generate sustainable free cash flows which in turn means dividends are more likely to be robust.

Optimizing the Dividend Yield

The conservative overwriting strategy is straight forward and dynamic, allowing investors to retain maximum exposure to high conviction equity positions and not suffer the cash drag typically associated with some option strategies.

 
 
 
Investment Process
1
Screening the Universe

Companies with a free float market capitalization greater than $2 billion are screened based on financial metrics that the team believes are associated with strong franchise businesses. The key financial characteristic these companies possess is a sustainable, high unlevered ROOCE, which is generated by a combination of recurring revenues, high gross margins and low capital intensity. This helps support strong free cash flow generation which must be either reinvested at similarly high returns or distributed to shareholders.

2
Security selection

The team looks for high-quality businesses with the following characteristics:

  • Difficult-to-duplicate intangible assets that help protect the durability of the franchise
  • A sustainable, high ROOCE on an unlevered basis
  • High gross margins and low capital intensity
  • A reliably recurring revenue stream and organic growth potential
  • Financial strength and capable management 

Through company visits and meeting management, the team monitors signs of franchise abuse, including failing to reinvest capital in high ROOCE businesses, preventing compounding by retaining excessive cash, and earnings-per-share6targets having precedence over ROOCE, which reward short-sighted behaviour.

When assessing valuation, the team uses free cash flow yields rather than reported earnings ratios as their primary valuation metric. The investment team thinks about risk management in exactly the same way as they do for Global Franchise. They consider absolute risk – the chance of losing money – as integral to their stock selection process.

3
Income Generation

A systematic options overwrite strategy developed by Morgan Stanley Investment Management’s Solutions & Multi Asset team is used to generate income in addition to the dividend yield on the underlying stocks. Short-term index call options on six liquid global indices are sold, earning premiums. Call options on indices, rather than the underlying stocks, are sold in order to retain the individual stock level exposure of the portfolio as well as reducing the likelihood of conflicts of interest between the stocks and the options.



The premiums received from the sale of index call options enhances the yield. This dynamic yet conservative options strategy is designed to help meet the yield target with confidence.

* 2% post withholding tax.

 
 
Investment Team
Head of International Equity Team
26 years industry experience
Managing Director
24 years industry experience
Executive Director
20 years industry experience
Executive Director
20 years industry experience
Executive Director
16 years industry experience
Executive Director
18 years industry experience
Executive Director
10 years industry experience
Executive Director
9 years industry experience
Vice President
12 years industry experience
 
 
Insights
Global Equity Observer
It’s All About The Earnings
Sep 17, 2018
In response to the latest emerging markets wobble, the International Equity Team argues that a focus on the fundamentals is the best way to avoid the destruction of capital.
Manager Q & A
Q&A with William Lock
Jan 15, 2018
William Lock discusses how a strategy that his team manages has incorporated the Buffett philosophy into a long standing, successful global investment strategy.
Macro Insight
The Power of Compounders with William Lock
Sep 27, 2017
William Lock explains why he believes a company’s intangible assets are integral to achieving sustainably high returns.
 
 
 
 

RISK CONSIDERATIONS  

Past performance is not a guarantee of future performance. The value of the investments and the income from them can go down as well as up and an investor may not get back the amount invested. There can be no assurance that the strategy will achieve its investment objectives.

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market value of securities owned by the portfolio will decline. Accordingly, you can lose money investing in this strategy. Please be aware that this strategy may be subject to certain additional risks. Changes in the worldwide economy, consumer spending, competition, demographics and consumer preferences, government regulation and economic conditions may adversely affect global franchise companies and may negatively impact the strategy to a greater extent than if the strategy’s assets were invested in a wider variety of companies. In general, equity securities values also fluctuate in response to activities specific to a company. Investments in foreign marketsentail special risks such as currency, political, economic, and market risks. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility. Option writing strategy. Writing call options involves the risk that the Portfolio may be required to sell the underlying security or instrument (or settle in cash an amount of equal value) at a disadvantageous price or below the market price of such underlying security or instrument, at the time the option is exercised. As the writer of a call option, the Portfolio forgoes, during the option’s life, the opportunity to profit from increases in the market value of the underlying security or instrument covering the option above the sum of the premium and the exercise price, but retains the risk of loss should the price of the underlying security or instrument decline. Additionally, the Portfolio’s call option writing strategy may not fully protect it against declines in the value of the market. There are special risks associated with uncovered option writing which expose the Portfolio to potentially significant loss.

 

This communication is only intended for and will be only distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Past performance is no guarantee of future results.

A separately managed account may not be suitable for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment manager, please refer to Form ADV Part 2.

Any views and opinions provided are those of the portfolio management team and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring. The views expressed do not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

All information provided has been prepared solely for information purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

DEFINITIONS

Return on Operating Capital Employed (ROOCE) is a ratio indicating the efficiency and profitability of a company’s trade working capital. Calculated as: earnings before interest and taxes/property, plant and equipment plus trade working capital (ex-financials and excluding goodwill).

Call Options are agreements that give an investor the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specified time period.

Yield is forward-looking and measures the income, such as interest and dividends, that an investment earns. 

Dividend Yield is the ratio between how much a company pays out in dividends each year relative to its share price.

OTHER CONSIDERATIONS

The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

The MSCI World (Net) Index is a free float adjusted market capitalization weighted index that is designed to measure the global equity market performance of developed markets. The term "free float" represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends. The index is unmanaged and does not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

The weights, tracking error typical yield duration, and the number of issuers represent typical ranges and are not a maximum number. The portfolio may exceed these from time to time due to market conditions and outstanding trades.

 

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