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
Another Emerging Markets Wobble?
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.
Global Equity Observer
It’s All About The Earnings
Aug 15, 2018
The one sure fact about the next downturn is that it will be different from the last one. The International Equity Team ask which sectors really are defensive.
Global Equity Observer
The End of the World As We Know It?
Jul 17, 2018
Market environments always change, sometimes violently. The International Equity Team asks: is this the end of the world as we know it?
 
 
 
 

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