Global Quality Strategy
Global Quality Strategy

Global Quality Strategy

 
 
 
Summary

The Morgan Stanley Global Quality Strategy is a concentrated global equity strategy. To achieve the investment team’s aim of compounding shareholder wealth at attractive rates of return over the long term, the Strategy focuses on high-quality, resilient, well-managed companies.

 
 
Investment Approach
Philosophy

The team believes there are two key tenets to investing: first, that the best route to long-term returns is through compounding and providing a measure of relative downside protection; and second, that high quality businesses can generate strong returns over the long term. Such businesses are typically built on dominant market positions, underpinned by powerful, hard-to-replicate intangible assets that can generate resilient, high, unlevered cross cycle returns on capital. Other characteristics are: resilient revenue streams, pricing power, typically low capital intensity and the opportunity for organic growth.

These companies are rare. High quality management is critical. When evaluating the quality of a management team, we seek evidence of disciplined capital allocation and distribution practices, as well as remuneration or incentive policies aligned with their shareholders.

The team’s primary worry is about permanent loss of capital rather than relative risk; losing money is worse than missing the chance to make it. The team does not worry about tracking error, short-term macro noise or the latest fad. Instead, risk is managed first and foremost at the company level, aiming to avoid companies where any form of franchise, regulatory or management risk that could result in diminishing returns. The team also believes there is an inherent risk of overpaying for high-quality companies. Consequently, the team uses ongoing and rigorous fundamental analysis to assess the fair value of each stock. According to the team's research and their investment philosophy, only 200 to 250 companies meet their quality standards.

 
Differentiators
DEFENSIVE CHARACTERISTICS, COMPOUNDING POTENTIAL

The team’s research shows investment in high-quality companies, which exhibit characteristics such as strong franchise resilience, high and recurring cash flow generation, low capital intensity and minimal financial leverage, have historically generated strong risk-adjusted returns across various market cycles.

TEAM OF PATIENT INVESTORS

The team’s long-term investment horizon seeks to allow these rare, high-quality compounders to capitalize on their financial characteristics, leverage their well-managed intangible assets and compound shareholder wealth over time. The average annual turnover of the Strategy is expected to be 20% to 30%.

WE FOCUS ON MANAGING THE RISKS THAT MATTER

The team believes that quality compounders are less vulnerable to economic volatility, while indices, in their view, are inherently risky. They believe that relative measures of risk fail to capture the chance of losing money. Accordingly, they seek to minimize loss of capital and focus on the resiliency of a franchise, while trying to avoid any company which exhibits any deterioration in management quality, its financial health or its valuation.

A STRONG HERITAGE

With an unchanged and disciplined investment philosophy stretching back well over 20 years, the team knows quality when it sees it.

 
 
 
Investment Process
How Quality Works–the Power of Compounding
 
How We Identify Compounders
1
Find High Return Companies
  • High and unlevered returns on operating capital employed (ROOCE)
  • High gross margins (pricing power)
  • Capital-light business models driving free cash flow (FCF) generation
  • Strong balance sheet
2
Make Sure Returns are Sustainable
  • Intangible assets – portfolio of strong brands, copyrights, licenses or networks, which act as high barriers to entry
  • Returns sustainable against material threats, including Environmental or Social issues
  • Dominant market shares helping to protect against new entrants
  • Stable sales – often repeat business driving recurring revenues
  • Geographic spread
  • Steady organic growth
3
Check Management Looking to Sustain Returns
  • Committed to innovation and investment in franchises
  • Focus on returns on capital rather than sales or EPS growth
  • Capital discipline (reinvest FCF at a sustainably high ROOCE or return the excess capital to shareholders)
  • Appropriate management incentives
  • Sound Governance structure
 
 
 
 
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
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?
Investment View
Q&A with Nic Sochovsky
Dec 29, 2015
Nic Sochovsky, a portfolio manager on the International Equity Team, discusses the team’s significant exposure to what they consider high-quality Consumer Staples.
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 indicative of future results. 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 portfolio. Please be aware that this portfolio may be subject to certain additional risks. In general, equity securities values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging-market countries are greater than the risks generally associated with investments in foreign developed countries. 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. Investments in derivatives can magnify volatility, can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolios’ performance. Stocks of small- and medium-sized companies entail special risks, such as limited product lines, markets, and financial resources, and greater market volatility than securities of larger, more established companies.

 

There is no assurance this expectation will be met.

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).

Free cash flow (FCF) is operating cash flows (net income plus amortization and depreciation) minus capital expenditures and dividends.

Earnings before interest, taxes, and amortization (EBITA) refers to a company’s earnings before the deduction of interest, taxes and amortization expenses. It is a financial indicator used widely as a measure of efficiency and profitability.

Tracking error is the standard deviation of the difference between the portfolio and the benchmark returns.

Earnings before interest, taxes, and amortization (EBITA) refers to a company’s earnings before the deduction of interest, taxes and amortization expenses. It is a financial indicator used widely as a measure of efficiency and profitability.

Active share is the fraction of the portfolio or fund that is invested differently than its benchmark as of the last day of the reporting period. A portfolio with a high degree of Active share does not assure a fund’s relative outperformance.

OTHER CONSIDERATIONS
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 information presented represents how the portfolio management team generally implements its investment process under normal market conditions.

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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