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Roger Morley on the merit of obstinacy in global investing

Roger Morley is a Portfolio Manager with MFS Investment Management in London. He is Co-manager of the firm's Global Equity and Global Concentrated Strategies and lead manager of the European Core Equity strategy. He has been with MFS for about 20 years. Globally, MFS manages almost $A1 trillion across all asset classes, with headquarters in Boston, USA.

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GH: As a global equity manager with offices around the world, what do you consider some of the major investment implications of the war in Ukraine for either the near term or longer term?

RM: To start, we must say the humanitarian and social costs are terrible. From an investment point of view, there are implications for individual businesses, but in aggregate, it's not such a big deal for the global economy with one major exception. Russia is about 1.5% of global GDP, similar to Canada's. The Russian economy is not particularly integrated into global trade, again, with one big exception, which I'll come to.

We like multinational businesses and we typically like businesses that operate in emerging markets because there's good growth there. But for our typical business, Russia is 1 to 3% of sales, such as for AkzoNobel (paints and coatings), WPP (advertising agency), Nestle, Linde (industrial gases). There will be some surprises, such as Visa, MasterCard and American Express. Russia and Ukraine together represent about 5% of revenues for Visa, one of our biggest holdings. That's because Russians travel and spend a lot on cards and cross border business is more profitable than domestic business. But even that shows Russia is not a major part of the world economy. We own Carlsberg, which has about 15% of its business in Russia and Ukraine.

The one caveat is the Russian supply of raw materials, principally energy. It’s one of the world's largest oil exporters and a huge exporter of natural gas to Europe. Natural gas is 25% of European energy consumption and 40% comes from Russia, of which a vast majority goes to Germany and Italy. So the company level modest exposure exception is where companies are particularly exposed to high energy and raw material prices.

A few companies will be clear beneficiaries. We met at a couple of US defense companies last week, talking about the low state of preparation of many European militaries and the need to increase resources. It’s a medium-term benefit because it takes a long time to ramp up the manufacture of missiles, engines, fighter planes.

GH: I was surprised when I saw a map of Europe on the gas pipelines coming from Russia through Ukraine, with an extraordinary level of dependence. Is there a feeling now among European governments that the dependence was too complacent?

RM: Very much so, especially in Germany. There was a lot of controversy over the building of the Nord Stream 2, which was supposed to reduce the reliance on the pipelines that went through Ukraine. Russia could then turn off the gas to Ukraine without turning off the gas to Germany because they pay the bills.

GH: Let's look at some broader portfolio matters. To what extent do macro factors influence your investment decisions? For example, if you had a chemical company in Europe and another in the US, do you consider whether the economy in the US is better than Europe for the next few years?

RM: Through our global investment platform, we uncover what we believe are the best investment opportunities in the market. We are looking for an analytical advantage by evaluating the long-term quality, sustainability, improvement potential and value of businesses. It's fundamentally bottom up, research driven. We invest in businesses, not markets, we invest in companies, not stocks. You can't escape the macro but we focus on understanding the business and on the equity side, we have 60 research analysts based around the world. They tend to follow companies on a regional basis so we do compare stocks across a region, but then the global managers sit above that and it's easy to pull the analysts together to compare ideas and get the best on a risk-adjusted basis globally. Internally, we never talk about regional overweight and underweight. We don't care where a company's headquartered or listed with the single exception of governance, as there are different country regulations.

GH: You manage a concentrated portfolio as well as a broader global equity portfolio. What's the difference?

RM: It's the same team-based approach, with Ryan McAllister and I co-managing both portfolios. We run them in parallel, but the concentrated one holds between 20 and 30 stocks as a subset of the diversified portfolio which is usually between 80 and 100 stocks. We pick what we consider the best names on a risk-adjusted basis. Sometimes, I think people confuse concentration with aggression, but the stocks we pick are a little more conservative because we own a bigger position. So we may have a stock in the diversified portfolio where there's a wider range of outcomes that we think is a good stock on a risk-adjusted basis, but there could be a lot of potential downside because of technological change or balance sheet leverage or political exposure or regulatory exposure, something like that. We can limit that downside with position sizing, but in a concentrated portfolio, we own 2.5% minimum and the average position size is 4%. So a company like that doesn't go into the concentrated portfolio. It’s not aggressive investing in that way because we worry especially about the downside in the concentrated portfolio.

GH: And how's the relative performance of the two funds over time?

RM: Over the long term, the concentrated portfolio has marginally outperformed. In a way, I find that slightly annoying because a constraint on a portfolio manager should detract from performance. I think there are a couple of explanations. One is that we’re better at managing a concentrated portfolio than a diversified one. By being forced to have conviction, you get the better ideas. In times like these, it can be difficult to differentiate between active skill versus the market environment, but it reinforces the importance of security selection by focusing on quality growth companies and considering all risks.

GH: In your current valuations of companies, are you seeing pockets of expensive or cheap? In other words, where are you seeing the best opportunities?

RM: In the areas that we think are cheap, I'd call out medical devices in particular and healthcare in general. We own large positions in stocks like Medtronic, Stryker, Abbott. A company like Medtronic is still somewhat depressed because a portion of its business is elective surgery. Many elective procedures have been postponed in the last two years, clearing the decks for COVID. The recovery of these businesses has been slow because staff are off work and isolating. They weren't defensive stocks in the downturn because of their exposure to the realignment of the healthcare system but they look inexpensive.

Another area is US cable companies, such as Comcast and Liberty Broadband. We all know how vital a fixed broadband connection is, and those businesses are increasingly not pay TV companies. They are broadband and telecommunication providers. There's always fear of technological change, whether it's Elon Musk sticking satellites up or 5G wireless broadband but fixed broadband connections are not going away anytime soon for the vast majority of consumers.

GH: And on the expensive side?

RM: I would still call out some technology stocks even after they’ve been de-rated, the ones with no profits and no clear path to a free cash flow. There are some remarkable businesses in the technology space that we would happily own at lower valuations.

GH: Is there a stock you would identify that you think has such a good long-term runway, a compounder that you're confident you will own for the next 10 years?

RM: I probably call out a railroad stock, Canadian National or Canadian Pacific. Perhaps not the world's most exciting companies, but it's the 10-year picture that's important. Canadian National has been known to us for over 25 years. Railroads face relatively little technological change, they are pieces of infrastructure that are vital to the North American economy. They are very hard and very expensive to replicate. They are oligopolistic and probably monopolistic. We love monopolies from an investing point of view. We don't like monopolies from a regulatory point of view, so I'd rather call them oligopolistic, but they have monopolistic qualities. They've got tailwinds from the ESG side with a much lower carbon footprint to move something around North America than by road. Vastly better than air freight or other alternatives.

Canadian National will grow at GDP plus with a bit of pricing on top of volume growth and operating leverage from the vast fixed cost base. It’s still a capital-intensive business so it's hard to see any form of disruption coming. We don't really worry about driverless trucks that may dramatically change the economics of rail versus road transport. That floats out there in the far distance. From the economic cycle, volumes tend to vary a little but pricing doesn't.

GH: Is there an investment lesson that you've learned recently, despite all your years in the business, due to a stock that didn't work out and perhaps you sold it? Perhaps something you missed?

RM: In this job, you think by the time we retire, we’ll be geniuses because you make mistakes and you say, “Well, I won't do that again.” And then a mistake is around the corner and sometimes you repeat a mistake because the situation looks different. A quality we have is that we're very long term, we're pretty obstinate. That the market overreacts on the downside, it overreacts to fears of disruption and change and usually that disruption and change is less than anticipated.

But sometimes we're slow to spot that an investment case is just wrong. For example, for many years we owned the US trust banks, State Street and Bank of New York. Our view was that these trust businesses would discover pricing power but that just hasn't been the case. And what's annoying is that I had people tell me that their prices only ever go down. I talked to people internally at MFS and they said prices always go down when we renew our contract. And why, I don't know. The business is just competitive enough, there are just enough players in it. So that’s a case where we ignored the fundamental evidence that was before our eyes or we didn't look for it properly.

They weren't terrible stocks, they did all right, but they were always relatively cheap so that limited the downside. But if you own stocks like that for a long time, they become a big hole in your attribution over time. It’s the grinding underperformance where we've been too dogmatic in hanging on to them.

GH: Final question. You’ve done this job for a long time. What’s the attraction?

RM: It's fascinating, particularly at a time like this, when so much is going on in the world. As a portfolio manager at a firm like MFS, you're like a fly on the wall of the world. You get to meet people like the CEO of a supplier of Stinger missiles and anti-tank missiles. A month ago, we met with a former security adviser to Donald Trump. He said the prospect of a war in Ukraine was 80% and it will probably happen. Very hawkish. It was a striking contrast between his certainty and others being generally laid back. It’s the access to people that makes the job so fascinating.

 

Roger Morley is a Portfolio Manager with at MFS Investment Management, a sponsor of Firstlinks. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. No forecasts can be guaranteed.

For more articles and papers from MFS, please click here.

 

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