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Uruguay April 2019 Quality Equities and the Power of Compounding

Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

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Page 1: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

Uruguay – April 2019

Quality Equities and the Power of Compounding

Page 2: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

2

8.0

10.0

12.0

14.0

16.0

18.0

20.0

50.0

72.0

94.0

116.0

138.0

160.0

De

c-0

4

Ma

y-0

5

Oct-

05

Ma

r-0

6

Aug-0

6

Jan-0

7

Jun-0

7

No

v-0

7

Apr-

08

Sep-0

8

Feb

-09

Jul-0

9

De

c-0

9

Ma

y-1

0

Oct-

10

Ma

r-1

1

Aug-1

1

Jan-1

2

Jun-1

2

No

v-1

2

Apr-

13

Sep-1

3

Feb

-14

Jul-1

4

De

c-1

4

Ma

y-1

5

Oct-

15

Ma

r-1

6

Aug-1

6

Jan-1

7

Jun-1

7

No

v-1

7

Apr-

18

Sep-1

8

Feb

-19

Jul-1

9

De

c-1

9

12M forward EPS (LHS) 12M forward PE ratio (RHS)

We are in phase four of the cycle – will earnings implode?

MSCI World EPS Expectations 12M Forward and PE 12M Forward MSCI World EPS NTM Percent

MSCI World PE ratio NTM Multiple

Source: FactSet, Data as of 31/12/2018

PE down –

EPS to follow?

Phase 1

EPS up/PE down

Phase 2

EPS flat/PE up (a lot)

Phase 3

EPS up/PE flat

Phase 0

PE down

then EPS

Page 3: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

3

Forward PE back within historic ranges

MSCI World Index PE 12M forward (broker estimates)

Multiple

9

13

17

21

25

Jan-9

9

Jul-9

9

Jan-0

0

Jul-0

0

Jan-0

1

Jul-0

1

Jan-0

2

Jul-0

2

Jan-0

3

Jul-0

3

Jan-0

4

Jul-0

4

Jan-0

5

Jul-0

5

Jan-0

6

Jul-0

6

Jan-0

7

Jul-0

7

Jan-0

8

Jul-0

8

Jan-0

9

Jul-0

9

Jan-1

0

Jul-1

0

Jan-1

1

Jul-1

1

Jan-1

2

Jul-1

2

Jan-1

3

Jul-1

3

Jan-1

4

Jul-1

4

Jan-1

5

Jul-1

5

Jan-1

6

Jul-1

6

Jan-1

7

Jul-1

7

Jan-1

8

Jul-1

8

-6%

below

average

Source: FactSet, Data as of 31/12/2018

Page 4: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

4

Adjusting for leverage, buy backs and tax, EV to EBITDA +1 STDEV

above average

MSCI World – EV to EBITDA 12M forward EV to EBITDA (broker estimates) Ratio

6

7

8

9

10

11

12

Jan-9

9

Jul-9

9

Jan-0

0

Jul-0

0

Jan-0

1

Jul-0

1

Jan-0

2

Jul-0

2

Jan-0

3

Jul-0

3

Jan-0

4

Jul-0

4

Jan-0

5

Jul-0

5

Jan-0

6

Jul-0

6

Jan-0

7

Jul-0

7

Jan-0

8

Jul-0

8

Jan-0

9

Jul-0

9

Jan-1

0

Jul-1

0

Jan-1

1

Jul-1

1

Jan-1

2

Jul-1

2

Jan-1

3

Jul-1

3

Jan-1

4

Jul-1

4

Jan-1

5

Jul-1

5

Jan-1

6

Jul-1

6

Jan-1

7

Jul-1

7

Jan-1

8

Jul-1

8

+9%

above

average

Source: FactSet, Data as of 31/12/2018

Page 5: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

5

…Looking at EV to sales, valuations down a bit, but still ~19%

above historic averages

MSCI World EV to Sales EV to 12M forward sales (broker estimates) Ratio

1.00

1.20

1.40

1.60

1.80

2.00

2.20

Jan-9

9

Jul-9

9

Jan-0

0

Jul-0

0

Jan-0

1

Jul-0

1

Jan-0

2

Jul-0

2

Jan-0

3

Jul-0

3

Jan-0

4

Jul-0

4

Jan-0

5

Jul-0

5

Jan-0

6

Jul-0

6

Jan-0

7

Jul-0

7

Jan-0

8

Jul-0

8

Jan-0

9

Jul-0

9

Jan-1

0

Jul-1

0

Jan-1

1

Jul-1

1

Jan-1

2

Jul-1

2

Jan-1

3

Jul-1

3

Jan-1

4

Jul-1

4

Jan-1

5

Jul-1

5

Jan-1

6

Jul-1

6

Jan-1

7

Jul-1

7

Jan-1

8

Jul-1

8

+19%

above

average

Source: FactSet, Data as of 31/12/2018

Page 6: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

6

15%

16%

17%

18%

19%

20%

De

c-9

8

Jun-9

9

De

c-9

9

Jun-0

0

De

c-0

0

Jun-0

1

De

c-0

1

Jun-0

2

De

c-0

2

Jun-0

3

De

c-0

3

Jun-0

4

De

c-0

4

Jun-0

5

De

c-0

5

Jun-0

6

De

c-0

6

Jun-0

7

De

c-0

7

Jun-0

8

De

c-0

8

Jun-0

9

De

c-0

9

Jun-1

0

De

c-1

0

Jun-1

1

De

c-1

1

Jun-1

2

De

c-1

2

Jun-1

3

De

c-1

3

Jun-1

4

De

c-1

4

Jun-1

5

De

c-1

5

Jun-1

6

De

c-1

6

Jun-1

7

De

c-1

7

Jun-1

8

…as the market still believes margins will continue to improve…

and earnings won’t implode

MSCI World EBITDA Margin 12M forward, broker Percent

+348bp

Source: FactSet, Data as of 31/12/2018

Page 7: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

7

MSCI World Index

Energy

Materials

Industrials

Cons. Disc.

Staples

Health

Financials

IT

Communications

Utilities

R² = 0.9631

0%

4%

8%

12%

16%

-4% -2% 0% 2% 4% 6% 8% 10% 12% 14%

Pri

ce C

AG

R

EPS CAGR

Earnings growth explains price movements in the medium term

10 Years EPS and Price CAGR by MSCI World Sector

Percent

MORE RERATING

LESS RERATING

Source: FactSet, Data as per 31/12/2018

Page 8: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

8

The share price outperformance of US markets versus Europe is

predominantly a function of stronger earnings

MSCI USA Price and EPS relative to MSCI Europe over the last 20 years Index

US relative EPS and price outperformance

55

75

95

115

135

155

Price EPS

Source: FactSet, Data as per 31/12/2018

Page 9: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

9

Two major threats to earnings

Corporate Profits/GDP

0%

2%

4%

6%

8%

10%

12%

14%

Political headwinds

The global political consensus

of the last 40 years is

unravelling:

• China shifting focus

• Trade wars

• Fragility of the Eurozone

• Rise of Populism

• Higher labour cost

• Tech regulation

Tightening is here

After nearly 10 years of

unlimited liquidity, we now

have:

• US tightening into a potential

slowdown

• Rising debt cost weighs on

net profit margins and

increases credit risk

• Growing government budget

deficits sap corporate

liquidity

• Renminbi devaluation?

Page 10: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

10

Two major threats to earnings

Corporate Profits/GDP

0%

2%

4%

6%

8%

10%

12%

14%

Political headwinds

The global political consensus

of the last 40 years is

unravelling:

• China shifting focus

• Trade wars

• Fragility of the Eurozone

• Rise of Populism

• Higher labour cost

• Tech regulation

Tightening is here

After nearly 10 years of

unlimited liquidity, we now

have:

• US tightening into a potential

slowdown

• Rising debt cost weighs on

net profit margins and

increases credit risk

• Growing government budget

deficits sap corporate

liquidity

• Renminbi devaluation?

Page 11: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

11

QE has been great for asset prices, but now QT is here

Central Bank Assets vs. MSCI World $ Trillions Index (Dec1998=100)

Source: FactSet

282

100

600

5

10

15

20

Fed (LHS) PBoC (LHS) BOJ (LHS) ECB (LHS) MSCI World Total Return (RHS)

Page 12: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

12

Tightening is here: US corporate leverage is close to all time highs

when adjusting for excessive EBITDA margin

Total Debt to EBITDA Ratio

1.50

2.00

2.50

3.00

3.50

Ma

r-9

0

No

v-9

0

Jul-9

1

Ma

r-9

2

No

v-9

2

Jul-9

3

Ma

r-9

4

No

v-9

4

Jul-9

5

Ma

r-9

6

No

v-9

6

Jul-9

7

Ma

r-9

8

No

v-9

8

Jul-9

9

Ma

r-0

0

No

v-0

0

Jul-0

1

Ma

r-0

2

No

v-0

2

Jul-0

3

Ma

r-0

4

No

v-0

4

Jul-0

5

Ma

r-0

6

No

v-0

6

Jul-0

7

Ma

r-0

8

No

v-0

8

Jul-0

9

Ma

r-1

0

No

v-1

0

Jul-1

1

Ma

r-1

2

No

v-1

2

Jul-1

3

Ma

r-1

4

No

v-1

4

Jul-1

5

Ma

r-1

6

No

v-1

6

Jul-1

7

Ma

r-1

8

No

v-1

8

Total Debt/EBITDA Normalised total debt to EBITDA

Source: FactSet, data as of 31/12/2018 Note: EBITDA adjustment assume average EBITDA margin 1990 – 2017.

Page 13: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

13

Two major threats to earnings

Corporate Profits/GDP

0%

2%

4%

6%

8%

10%

12%

14%

Political headwinds

The global political consensus

of the last 40 years is

unravelling:

• China shifting focus

• Trade wars

• Fragility of the Eurozone

• Rise of Populism

• Higher labour cost

• Tech regulation

Tightening is here

After nearly 10 years of

unlimited liquidity, we now

have:

• US tightening into a potential

slowdown

• Rising debt cost weighs on

net profit margins and

increases credit risk

• Growing government budget

deficits sap corporate

liquidity

• Renminbi devaluation?

Page 14: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

14

The Eurozone fragility is a recurring feature that dampened

business and consumer confidence in the upturn

Eurozone Economic Confidence Indicator

Index

50

62

74

86

98

110

122

Euro sovereign

debt crisis

Brexit

Italy election

and budget

Source: Bloomberg, Data as of 31/12/2018

Page 16: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

16

Populism could increase labor costs, and hit corporate profitability

US Wages and Corporate Profits as Percent of National Income

Percent

Source: BEA. Data last updated December 31, 2017

7%

9%

11%

13%

15%

58%

61%

64%

67%

70%

Ma

r-4

7

No

v-4

8

Jul-5

0

Ma

r-5

2

No

v-5

3

Jul-5

5

Ma

r-5

7

No

v-5

8

Jul-6

0

Ma

r-6

2

No

v-6

3

Jul-6

5

Ma

r-6

7

No

v-6

8

Jul-7

0

Ma

r-7

2

No

v-7

3

Jul-7

5

Ma

r-7

7

No

v-7

8

Jul-8

0

Ma

r-8

2

No

v-8

3

Jul-8

5

Ma

r-8

7

No

v-8

8

Jul-9

0

Ma

r-9

2

No

v-9

3

Jul-9

5

Ma

r-9

7

No

v-9

8

Jul-0

0

Ma

r-0

2

No

v-0

3

Jul-0

5

Ma

r-0

7

No

v-0

8

Jul-1

0

Ma

r-1

2

No

v-1

3

Jul-1

5

Ma

r-1

7

Wages as % of national income (excl. government) (LHS) Corporate Profits before tax as % of National Income (RHS)

Page 17: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

17

Tech regulation is on its way – as well as a more robust approach

to anti-trust

US Federal regulation by sector Thousands

215

128

124

99

85

47

45

37

27

Manufacturing

Finance

Transportation

Media & telecom

Natural resources

Utilities

Education

Health care

Technology & E-commerce

Source: BofAML Global Investment Strategy, Data as of 31/12/2018

Page 18: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

18

How to navigate challenging markets?

Page 19: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

19

Characteristics of quality earnings

High return on

unlevered operating

capital employed

Resilient earnings

and free cash flow

Recurring Revenues

Pricing Power

Strong Intangible

Assets

…pricing power should help

preserve margins

…low capital intensity drives higher

free cash flow conversion

…recurring revenues should protect

the top line

In uncertain times….

Page 20: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

20

(120%)

(100%)

(80%)

(60%)

(40%)

(20%)

0%

20%

HealthCare

ConsumerStaples

Utilities Telecoms Energy IT Overall Industrials MSCIWorld

Materials Financials ConsumerDiscretionary

IT Soft& Serv

ITHardware

ITSemis

Quality earnings are the most robust in a downturn

NTM Forward EPS Change During Financial Crisis Drawdown (Oct 2007 – Feb 2009)

Chart Source: FactSet. Data as of July 31, 2018

Page 21: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

21

What is a quality compounder

Distribution of wealth

to shareholders

Page 22: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

22

Compounding at work: Reckitt Benckiser

Organic Sales Growth (1)

(%) (%)

Attractive Total Returns (1)

Indexed, USD

10

15

20

25

30

0

4

8

12

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Organic Sales Growth EBITA Margin

0300600900

1,2001,5001,800

2000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2011 2012 2013 2014 2015 2016 2017

Reckitt Benckiser MSCI World Index

Reckitt Benckiser CAGR 16.8%

MSCI World Index CAGR 4.7% $1,638

$227

28.1%

Earnings per share CAGR 12.9%

Dividend per share CAGR 9.9% Category Kings:

• ROOCE (2): 123%

• Gross Margin (2): 59%

• CAPEX/Sales (2): 2.7%

• Margin Stability (2): 95%

• Organic Sales Growth (1): 6.0%

Source: FactSet & annual company report. 1. Data from January 1, 2000 to December 31, 2017. Updated Annually (from company report circ. March). 2. ROOCE (Return on Operating Capital Employed) = Ebita (Earnings Before Interest, Taxes and Amortization) / PPE (Property, Plant, Equipment) + Trade working capital (excludes goodwill). Ex-Financials. ROOCE, Gross Margin and Capex/Sales are last reported and ex-Financials. EBIT margin stability is (1-(std deviation)/mean)). Five year averages to December 31, 2017. This example is provided for illustrative purposes only. This should not be construed as a recommendation, but as an illustration of a broader theme. Past performance is not a reliable indicator of future results. Within an investment portfolio, this security could be one of many holdings and is not representative of how all holdings in portfolio would have, or will, perform. The portfolio management team did not hold this security during the entire time period reflected above and may have bought and sold the security (at a gain or loss) at various points through this period. There is no guarantee securities will perform well and compound shareholder returns over time. MSCI World index shown for comparative purposes only. It is not possible to invest directly in an index. CAGR = Compound annual growth rate as of December 31, 2017. Group EBITA Margin ex Reckitt Pharma division. Holdings shown based on equities within the Top 10 Holdings for the quarter which have a return on operating capital employed of over 30% and gross margins over 30%. Logos reprinted with permission of Reckitt Benckiser

A superb innovator and brand extender

Flat

Page 23: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

23

Capital intensive companies do not generally compound

Where to find quality compounders

• Consumer staples

• Information technology

• Consumer discretionary

• Health care

• Materials

• Telecom

• Utilities

• Energy

• Real estate

Companies with pricing power and resilience are excellent sources

of quality compounders

TAKEAWAY

A search for quality compounders leads to a portfolio heavy in consumer and the softer side of tech

COMPOUNDER RICH COMPOUNDER LIGHT

Page 24: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

24

• Average returns are

not the same as

compounded

returns.

The example shown is for illustrative purposes only. The data have been chosen to convey the concept of compounding and the

erosive effects of volatility on returns.

YEAR LESS VOLATILE RETURNS

Alternating years of 7% and 9% gains

MORE VOLATILE RETURNS Alternating years of 32% gains, 16% losses

$1,000,000 $1,000,000

1 7% 1,070,000 32% 1,320,000

2 9% 1,166,300 -16% 1,108,800

3 7% 1,247,941 32% 1,463,616

4 9% 1,360,256 -16% 1,229,437

5 7% 1,455,474 32% 1,622,857

6 9% 1,586,466 -16% 1,363,200

7 7% 1,697,519 32% 1,799,424

8 9% 1,850,296 -16% 1,511,516

9 7% 1,979,816 32% 1,995,202

10 9% $2,158,000 -16% $1,675,969

Average annual return 8.0% 8.0%

Compound annualized return 8.0% 5.3%

TAKEAWAY

Quality stocks tend to have relatively low volatility of returns, which powers compounding

Compounding: How it works

Page 25: Quality Equities and the Power of Compounding · 2 8.0 10.0 12.0 14.0 16.0 18.0 20.0 50.0 72.0 94.0 116.0 138.0 160.0 04 5 5 6 06 07 07 07 8 08 9 9 09 0 0 1 11 12 12 12 3 13 4 4 14

25

Compounding at work

-

100

200

300

400

500

600

700

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

To

tal R

etu

rn o

f $

10

0

Years

$612

$395

10% CAGR

7.5% CAGR

$195

$380

$206

7.5% AVG

$209

Average returns are not the same as compounded returns

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• Historically, quality has

delivered lower volatility

and higher return than

traditional broad

equity benchmarks

Quality investing offers attractive risk return profile

Source: Morgan Stanley Investment Management 1. Past performance is not a reliable indicator of future results. Performance returns reflect the average annual rates of return.

The comparison indices are the MSCI World Index, the MSCI EAFE Index, the S&P 500 with Income Index, the MSCI World Consumer Staples Index, the FTSE All Share Total Return Index, MSCI AC World Free Blend (ACWI) Index and the MSCI World Quality Index. The period start date is March 31, 1996. Data updated quarterly.

2. The MSCI World Quality Index was launched on December 18, 2012. Data prior to the launch date is back-tested data (i.e. calculations of how the index might have performed over that time period had the index existed). There are frequently material differences between back-tested performance and actual results.

Volatility vs. Return – March 31, 1996 to December 31, 2018

Annualized Return (%)

MSCI World

MSCI EAFE

S&P 500 MSCI World Consumer

Staples

FTSE All Share

MSCI ACWI

MSCI World Quality

2

3

4

5

6

7

8

9

10

10 11 12 13 14 15 16 17 18

Volatility (Standard Deviation %)

(2)

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The key to compounding wealth

Think in

Absolute

Rather Than

Relative Terms

Strive to

Avoid the

Permanent

Destruction

of Capital

RULE 1: DON’T LOSE MONEY

RULE 2: DON’T FORGET RULE 1 – Benjamin Graham

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Appendix: Building a Quality Portfolio

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Source: Factset MSCI Indices February 2019

United States 609 Developed markets (ex US) 990 Emerging markets

Over 2,400

865

There are a lot of companies out there….

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What approach?

• Passive or Active

• Top-down

• Bottom up What markets?

• Developed markets

• Emerging markets

• Regional

What style?

• Growth

• Value

• Large cap

• Mid cap

• Small cap

…And many ways to approach the market

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• The ‘management’ choice > Active or Passive?

• The ‘style’ choice > Growth or Value?

• The ‘market’ choice > Developed or Emerging?

• The ‘investment approach’ choice > Top Down or Bottom Up?

Where do you start?

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ACTIVE MANAGEMENT PASSIVE MANAGEMENT

Objectives • Alpha

Deliver alpha relative to a representative benchmark or

index

• Absolute return-orientation

Generate a positive return regardless of market conditions

• Seeks to replicate a benchmark

Aims for “market” or “index” returns

Strategy • High conviction strategy

Portfolio based on research and a defined philosophy &

process for implementation

• Replication strategy

Portfolio is constructed to closely mirror that of the index

Risk management • Defined in absolute terms (loss of capital)

• Cares about price and quality

• Defined by the index (loss vs index)

• Doesn’t care about price or quality

Cost • Higher cost

Management fees are generally higher to compensate for

time and expertise to manage strategy

• Lower cost

Management fees are generally lower than those of active

managers

Behavior • Returns may vary significantly vs index • Returns closely track index

minus fees

The ‘management’ choice

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Average

market

valuation

Growth investors purchase stocks with high and rising

earnings expectations

• Growth stocks’ growth rates are

projected to be above the market

average

• Often do not pay dividends

• Returns often based solely on

capital gains

• Popular growth stocks include

Amazon, Tesla and Square

Challenge overpaying for growth

The ‘style’ choice

Value investors

purchase stocks at depressed prices,

with the expectation they will recover

• Often described as under-valued

or mispriced

• Typically generate a high dividend

yield

• Popular value stocks include Bank

of America, AT&T and Walmart

VALUE

TRAP

Challenge avoiding ‘value traps’

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The ‘markets’ choice

DEVELOPED MARKETS EMERGING MARKETS

Characteristics • Ease of capital movement

• Efficiency of market institutions

• Developed infrastructure

• More consumption driven

• Increasing economic freedom

• Gradual integration with global marketplace

• Expanding middle class; improving living standards

• More capital driven

Risk-return profile • Relatively stable economies

• GDP growth generally lower with less volatility

• High quality of governance

• Less stable economies

• GDP growth generally higher with higher volatility

• Lower quality of governance

Ten largest (per GDP2)

1. U.S.

2. Japan

3. Germany

4. United Kingdom

5. France

6. Italy

7. Canada

8. Australia

9. Spain

10. Netherlands

1. China

2. India

3. Brazil

4. Russia

5. South Korea

6. Mexico

7. Indonesia

8. Turkey

9. Saudi Arabia

10. Argentina

1 As defined by per capita income 2 Source: Wikipedia

as of 2015-2018

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The ‘investment approach’ choice

TOP-DOWN

portfolio construction focuses on macro factors:

• GDP

• Trade balances

• Inflation

• Interest rates

• Government

• Market risk

BOTTOM-UP

stock selection focuses on company specifics:

• Business model

• Competitive advantages

• Margins, cash flow, leverage

• Capital requirements

• Management

• Company risk

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The Quality Choice . . .

High Quality

Active

Global

Fundamental

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Growth stocks Value stocks

Growth

investors

Value

investors

Quality

Management Good capital allocators

Powerful Intangible

assets - Brands and networks

Pricing power

- high gross margins

Strong free

cash flow

Sustainable profits - high rooce*

FILTER FOR QUALITY ATTRIBUTES

*ROOCE (Return on Operating Capital Employed) = Ebita (Earnings Before Interest, Taxes and Amortization) / PPE (Property, Plant, Equipment) + Trade working capital (excludes goodwill).

Choose quality rather than a growth or value style box

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PASSIVE MANAGEMENT ACTIVE MANAGEMENT

Objectives Seeks to replicate a benchmark Sustainable compounding of long term returns

Absolute return-orientation

Strategy Replication strategy High conviction strategy

Risk management ???

Absolute

Behavior Returns closely track index Returns may vary vs index

Choose active, high-conviction

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Choose to invest globally….

Revenue

from

emerging

markets

….Given the scarcity of high quality companies

There are so few high quality compounding companies even when you

search everywhere in the world.

A disciplined investment process results in a portfolio of companies

listed in developed markets – multi nationals generating revenues

throughout the world

The result is a portfolio of companies with strong governance practices

(often a by-product of developed markets exposure) while accessing the

growth of the EM consumer indirectly

1 Economic Exposure in Global Investing; 2014 MSCI Inc.

21%

MSCI World Index

Average % of revenue of developed companies

derived from emerging markets. 1

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Buy businesses, not macro

TOP-DOWN BOTTOM-UP BUY BUSINESSES FOR

THE LONG TERM

Portfolio construction focuses on macro

factors:

• GDP

• Trade balances

• Inflation

• Interest rates

• Currency swings

• Sector outlooks

• Other ‘factor’ exposures

Stock selection focuses on company

specifics:

• Business model

• Competitive advantages

• Margins, cash flow, leverage

• Capital requirements

• Material ESG factors

• Company management

• Intangible assets

• Other stock-specific attributes

Owning a stock means owning a business

• Make investments for the long term, to allow seeds of

compounding to bear fruit

• Avoid the distraction of top-down, short-term market noise

Examine stock-specific attributes

• Franchise Quality

• Management Quality

• Financial Strength

Avoid unnecessary constraints

• No benchmark constraints

• No geographical constraints

• No style box constraints

• No sector constraints