Five thematic drivers to boost client returns
Investors keen on enhancing their developed market (DM) returns over the coming five- to 10-years will have to pay close attention to five thematic drivers when making their asset class allocations, and choosing financial instruments within each class. In his presentation to the Glacier International Seminar 2024, AJ Gracely, Principal at Fayez Sarofim & Co, identified ageing populations, artificial intelligence (AI), geopolitics, energy transition and inflation as key themes to invest by.
Considering profitability over geography
For readers who are not familiar with the brand, Fayez Sarofim & Co is an independent, employee-owned global investment manager with a 65-year investment history and a ‘sustainable growth’ investment philosophy.
“Sustainable growth means looking for companies that are capable of delivering compound earnings growth over a five- to 10-year investment horizon,” Gracely said, before commenting that the profitability of the companies in his funds was more important than where those companies were based. Fund managers must, therefore, unpack and understand global investment themes in light of the potential impact on the profitability of their preferred companies, over the mandated investment horizons.
The inflation theme was first up for discussion. DM equities have ebbed and flowed on inflation-linked expectations going back to 2022. Share prices dipped as inflation in the United States (US) and Eurozone soared to 40-year highs; but started to regain lost ground after the impact of central banks’ aggressive interest rate hiking responses started filtering through. Around May 2024, the inflation outlook was less clear, with growing concerns that it would not return to the rather benign levels seen over the 15-years post the Global Financial Crisis (GFC).
“Global DM shares could continue to rally on the view that central banks will normalise policy because inflation is coming down; but recent inflation readings do not support that perspective,” Gracely warned. He noted that stickier or stubbornly-high inflation would “impact the magnitude and duration of central bank policy normalisation”. Put another way, asset managers, financial advisers and their clients will have to figure out which asset classes will perform best in a ‘higher for longer’ inflation and interest rate environment.
The clear leader in global beauty…
Sarofim & Co’s favourite inflation ‘play’ is French multinational L’Oreal SA. “The global beauty market has grown every year for the last 20-years, and L’Oreal has outgrown that market [by] growing sales at double-digits over the last three years,” Gracely said. He said the company had a strong portfolio of brands across different categories, geographies, and price points. It has also successfully leveraged those brands to grow faster than the market, using periods of market dislocation to grow its market share.
The ageing population thematic driver exhibits in long-term population data. At present, around 18% of the DM population is age 65 plus, with this percentage forecast to grow to 22% over the next decade. “The result is an increase in the dependency ratio, or the number of people aged 65-plus divided by the working age population; [keeping in mind that] the working age population supports healthcare for the elderly,” Gracely said. In the DM context, growing healthcare expenditure is also disproportionately carried by governments.
The trend-linked share offered up during the presentation sits in the sweet spot of the rising demand for healthcare services and governments’ increasing focus on reducing their healthcare-related exposures by using preventative methods. “The company best-positioned to provide [obesity] prevention is Novo Nordisk, and we are really excited about the opportunity in the company,” Gracely said. This company could double its USD34 billion 2023 revenue by achieving a 2.5% penetration rate among the growing cohort of morbidly obese people. If you assume a 17.5% penetration rate, the revenue could grow 17x, though there are other firms competing for their slice.
Friend-shoring and war dominate geopolitics
Geopolitics remains a major influencer of global investment decision making. As this newsletter went to ‘print’, the Russia-Ukraine War was entering its 114th week while the more recent Hamas-Israel conflict had already gone beyond 205 days. “Nowadays it is almost impossible to open up a newspaper and not see some headline about US / China tensions or the conflict between Russia and Ukraine or what is going on in the Middle East,” Gracely said. “In addition to an increase in geopolitical tension, and maybe as a result of it, we are seeing a global trade reconfiguration [in a construct] called friend-shoring, nearshoring or reshoring”.
The defence sector, therefore, offers excellent opportunities for fund managers in search of long-term profitable companies. Rather than back so-called one-trick-ponies like Lockheed or Northrop, Sarofim prefers UK-based BAE Systems. The latter offers geographically diversified revenue that is not ‘tied’ to a single weapons systems whereas the former two companies are US-centric and / or tied to a single-platform, just think Lockheed and the F-35 fighter jet. BAE, with its 50% exposure to the UK, and 50% international, is in line to benefit as most European Union countries near their 2.5% of GDP ‘cap’ on defence spending in the coming years.
You cannot have an AI discussion without someone ranting about the valuation of the Magnificent Seven US-listed companies, or complaining about having missed the opportunity in trend. “There has been a substantial increase in the stock prices that are levered to AI; but the market tends to drastically underestimate the magnitude and duration of these changes in the computing environment … we think this trend will persist for the next five- to 10-years at a minimum,” Gracely said, tackling both concerns in a single statement. His favourite for the AI-trend is Microsoft which boasts 440 million users already paying an average USD10 per month for its services.
An unexpected up-vote for fossil fuels?
The final trend, called the energy transition, is of particular interest to the South African audience due to the country’s ongoing and well-documented energy supply constraints. There was some wonderful news for Africa’s worst greenhouse gas emitter: this investment manager reckons the energy transition is best-leveraged through ongoing investments in conventional energy businesses. Finally, a common sense realisation that the rush to renewables is leaving countries and markets horribly exposed.
“Over the next five or so years, returns for the energy transition are going to be depressed; at the same time, the world is going to need more and more energy which is going to continue to come from conventional energy,” Gracely said. His fund’s positioning over the next year or two is to remain overweight healthcare and staples; to overweight the technology sector with a clear preference for AI-winners; and underweight industrials. “Investors should be focused on companies that are not overly capital-, energy- or labour-intensive,” he concluded.
Writer’s thoughts:
The audience at the Pretoria leg of the Glacier International Summit 2024 was close to 50:50 when asked whether developed markets (DM) or emerging markets (EM) would drive investor returns over the coming years. Your writer voted DM; where do you stand? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.
