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Sectors to embrace (and avoid) in global equity markets

27-Jul-2016

Hyperion proves sticking to the fundamentals pays off in any market.
This year Hyperion celebrates its 20th year of managing high quality equity portfolios on behalf of our clients and our commitment to delivering strong long-term performance for our investors continues unabated. 
Many of the Australian listed businesses which we invest in have been leveraging their Intellectual Property for many years and successfully rolling out their business models into overseas markets.  As a result of this global expansion, it has always been vital for us to have an in-depth understanding of international markets

Our research of global businesses over the last 10 years has provided invaluable insights into the growth prospects and competitive advantages of our domestic portfolio companies as well as the risks of disruption posed by global competitors.  It is evident to us that our bottom up approach to quality investing can be translated across domiciles, as our definition of quality growth businesses and our high conviction approach is consistent. 
In May 2014, the investment team of Hyperion seeded a global equities fund to put this research into practice. The Hyperion Global Growth Companies Fund has now accrued a two year performance record with strong, yet unsurprising results; given the portfolio is run by the same investment team under the same philosophy and process as our successful Australian equity portfolios. 
While the fund is not yet open to retail investments (a Product Disclosure Statement has not been issued) we do anticipate releasing this fund to the broader market in the near future. In the meantime we would like to take the opportunity to share with you a few insights from Hyperion Portfolio Manager Joel Gray into the investment philosophy and resulting composition of the Hyperion Global Growth Companies Fund. 
Our investment philosophy is that the economics of a business drives a company’s long-term share price.  As a result, we believe buying high quality companies with superior economics at a reasonable price leads to attractive investor returns over the long-term. By superior economics we mean companies with a demonstrated high return on capital business model, a sustainable competitive advantage, predictable earnings streams, low levels of gearing and strong organic growth options.
When constructing and managing our global portfolio we are looking for the highest quality 15-30 business franchises at the exclusion of everything else. As a result of this targeted and concentrated approach to investment we tend to be perennially over and under-represented in particular sectors of the economy and therefore can be over and under-weight certain sectors when compared to indices or other funds. In keeping with our definition of superior economics, our fundamentally driven investment approach generally leads to positions in financial services businesses, software companies, online media businesses, food, luxury and online retailers and parts of the healthcare industry.
Similarly, there are sectors of the market that are of little interest to us due to high capital intensity and gearing levels, low growth rates, difficulty in understanding or difficulty in determining a sustainable competitive advantage and/or difficulty in predicting long-term earnings streams.  Examples of sectors of little interest include infrastructure companies, airlines, tobacco companies, resources or mining service businesses, sectors with acute regulatory risk such as gaming and branded pharmaceuticals, property, banking, insurance, biotechnology and commodity goods or service providers in general.  This is not to say that we cannot find a gem amongst these sectors but it is far less likely than in other sectors of the market.
The success and point of difference of Hyperion’s portfolios can be attributed to the stocks we have invested in as well as the stocks and industries we have chosen to exclude. When comparing our global portfolio composition to our peers, our significant under-allocation to the banking, pharmaceuticals and insurance industries means we stand out from the crowd. There are structural impediments in these industries and we avoid them. Our reasoning is that: 
  • The banking industry is becoming increasingly capital intensive due to increased regulation and banks will find it increasingly difficult to grow given the subdued credit growth environment, tight interest margins and increasing bad debts. 
  • The insurance industry is highly competitive and generally runs at an underlying loss.  Underwriting discipline is key, as the cost of a policy written today is not known until future periods.  Investment gains on premiums provide the majority of investment returns but the value of the float is less in low interest rate environments.  Therefore, growth and competitive advantage are the main impediments to Hyperion investing in this sector.
  • Products have a limited lifespan in the pharmaceutical industry. A product generally comes off patent after 20 years and prices drop in the vicinity of 80% due to the availability of generic substitutes. Generic substitutes are a favoured tool by Governments to minimise the healthcare costs of an ageing population, which is unlikely to change. In this environment it’s difficult for pharmaceutical companies to grow revenues, as new drugs replace older drugs’ revenue coming off patent.
Since Hyperion was founded 20 years ago, we have been successfully managing Australian equity portfolios under a consistent philosophy and process. It is apparent to us at Hyperion that the same fundamental investment approach can be applied to global equities, taking advantage of a wider universe of high quality businesses with larger addressable markets, to produce attractive long-term returns for our clients. We look forward to sharing further details of the Hyperion Global Growth Companies Fund with you in the future. 

The information in this document was prepared by Hyperion Asset Management Limited (‘Hyperion’), ABN 80 080 135 897 AFSL 238 380, for wholesale investors. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. This document does not take account of any person’s objectives, financial situation or needs and before acting, an investor should consider the appropriateness of the investment having regard to their objectives, financial situation and needs. Any opinions or forecasts reflect the judgment and assumptions of Hyperion and its representatives on the basis of information at the date of publication and may later change without notice. This document is provided to the recipient only and must not be copied or passed on to any other person without the consent of Hyperion Asset Management Limited. Past performance is not an indicator or guarantee of future performance. Investment performance is presented gross of investment management fees and other expenses, including custody. Hyperion Asset Management Limited believes the information contained in this communication is reliable, however, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. To the extent permitted by law, Hyperion disclaims all liability to any person relying on the information in respect of any loss or damage (including consequential loss or damage) however caused, which may be suffered or arise directly or indirectly in respect of such information contained in this communication. Figures provided as at 28th February 2017. Morningstar Awards 2016 (c). Morningstar, Inc. All Rights Reserved. Awarded to Hyperion Asset Management for Fund Manager of the Year, Domestic Equities – Large Caps Category Winner and Domestic Equities – Small Caps Category Winner, Australia. 


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