Hyperion Asset Management is very much “bottom-up” in its approach to stock picking.
But chief investment officer Mark Arnold says the macroeconomic outlook favours the firm’s concentrated, high-conviction style that has seen the Hyperion Global Growth Companies Fund earn 18.6 per cent a year after fees since inception in June 2014.
With a track record spanning two decades, Hyperion manages $6 billion across its domestic small caps, domestic large caps and global growth funds. The global fund ranked number 1 in the last Morningstar survey and was issued a “recommended” rating from Zenith in February.
Arnold says the world faces a low-growth, low-inflation, low- interest rate environment with headwinds including ageing populations, high debt levels and a “disappearing” middle class in Western economies, and that inflation will be restrained by renewable energy, electric and autonomous vehicles and artificial intelligence.
While the US Federal Reserve is tightening interest rates from record lows and other central banks are expected to follow in the years ahead, Arnold says inflation and interest rates could stay relatively low for a decade.
“We’ve had a bit of a cyclical pick-up with the reflation trade in recent times but for structural reasons we don’t think it will be sustained,” he says.
“You’ve also got an emerging abundance of renewable energy, so energy is going to get very cheap and that’s going to put downward pressure on inflation.
“The marginal cost of the technology that backs renewables is basically zero, so it’s a situation where the efficiency of those technologies is improving all the time and lowering costs.”
Arnold expects electric and autonomous vehicles to have a big impact on the efficiency and cost of transport, adding to the downward pressure on inflation, and as long as inflation stays low he expects interest rates to stay low.
Rather than be left behind in “old economy” stocks, Hyperion’s funds are focused on the high-quality innovative disrupters of the future that can structurally grow revenues and profits at higher rates than the market.
Alphabet, Amazon, PayPal, Facebook and Intuit are the top five shareholdings of the Global Growth fund, while the domestic large caps fund has REA Group, Seek, Cochlear, Macquarie and Domino’s.
The small caps fund also has REA and Domino’s, as well as stocks such as TechnologyOne, IRESS, Hub24 and Netwealth.
Interestingly, Arnold also finds that the market often undervalues those sorts of businesses over long periods of time.
They might look expensive at face value, but their earnings often prove to be much stronger than the market expects.
“The market tends to underprice those really high-quality businesses because analysts expect their earnings to mean revert after a couple of years — which is absolutely correct for the average business — but it’s the 1 per cent of companies where revenues can continue to grow at double-digit rates that the market tends to undervalue.”
To work out which companies are the gems involves detailed quantitative and qualitative research about why a company’s customers buy its products.
“It’s really the companies that have got very strong value propositions and they’re disrupters — the value proposition isn’t just a little bit better than their competitors, it’s a lot better — that really makes a difference,” Arnold says.
“That structural growth comes from these companies having superior value propositions for their customers and that really allows them to take market share over time. It’s about buying the highest quality businesses that we can.”
He’s looking for companies with strong and sustainable competitive advantages, strong value propositions, potential for sustained double-digit revenue growth and rising free cash flows.
“Companies with that structural growth and are capital light can throw off a lot of free cash, so their intrinsic value will be rising and the share price should follow that growth,” Arnold says.
Some of Hyperion’s winners in small caps this year include financial services companies Netwealth and Hub24.
“Because of the structural shift away from the legacy platforms, financial planners are leaving the majors and becoming independent, which is part of that story. There’s been a shift out of AMP and into Hub24 and Netwealth.”
Domino’s is another good example of a company whose value proposition is much stronger than its competitors.
“No one else can price a pizza at $5 on a sustainable basis,” Arnold says. “Domino’s has a tiny market share in Europe and once they get to a reasonable scale they really accelerate that growth, so we think that over the next decade Domino’s Pizza can add thousands of stores in Europe.”
But A2 Milk doesn’t fit the bill.
“We have looked at A2 Milk but we have not added it to the portfolio because we want a fair degree of predictability in the long term and we’re just not sure that those guys will not get disrupted by other competitors at some stage.”
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