Checking in with the Nedgroup Investments Global Equity Fund
The Nedgroup Investments Global Equity Fund is one of the flagship funds in our international range. This quarter we will provide an overview of the fund’s investment philosophy and structure and dive deeper into one of the key holdings in the fund – Rolls Royce Holdings.
The Nedgroup Investments Global Equity Fund - How we got here
The Nedgroup Investments Global Equity Fund is a concentrated, unconstrained portfolio where the focus is on protecting and growing the real value of investors’ capital. Veritas Asset Management has been appointed as the Sub-Investment Manager to this mandate since 2010. Some of the key characteristics that we like about Veritas include:
- Alignment of interests through co-investment and controlled growth
- Partnership culture
- Global equity core-competency
- Stable and experienced team
Furthermore, the Nedgroup Investments Global Equity Fund mirrors Veritas’ Global Focus Strategy, which has a track record going back all the way to 2001. Over this period, Veritas have outperformed their peer group by almost 3% p.a. which is a notable achievement (see first chart on opposite page).
Over time, they have also displayed favourable downside protection characteristics, resulting in lower volatility and drawdowns during market stress events. Interestingly, this is also evidenced when one compares their rolling 5 year returns to their global peer group, where they tend to lag in momentum driven markets but protect capital much better during downturns, resulting in the above-mentioned strong cumulative returns versus the peer group as well as the market.
Turning to the Portfolio’s current positioning, the largest sector overweights are Healthcare, Technology and Industrials. On the other hand, there is currently no allocation to Energy, Materials and Telecoms as shown in the chart below:
Drilling down to the stock level, there are four key themes currently being utilised within the Fund:
- Big data/mobility
- Value based healthcare
Major stocks within these themes are shown in the pictorial below:
Veritas spends lots of time trying to figure out which industries will be bigger in the next 10 years, and more specifically which companies will be the beneficiaries of that growth. Importantly, they also evaluate how these companies would perform in a downturn and consider other shocks that may impact profitability. Veritas choose to invest in high quality companies with sustainable competitive advantages and will only invest if attractive real returns are achievable. Their strict valuation discipline is a critical part of their process and if there aren’t any attractive opportunities available they will prefer to hold more cash. As an example of their investment process, an interesting stock that we will discuss in more detail below is Rolls-Royce Holdings.
What is the appeal of Rolls-Royce Holdings?
Aerospace and Defence is an industry with strong barriers to entry. Besides the required certifications and a proven safety record, companies must still spend significant sums on R&D to remain competitive. Furthermore, a high-quality aftermarket support network needs to be maintained given the life of a plane is more than 40 years. As an example, the Boeing 747 was first launched 50 years ago and many of these planes still fly today. With their business model, Rolls Royce typically makes R&D losses in the early years, and makes a loss on sales but this is recouped on maintenance contracts with the purchaser of the engine over the ensuing decades:
Also interesting is that the total number of air passengers per year keeps growing over time, and there have been only five years since 1960 when these numbers declined, demonstrating robust growth in volumes and strong long-term demand – from approximately 100 million air passengers in 1960 to four billion currently. Despite external shocks air traffic has proven to be resilient, while also doubling approximately every 15 years. According to research done by United Technologies, over 80% of the world’s population have not yet travelled by aeroplane so there appears to be strong tailwinds to growth (although for some air travel has now become a standard part of modern life).
Rolls Royce also have a huge order back-log (more than 2400 engines!), with the growth in their installed fleet of engines resulting in larger deferred profits (as explained above). Furthermore, the business’s transformation is well underway:
- Taking market share with higher delivery and operational leverage
- Efficiency programme resulting in margin improvement
- Falling R&D and capex causing free cash flow to increase rapidly
Here are some interesting facts about the new Rolls Royce Trent XWB Engine, shown below:
Firstly, the single biggest cost for an airline is fuel, so efficiency is very important. This engine is 17% more fuel efficient than the engine it replaces. Rolls Royce has a reputation for almost 100% engine reliability (airlines of course expect no less). These engines operate for up to 4000 hours per year which translates into approximately 10 hours per day on average, on routes ranging up to 14 000 km. Each engine is made up of 20 000 individual parts, leading to a total weight of 7 000 kg. Every engine has 68 turbine blades, each of which generate 800 horsepower (equating to the total power produced by 68 F1 cars). As you can see, these engines are quite an impressive feat of engineering!
Yet despite how exciting the product may be, Veritas has still put in lots of effort to evaluate whether the business case for Rolls Royce is sensible and whether the shares are investable given their strict valuation criteria. This analysis included:
- Proprietary work to deconstruct cash flows
- Comparing cost structure with peers to estimate normalized margins
- Evaluating impact of business restructuring to restore competitiveness
Veritas also wanted to ensure that the Rolls-Royce management team are sufficiently alert to adequately investing in new technologies, which they’ve confirmed via site visits and by reviewing other publicly available data.
In summary, Veritas manage the Fund with a real return mindset emphasising capital preservation and growth. They only look for quality companies that have a durable competitive advantage and perform deep primary and proprietary fundamental analysis before deciding whether to purchase. They are value disciplined to ensure that there is a sufficient margin of safety in the share price and are willing to rather hold cash when valuations do not meet their stringent criteria. The highly desirable outcome of all this is that they have consistently delivered attractive real returns for investors through various market cycles.
The author would like to thank Veritas Asset Management for the use of their proprietary research and commentary to compile this article. More in-depth analysis is available to investors upon request.