World Markets Review
Investment insights from Capital Group
Growth stocks have continued to outpace value in the market decline and subsequent recovery following the COVID-19 demand shock. In our view, growth will continue to command a higher premium relative to other investment opportunities for two reasons:
As the economic environment has become more challenged, members of our investment team are finding that not all growth opportunities are on equal footing. Increasingly, many of our portfolio managers are focusing on a subset of growth companies that they view to be Quality Growth. While there is no perfect screen or set of rules that can embody all aspects of what we’re referring to, the following exhibit summarizes some key aspects that we believe define Quality, Growth and Quality Growth companies.
Clearly, not all of these characteristics are exclusive to Quality Growth companies — strong balance sheets and high-quality, experienced management teams are traits that portfolio managers look for across all types of companies. But when these traits are found in companies that also have attractive business models or are tapping into secular growth opportunities with a long runway, they can potentially make for attractive investment opportunities.
One example of a strong secular growth trend is subscription-based businesses — they have compounding characteristics that remain attractive in most market conditions, often gaining share even in periods of economic slowdowns as consumers and enterprises shift behavior.
At the same time, subscription-based businesses often address large total addressable markets (TAMs) that are global in nature, and this enhances their potential for compounding growth rates in stronger economic conditions.
An interesting aspect of many Quality Growth companies is that they have shown greater resilience and quicker recoveries versus the broader market. The chart below shows the MSCI ACWI Quality Index as a proxy. The companies in this index are selected based on high return on equity, stable year-over-year earnings growth and low financial leverage.
There are certain investment products in the marketplace based off the MSCI ACWI Quality Index. However, it is our view that the most attractive long-term Quality Growth stocks are identifiable, but only from a detailed understanding of each company’s fundamentals. A deep grasp of a company’s business model helps our investment team consider whether a company is merely riding the coattails of the economy or has a genuine ability to grow revenues from sustainable sources.
While Quality Growth companies, as a group, have often held up relatively well during market downturns, it is important to remember that their ability to do so has been largely predicated on their ability to continue growing, even when many other companies cannot. Hence, the cause of the downturn is an important consideration, and some quality growth companies may fare better than others in some downturns. Here are some anecdotes from the last five market corrections to help illustrate that point.
Great Financial Crisis (11/1/07–3/9/09)
European Debt Crisis (7/8/2011–10/4/2011)
China’s hard landing (5/22/2015–2/11/2016)
U.S./China Trade War (1/27/2018–12/25/2018)
London-based portfolio manager Chris Thomsen recently noted that “in a growth-starved world, I expect the market to continue to pay up for growth. Interestingly, many of those companies today have net cash balance sheets and high free cash flow generation.”
And portfolio manager Jonathan Knowles in Singapore put it this way: “Debt, deflation, devaluation, disruption: my acronym for what is going on remains DDDD. We have been in a period of significant disruption: old economic models are being upended by the rise of a new set of companies. Several of the world’s largest market caps barely existed 20 years ago. Now, we are witnessing another disruption more than a decade after the global financial crisis, characterized by unprecedented money printing and rising levels of government debt. In this environment, companies with strong business models in industries with long-term growth potential will continue to command a premium over the broader market.”
Many Quality Growth franchises have proven to be resilient so far this year, and changes in how people work and spend their leisure time have created opportunities for companies that provide the tools and solutions for altered lifestyles. The following are some examples.
So how is Capital Group positioned to identify these trends and differentiate between the companies that might benefit and those that may suffer setbacks in the post-COVID world?
Capital Group takes a hands-on approach to fundamental company research, leveraging a team of more than 300 analysts, portfolio managers and economists who have been at Capital for an average of 13 years (as of March 31, 2020). Last year they participated in more than 12,000 company meetings to gain deep insight into everything from macro and industry trends to company-specific trends across various regions. These meetings help our investment group calibrate both global and local trends. It is our view that our global footprint enables our group to have a view across global supply chains and company capital structures, helping them identify potential investment opportunities on both a bottom-up and top-down basis.
Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility, as more fully described in the prospectus. These risks may be heightened in connection with investments in developing countries. Small-company stocks entail additional risks, and they can fluctuate in price more than larger company stocks.
The MSCI ACWI captures large and mid-cap representation across 23 Developed Markets (DM) and 26 Emerging Markets (EM) countries.
The MSCI ACWI Quality Index is based on the MSCI ACWI Index, its parent index, which includes large and mid-cap stocks across 23 Developed Market (DM) and 26 Emerging Markets (EM) countries.
MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.
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