Picking quality companies
The portfolio managers’ process means that many more companies are analysed than the Trust invests in.
How quality companies are selected
Assessing quality is a highly subjective activity. The portfolio managers don’t go about it by ticking boxes, drawing up sets of screening criteria or plugging numbers into a computer. They believe these things often hide as much as they reveal.
Their approach is, however, both rigorous and methodical. The task of the portfolio managers is – part-analyst, part-historian and part-detective – is to painstakingly build a view of a company’s quality and valuation. This, in turn, allows them to feel comfortable about whether or not to buy a company’s share for the long term.
The process – and the high bar the portfolio managers set for inclusion – means that many more companies are analysed than the Trust invests in. These efforts, however, are not wasted: the many examples where true quality is lacking helps the managers to identify and appreciate high quality companies when they encounter them.
Risk factors
Capital at risk. The value of investments and any income from them may go down as well as up and are not guaranteed. Investors may get back significantly less than the original amount invested.
What the portfolio managers mean by ‘quality’
When looking for high-quality companies to invest in, quality is judged in three key areas:
Quality of management
The stewardship, or leadership, of a company is a key element in the assessment of quality. The portfolio managers understand that they are using shareholders’ money to buy, not a series of numbers on a screen, but rather a share of a living, breathing entity run by and for people.
One of the advantages of long-term investing is that time reveals the relationship between the returns a company generates on its shareholders’ behalf and the competence and integrity of the people who run it – the stewards. The portfolio managers are mindful that the quickest way to lose money is to invest alongside the wrong people.
There’s no point in having a management team who are clever but who are likely to steal from shareholders – or having managers who are honest but not up to the job. So the managers ask a series of questions, such as.
- What is their attitude to their employees or the communities where they operate?
- Do they take unnecessary risks?
- Can they develop and put in place strategies for sustainable predictable growth?
- Are they nimble and innovative enough to cope when things go wrong?
- Do they take short cuts by underpaying taxes or taking on too much debt?
- Are they good at managing the business’ finances over the long term?
"Shareholders’ money is not a series of numbers on a screen, but rather a share of a living, breathing entity run by and for people."
Douglas Ledingham, portfolio manager
Sustainability and environmental, social and governance (ESG) issues are key considerations for the portfolio managers when assessing the quality of a company’s management. So too are the ethics, conduct and integrity of its stewards.
One outcome of this focus on long-term stewardship is that the managers tend to favour family-controlled businesses that have been passed from generation to generation. There are, of course, many examples of family-controlled companies that do not treat other stakeholders (including minority shareholders) well – but the managers look to invest alongside owners who share the goal of creating value over the long term.
Quality of the franchise
The quality of a company’s franchise includes elements such as the strength of its brand, the extent of its market share, whether or not it has pricing power and whether it holds a sustainable competitive advantage.
As investors on behalf of the Trust’s shareholders, the portfolio managers are ultimately interested in finding companies that deliver a predictable stream of profits to their shareholders.
They are also looking for businesses whose profits can grow over the longer term – so developing a view on a company’s growth opportunities is another integral part of the process.
The managers also think about the strength of a company’s franchise in terms of its sustainability. Companies who profit by harming people or the environment are always at risk of having those profits taken away by regulators or policymakers or having their social licence to operate revoked; those that support sustainable development and provide benefits to society are more likely to see demand for their products grow.
"Companies that support sustainable development and provide a range of benefits to society are more likely to see demand for their products grow."
Douglas Ledingham, portfolio manager
For example, the managers would be likely to consider companies selling products with high levels of sugar, salt and fat to have a weaker franchise than those selling healthier foods, or consumer staples like toothpaste and soap. Because the former are contributing to poor health outcomes, they’re likely to face greater sustainability risks in the form of negative attention from policymakers.
Quality of the financials
The managers’ approach to a company’s financial situation is conservative. This is not to say that the portfolio managers don’t invest in strongly growing businesses, but rather that they like businesses that can weather whatever storms may come. These companies’ sales should be strong, resilient and profitable. Preferably, these companies should have cash reserves.
The portfolio managers never invest solely on the basis of whether a company is profitable or not today. Instead, they seek companies that have stood the test of time, delving into their performance over a number of economic cycles to build a fuller picture. How did a company fare in a period when economic growth was sluggish? How did it perform during a downturn?
While finding companies with the ability to grow their profits over the long term is important, the managers prefer that growth to be predictable and repeatable rather than merely rapid. They are alive to the power of compounding – repeatedly reinvesting the profits made today to grow over the long term. In their experience, sustainability issues are often neglected in the race for growth, so the portfolio managers prefer marathon runners to sprinters.
The portfolio managers also assess the quality of a company’s accounts and financial statements, as they are only too aware these can be manipulated. They consider the reputation of the company’s auditors, look for any unusual changes in financial year ends and are wary of aggressive accounting policies. Is a business spending a lot of its time trying to avoid paying tax? The portfolio managers have uncovered many corner-cutting risk-takers in this way.
“In our experience, sustainability issues are often parked in the race for growth, hence we prefer the marathon runners to the sprinters.”
Douglas Ledingham, portfolio manager
Companies that meet the criteria are included on the portfolio managers’ focus list. This list is evolving all the time as they refine their views and build their belief in the companies through ongoing meetings and analysis.
The managers’ judgment of quality is heavily influenced by their thinking about the challenges of sustainable development. They recognise and support the need for societies to maintain a sustainable ecological footprint as they develop. Furthermore, they believe that a company’s ability to contribute to, and benefit from, helping societies to achieve this – i.e. its sustainability positioning – is a key indicator of its quality.
As a result, sustainable development issues are fully integrated into the portfolio managers’ consideration of the three pillars of quality: management, franchise and financials.
How the Trust invests
The Trust’s portfolio managers treat the money with which they are entrusted as if it were their own.
Board of Directors & portfolio managers
Meet the people behind the Trust.
What is in the Trust?
Portfolio Explorer is an online tool that tells the stories of the companies Pacific Assets Trust invests in.
Explore it for yourself…
Risk factors
This web page is a financial promotion for Pacific Assets Trust plc (the “Trust”) only for those people resident in the UK and Ireland for tax and investment purposes.
Investing involves certain risks including:
- The value of investments and any income from them may go down as well as up and are not guaranteed. Investors may get back significantly less than the original amount invested.
- Emerging market risk: emerging markets tend to be more sensitive to economic and political conditions than developed markets. Other factors include greater liquidity risk, restrictions on investment or transfer of assets, failed/delayed settlement and difficulties valuing securities.
- Specific region risk: investing in a specific region may be riskier than investing in a number of different countries or regions. Investing in a larger number of countries or regions helps spread risk.
- Currency risk: the Trust invests in assets which are denominated in other currencies; changes in exchange rates will affect the value of the Trust and could create losses. Currency control decisions made by governments could affect the value of the Trust’s investments.
- The Trust’s share price may not fully reflect net asset value.
Where featured, specific securities or companies are intended as an illustration of investment strategy only, and should not be construed as investment advice or a recommendation to buy or sell any security.
For an overview of the terms of investment, risks, returns, costs and charges please refer to the Key Information Document.
If you are in any doubt as to the suitability of the Trust for your investment needs, please seek investment advice.
