Charles Luke, Manager, Murray Income Trust
“It’s a rare business that doesn’t have a way worse future than it has a past.” – Charlie Munger
On Murray Income Trust, quality is our lodestar. It is the guiding philosophy that drives our investment decision-making, helping us uncover those companies that can deliver strong, repeatable returns year after year – or in other words – companies that have at least as good a future as their past. Quality companies are rare, and hard to find. We have made it our business to discover them.
There are clear reasons to search for quality companies. They tend to have two key performance characteristics: their cash flows, revenues and dividends tend to be consistent and predictable in the short-term, but more importantly, their advantages build over time because of careful capital allocation, strong management teams and competitive positioning.
Equally, these companies will have fewer tail risks and a greater margin of safety. That means they may not see the astonishing rises of more speculative companies, but neither will they see the precipitous falls. They can navigate difficult environments more successfully than their more vulnerable peers.
Avoid the disasters is an under-rated part of long-term success in fund management. As investor Mohnish Pabrai once said: “I don’t have any wonderful insights that other people don’t have. I just have slightly more consistently than others avoided idiocy. Other people are trying to be smart. All I’m trying to be is non-idiotic.”
The worry for investors is that these companies are too expensive. Yet we believe that the market consistently underestimates the sustainability of returns from these high-quality companies. While they may not look cheap, they will often be undervalued versus their long-term prospects.
As with any investment philosophy, targeting quality won’t work all the time. There will be times when markets are in an optimistic mood, and ready to embrace the latest innovation without a great deal of scrutiny. However, over the long-term, we believe that a quality portfolio is not only a source of higher returns, but a tool to lower risk.
What is a quality company?
Quality companies will have certain non-negotiable characteristics. It will need a ‘moat’ – an enduring competitive advantage that helps it protect its margins. A range of factors can create this moat. It may be the strength of a company’s intangible assets and intellectual property. Within Murray Income, holdings such as AstraZeneca, Games Workshop or L’Oreal exhibit these advantages. Or it may be network effects, which help companies build advantage over time, such as those for Air Liquide or Mastercard. Or it may be a cost or scale advantage, evident for companies such as Howden Joinery.
It will need financial strength. This includes high margins, the return it achieves on the capital it invests, and its debt levels. Perhaps the most important factor will be the way a company uses the capital it has available over time. We look for high ‘return on capital employed’ not just over a single year or two, but over the very long-term. One or two years can be due to over-earning, or a lucky investment, but strong capital allocation over many years takes a skill and judgement only exhibited by the most capable management teams.
Our view is that it is very difficult to be a quality company with a significant debt burden. Why? Because debt makes companies vulnerable, whether to higher interest rates, to a change in business environment, or to a short-term slowdown in sales. In contrast, if a company is well-capitalised, it can thrive through all market conditions. It can exploit weak economic conditions to build market share or take over its competitors.
Quality companies will also have a strong management team at the helm. The team is likely to have a history of success, with a track record of running companies for long-term sustainable growth. We need to be able to trust that a management team has shareholder interests at heart.
Valuation will be important, but not in the way many investors believe. Quality companies will rarely be ‘cheap’ on conventional metrics, but to quote Warren Buffett “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Investors will tend to underestimate the long-term benefit that a sustainable competitive advantage will provide a company.
We agree with investment strategist and author Phil Fisher: “Finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market proved far more profitable to far more people than did the more colourful practice of trying to buy them cheap and sell them dear”.
It is also worth noting that not every insight is quantitative. In fact, quantitative data is often priced efficiently. Qualitative insight is less efficiently priced. Sometimes we need to take a step back from the quantitative and tune in to the softer signals we receive.
Learning over time
Quality isn’t always obvious. It is not unusual for companies to have a sheen of strength, but problems may lurk a little deeper. The investment team is well-versed in interrogating a company’s management team and finances, its business model and prospects. Over time, we have learnt to identify red flags. We build on this collective knowledge with every investment decision.
There are potential traps waiting for the quality investor. A company that is growing its revenues fast, but that’s not creating value, a company with a weak or unproductive culture, companies that overspend on speculative research and development, or companies that are complacent, and fail to spot disruption.
Not all sectors and industries are created equal – we need to fish where the fish are. It is not possible to find quality companies in every industry. Economies evolve, and there is no use hoping for a revival of the horse and cart when everyone has moved on to the car. We are attentive to the characteristics of individual industries, their long-term prospects and the likelihood of disruption. This is part and parcel of ensuring that companies have a sustainable competitive advantage.
These companies are still the exception. Few companies exhibit the quality characteristics we value. When we have found those companies, we want to stick with them. There will always be reasons to sell. At the moment, the ructions over trade could send investors scurrying for the exit. Investors may have felt the same during the first round of Trump tariffs, or Covid, or the European sovereign debt crisis. At each point, exiting would have been the wrong decision. We want to take advantage of irrational behaviour, rather than succumbing to it.
To quote investor Howard Marks, “Experience is what you got when you didn’t get what you wanted”. The future remains unknowable – we will continue to make mistakes, but we will continue to learn from them. All of this is an attempt to shift the odds in our favour, and to align ourselves with the strongest companies over time.
Important information
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- The Company may charge expenses to capital which may erode the capital value of the investment.
- Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
The details contained here are for information purposes only and should not be considered as an offer, investment recommendation, or solicitation to deal in any investments or funds and does not constitute investment research, investment recommendation or investment advice in any jurisdiction. Any data contained herein which is attributed to a third party (“Third Party Data”) is the property of (a) third party supplier(s) (the “Owner”) and is licensed for use with Aberdeen. Third Party Data may not be copied or distributed. Third Party Data is provided “as is” and is not warranted to be accurate, complete or timely. To the extent permitted by applicable law, none of the Owner, Aberdeen, or any other third party (including any third party involved in providing and/or compiling Third Party Data) shall have any liability for Third Party Data or for any use made of Third Party Data. Neither the Owner nor any other third party sponsors, endorses or promotes the fund or product to which Third Party Data relates.
The Murray Income Trust PLC Key Information Document can be obtained here.
Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG, authorised and regulated by the Financial Conduct Authority in the UK.
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