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Company quality is no absolute: Loomis Sayles
The valuation of companies that form the spine of growth sleeves in portfolios is a skill that fund managers hang their collective hats on. Defining and assessing quality plays a large part of that skillset, but Boston-bred money manager Loomis Sayles believes quality is just part of a spectrum.
The notion of quality can be defined, according to Loomis Sayles vice president Lee Rosenbaum, as “companies with a durable competitive advantage driven by multiple dimensions”.
But quality in itself is an ill-defined, shape-shifting thing, believes Rosenbaum, who also runs the firm’s global equity opportunities and global allocation strategies. Speaking at The Inside Network’s Growth Symposium in Sydney via video-link from Boston, Rosenbaum explained some of the philosophy behind the group’s valuation process.
“I think we can all recognise that the definition of quality varies, and I’m not here to tell you that our way is the right way for everyone,” he said. “Our approach is what we sometimes refer to as multi-dimensional. We don’t think quality is an absolute, it can flex and bend, strengthen and weaken depending on the situation and over time.”
Quality is intrinsic to the long-term health of any company investment, Rosenbaum explained. Defining quality characteristics Loomis Sayles looks for include capital allocation, business model, strong management, ESG, intangible assets, market structure and return on invested capital.
“Our ultimate goal is to really understand the sources and sustainability of a business’s competitive advantage, and how durable that advantage is,” he said. “It’s not a set of [rules] or a checklist, and it’s not a set of binary outcomes. You don’t need all seven for a business to get in the portfolio.”
Aside from quality, however, Rosenbaum believes two other factors require serious consideration.
“While quality’s one of the three ways that we think about how to generate output, we also embed – and it’s equally as important – what we call an intrinsic value growth alpha driver, as well as a valuation output driver.”
It’s when these three come together, Rosenbaum said, that Loomis Sayles is most successful in the research and underwriting processes it uses to bring businesses into its global equity portfolio.
“Buying businesses at a discount to our assessment on a range of scenarios from a net present value perspective, is equally as important in our overall underwriting of businesses… as how we think about managing the portfolio from a portfolio construction perspective.”
Quality viewed through the growth prism
Also on the panel, and being beamed in from Scotland, Dundas Global Investors analyst David Keir acknowledged the role quality plays, but took a more growth-orientated slant to assessing business health.
“We believe, firstly, you’ve got to be long term,” Keir said. “You’ve got to follow a clear, thorough philosophy, and most importantly, you’ve got to be disciplined.”
As growth, rather than income, takes primacy for Dundas, the group would rather see dividends reinvested in the company it invests in. Accordingly, the “flywheel” of quality metrics it looks at differs from that of Loomis Sayles.
“We’re the manager who wants less dividends today,” he said, explaining that the payout ratio is much more important. “We spend a lot of time looking at how much [businesses] retain to reinvest in the business.
“For us, it’s a mitigating relativism, a measure of historical performance,” Keir continued. “It really is a covenant with shareholders, and it is absolutely an active decision taking over your boardroom table.”
