Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Blake Hutchins, Manager of the Investec Global Quality Equity Income Fund.
Blake Hutchins: Hi. Good morning.
Wall: So, your fund is global in its name and in its nature, but there is a large proportion of the fund in US and UK stocks at the moment. Why is that?
Hutchins: Yeah, we take very much a quality approach to our income investing and that means that we're focused on companies with sustainably high returns and very cash-generative, capital-light businesses with good growth potential, and then we look for them to pay a proportion of their growing cash flow as a dividend.
And it just so happens that we find the best opportunities for those kind of companies in the US. Actually, if you look at the aggregate quality of the various indices, the US actually have the highest quality indices. They have the highest returns in that market, followed by the UK and then Europe and then it falls away towards emerging markets and Japan. So, I don't think it should be a surprise that we find the most opportunities for these kind of investments in the US.
Wall: And then looking then at the US and the UK, they've got quite different prospects for rates but they've had a similar history in that for seven years now we've seen record low interest rates in the UK. We may well even get a cut on Thursday this week, which of course, has driven investors into equities, into income-paying equities because they can't get returns on cash or bonds. This has made some of these stocks quite expensive. How have you folded that into your investment philosophy?
Hutchins: Well, I think, you're right and the outlook for bond investing is challenged in that I think there's $13 trillion of sovereign and corporate bonds that are currently having negative yields. And you say that equities are expensive, but I put that in the context of the free cash flow yield, so the yield that we would value the fund on of the Global Quality Equity Income Fund, is actually close to 5 per cent, in line with that of the wider market.
So, if you compare a free cash flow yield of 5 per cent supporting a dividend yield of 3 per cent compared to some of these low yields from corporate and sovereign debt that we're seeing, we actually think the relative valuations are reasonably attractive.
And then on absolute terms versus their history, we see them as roughly in line with their history. So, we're not at bargain basement anymore. We've rallied quite hard from the bottom of the market. But we're not necessarily looking for a re-rating of the companies that we invest in. They have natural growth. So, if we can get close to double-digit free cash flow growth with a good starting dividend yield, we still see decent prospects for our total returns.
Wall: At this point in the market though, are you looking at different sectors than you may have been sort of five years ago bearing in mind the rally that we've seen since the lows?
Hutchins: We still think there's value in some of the sectors that have performed very well. I get asked a lot, as you'd expect, about the valuation of consumer staples, for example, other quality sectors that we invest in such as healthcare or IT. And we actually see when you adjust for cash flow, cash generation, which is absolutely crucial to us, and debt levels, the valuation of those kinds of companies are more or less in line with that of the wider market. And as I've said, on the fund in general, we have a free cash flow yield in line with the market.
I look at Nestlé as an example. It has about a 4.5 per cent free cash flow yield. It had the same free cash flow yield 5 years ago, 10 years ago, 15 years ago. Now, I think that the actual relative merits of those companies in today's world of low-growth and high volatility still warrant that kind of attraction. So, we're still finding the same opportunities, albeit what we like with an income approach if you do it right and I emphasise if, you are rotating at the margin into stocks that are a little bit expensive into stocks that are a little bit cheap. And that buy low sell high mentality is obviously a good one.
Wall: Blake, thank you very much. This is Emma Wall for Morningstar. Thank you for watching.