Under the hood of long-term global equity outperformance

The BlueAlpha BCI Global Equity Fund is a rare beast - a portfolio that has outperformed the MSCI World Index over 10 years. I chatted to co-portfolio manager Richard Pitt about the firm's approach.

Over the last 10 years, the BlueAlpha BCI Global Equity Fund has returned 13.2% per annum. That is significantly above the fund’s benchmark – the average return from funds in the ASISA global equity general category – of 11.2% per year.

Notably, it is also comfortably ahead of the return from the MSCI World Index, which is up 12% per annum in rand terms over this period.

Source: BlueAlpha Investment Management. Inception date: September 2014. Performance is for the A Class net of fees in ZAR. Sector average: ASISA global equity general.

That kind of long-term outperformance over a broad global market index is extremely rare – particularly in the recent market environment characterised by high levels of concentration in mega US tech stocks.

BlueAlpha does own some of those names. Meta Platforms and Broadcom both appear in the portfolio’s top 10. But portfolio managers Richard Pitt and Walter Jacobs have always focused on finding quality companies with the potential to grow ahead of market expectations. And many of those – like Alibaba and SS & C Technologies – are not exactly market darlings.

“The first thing we look at is to what extent a business generates returns above the cost of capital,” Pitt says. “The higher the better. And then, importantly, can it grow?”

Justifying the premium

This second component is an essential element of the return equation for BlueAlpha, particularly because higher-return businesses are generally priced at a premium.

“On a look-through basis, people say if I buy a company that makes a 10% return on its book value and I can buy it at half its book, that means I’m making a 20% return,” Pitt says. “Equally, if I buy a business that makes a 30% return on its book but I have to pay 3x book value to buy it, then I’m only getting a 10% return.

“But the difference that people often miss is that if the company can grow, there is the opportunity to reinvest its cash flows at book value, not at its market value. It takes time for that difference to play out, but that’s one of the big advantages you get investing a high quality business that can grow. Hopefully, over time, your external return measure should start trending towards that of the company itself.”

To find these names, BlueAlpha starts with screening the global universe.

“We are looking at a huge universe, so we need to shrink that down to something more manageable,” Pitt says. “We probably start with 1,000 companies and shrink that down to 100.

“Of that 100, we try to find stories that make sense, that we can understand, and that, on a qualitative basis, appear to have the wind at their sails. It’s always better to invest in a company that has some operating momentum, which we see through consensus forecasts.”

Return expectations

A key part of this process is also determining what level of future returns are implied in the market price.

“Rather than agonise over whether a company is expensive or cheap, just based on the market price we ask: what is the expected return on invested capital going forward.”

Pitt says that this can lead to some interesting comparisons.

“Currently, you can look at ASML, which was a market darling up until recently, but is still a really good businesses, has an extremely dominant position, and high returns of capital. Then compare that with company like Rheinmettal, a German arms manufacturer. They are basically priced as if they are going to make the same return on invested capital going forward.

“Of course, semiconductors are down a lot. And there is a story that Europe has to take more accountability for its military spending. That is a thematic difference paying out. But I find it very hard to believe that over the next five years Rheinmettal will make the same return on invested capital as ASML.

“Of course we could be surprised. Sometimes themes can go on for a while. But we are looking for those kinds of differences to find opportunities.”

Pitt (pictured above) points out that they are generally investing in big, well-covered companies. They have no extra insight over the market into the underlying businesses, and they rely on market forecasts.

“What is the big swing factor then?” Pitt asks. “It’s sentiment. That can go wildly in both directions with businesses, and we are trying to look at a basket of good businesses and find opportunities to buy them at a reasonable price.

“Unfortunately, investing in stocks is quite a hazardous business. So, it’s not so much about having a certain view about the future, as asking what opportunity the market is offering at the moment, and does it look relatively attractive?”

And those relative opportunities are almost always related to changes in perception.

“From a knowledge point of view, the collective view of the market is good,” Pitt says. “From psychological, emotional point of view, the market is all over the place. There is a lot of herding.”

He points to China as an example.

“At the end of 2022 and into 2023, the collective view was that China is uninvestible. But we owned Alibaba and it has done very well since then.

“When people come up with terms like ‘uninvestible’, often it’s an indication that sentiment is a bit skewed.

Understanding sentiment

“If something is priced for perfection, even if things are perfect it’s going to be hard to make money,” Pitt adds. “But if a stock is priced for an average outcome, the chances of it exceeding that are quite good, especially if it’s a business that has historically shown good financial metrics.”

This doesn’t mean that BlueAlpha trades regularly. Portfolio turnover is between 10% and 15% per annum. But it also does not follow a simple buy-and-hold approach.

“I don’t think we say we find the best companies and hold them forever,” Pitt says. “Circumstances change, and we are always looking at what other opportunities there may be.

“At the moment, we are looking at changing quite a lot. We’ve had a lot of US exposure – not by design, but by outcome. And recently that has been quite a painful thing to carry. There is a lot more risk and uncertainty there now, so we are looking to expand our exposure a bit more into Europe and South America.”