There's only 25 businesses in the world that can generate returns of 10% p.a. today. Here are some of them

"When I was 12 years old, my parents got swindled by an insurance agent, who essentially was taking a 60% upfront commission on the contributions they made. 20% went to the insurance company, and only 20% stayed with them," he recalled. 

"The insurance agent was being fed clients through a series of accountants. And in 1984, he earned $5 million in commissions. That's a lot of money now. It was an incredible amount of money then. 

"All this came undone when my parents' accountant died, a new accountant came in place, brought in an independent financial planner and he uncovered this financial charade that was going on."

Thankfully, and after many a TV interview, Robertson's parents were able to get their money back. Hundreds of the insurance agent's victims did not. 

"It's now the reason that independent financial advisers have to disclose the commissions they are paid," Robertson said. 

After witnessing the stress this insurance fraud brought to his parents' lives, Robertson realised he would need to become financially literate. And so, in the school holidays, he interned with his family's new independent financial planner. 

While it's a truism of investment markets that Value outperforms Growth over the long term, there will likely be some traps along the way. 

What is a Value trap? Well, this occurs when an investor values a stock and realises, thanks to its current share price and fundamentals, that it is valued at a discount. They buy the stock, looking forward to the rerate that is to come, but it never eventuates - perhaps because the stock later releases disappointing earnings, or because the fundamentals weren't as strong as they thought.

For example, a stock is trading at $2. On valuation, you realise it's actually worth $4. Cha-ching! You buy the stock, earnings come out and disappoint, you reassess your valuation and it's now worth $3. Thanks to the stock being sold off on that pesky poor result, it's now trading at $1.50. So, you buy more. After all, that's 100% upside! But yet again, it disappoints. Now, your valuation is $2, but the stock is trading at $1. Maybe you buy more, maybe it recovers to $2, but you never get your money back on your $3 or $4 valuation. 

"Part of the reason those Value traps exist is we think that you don't look for the right types of investment criteria," Robertson said.  

Instead of just focusing on undervalued businesses, Robertson and the Lazard team spend a great deal of their time identifying "economic franchises". 

"These are a universe of predictable, long-established businesses. Typically, they've got market-leading positions, high free cash flows, high margins, and manageable balance sheets," he said. 

"Now, when people talk about that type of business, you normally associate that with a Quality or Growth manager. What we dovetail into that is a fixation on valuation, and paying the right price for a business." 

After all, even the greatest business in the world can make a lousy investment if you don't pay the right price for it, he added. 

So what isn't included in this universe? 

Surprisingly, banks, insurers, energy companies and miners don't make the cut - typically staples in a Value investor's portfolio. 

"Banks operate in competitive markets, and they are highly subjected to managing the net margin, and credit growth. There's a whole range of factors that are quite difficult to forecast, and investors can easily make mistakes on," Robertson said. 

To identify portfolio opportunities, the Lazard Global Equity Franchise team start off with the MSCI World Index and filter it down to only include those businesses they would define as "economic franchises". This dwindles the investment universe down from more than 1500 stocks to just 250. 

"Essentially, the ones where the dislocation's the biggest, and where I think the value is well above where the share price is, that's what we own in the portfolio," Robertson explained. 

Stocks are typically chosen by the team thanks to the long-term ability to forecast their earnings, he added. 

"That's a stable return on assets, moderate gearing, and good margins," Robertson said. 

"We've got a proprietary criteria scoring system that we use to look at product lifecycle, industry structures, and leverage. We consider the environmental, social and governance risks. 

"But at its heart, our objective is simple identify businesses with more predictable and forecastable earnings and cashflows, thus making the job of valuation easier than many other businesses with much more unpredictable or varied potential outcomes. And then in determining what we own is equally as simple.”

In plain English - the bigger the difference between a stock's intrinsic value and its share price, the bigger position it will hold in the Lazard Global Equity Franchise Fund.

"You've seen the bond market and equity market moving in sync for the latter half of 2022 and early 2023, but have just all of a sudden started to diverge," Robertson said. 

"The bond market thinks there's a problem; the equity market thinks there isn't. And it's all because the Federal Reserve may pause on interest rates. And that might mean that we can go back to the days of the great modern monetary theory experiment. We don't think that scenario is plausible." 

Subsequently, of Lazard's 250 stock universe, the team only owns 25 stocks. 

"Not because we want to be punchy, but because they're the stocks that we think are attractively priced," Robertson said. 

"There aren't that many of them. 90% of our universe won't achieve the return objectives we want, which are greater than 10% per annum. And that's why we own 25 stocks. We would love to own 50, but we can't find 50 that offer a decent return." 

What does the portfolio look like? 

The Lazard Global Equity Franchise strategy has been running for a decade, and while some allocations are similar to those at the portfolio's outset, most have changed immensely. 

A few quick stats for you: 

• Today, 20% of the portfolio is invested in IT. A decade ago, 25% was invested in the sector. Back then, the portfolio held stocks like Oracle (NYSE: ORCL), Microsoft (NASDAQ: MSFT) and Intel (NASDAQ: INTC). Today, it holds positions in eBay (NASDAQ: EBAY), Cisco (NASDAQ: CSCO), Visa (NYSE: V) and Alphabet (NASDAQ: GOOGL).
• Today, 25% of the portfolio is invested in healthcare. This is the same as it was a decade ago. 
• Industrials exposure was 15% a decade ago, and is still 15% today. 
• In 2013, 15% of the portfolio was invested in consumer staples - they owned Coca-Cola (NYSE: KO), Kellogg's (NYSE: K), and Walmart (NYSE: WMT). Today, only one consumer staple stock is attractive. And it's a small position, it's Anheuser-Busch (NYSE: BUD), the biggest brewer in the world.
• 15% of the portfolio was invested in utilities in 2013, today the portfolio only invests in two stocks in this space. 

"We're trying to steer ourselves towards businesses that we think have economic moats around them so that you can make that call that in 15 years' time, this business is still going to be a market leader," Robertson said. 

"That is a big call, and it's one you are constantly going back to revisit." 

It's not what the bond markets are doing, or the volatility of equities markets, that should be keeping investors up at night. It's structural change, Robertson said. 

"If you go back 30 years ago, newspapers were a business that everyone thought was infallible. And the internet changed that. It didn't change overnight, it took longer than people thought, but today, newspapers are a dinosaur," he said. 

He points to a current portfolio position Medtronic (NYSE: MDT) as an example, an "800-pound gorilla of the medical device industry" which makes catheters, stents, defibrillators, and pacemakers. 

"If a pharmaceutical company comes up with a pill that reduces heart disease, that economic moat of 5,000 patents and billions of dollars a year in R&D could be under threat for Medtronic. So it's not infallible," Robertson said. 

"You've always got to worry about that black swan risk. And it's structural change for businesses.

"It's not that you will wake up one morning and the banking industry will be in crisis again. That's something you can't predict. That's a Rumsfeld unknown unknown. The known unknown is structural change, and that's what worries us." 

Learn more

Warryn invests in global listed companies which he considers to have an “economic franchise”, meaning companies which possess a combination of high degree of earnings forecastability and large competitive advantages. Find out more by visiting the fund profile below 

Managed Fund

Lazard Global Equity Franchise Fund

Global Shares

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