What "quality" means to these stock pickers - and a handful of ideas for you to consider

Earlier in the week, Livewire attended a panel session in Melbourne hosted by Genevieve Frost from Netwealth, which featured Claremont Global’s Bob Desmond, Fairlight Asset Management’s Abbey Cook, and Pzena Investment Management’s John Goetz.

The session was titled A Long-Term Lens on Global Equities: How to Future Proof your Portfolio.

It was a rollicking session that addressed some big ideas and had the audience fully engaged. Below is a summary of the major themes and key points.

A question of quality

The conversation started with how each guest defines “quality” and what it means in today’s markets.

Bob Desmond of Claremont Global emphasizes a highly selective approach, managing a focused portfolio of 10–15 stocks with a goal of 8-12% annual returns.

“We don’t take macro bets or thematic bets; we are totally bottom-up stock pickers,” Desmond explains, highlighting Claremont’s commitment to stable, predictable businesses with solid earnings.

Quality for Desmond means “predictability of the earnings, predictability of the competitive advantage of the business,” alongside high margins, strong balance sheets, and dependable management teams. His approach aims to “sleep easy at night,” prioritising consistent, reasonable growth over speculative gains.

Abbey Cook from Fairlight Asset Management also operates a focussed strategy. Cook's portfolio has 30–40 stocks in it and is exclusively made up of small and mid-cap companies outside Australia and New Zealand.

Cook outlines Fairlight’s “CROCI” score (Cash Return on Capital Invested) as a quantitative benchmark for quality, requiring a business to achieve a 15% return over five years. This rigorous criterion is critical, given that in Cook's view, over half of the small and mid-cap index is “junk.”

This specificity enables Fairlight to identify high-quality opportunities which has allowed it to generate “290 basis points of alpha per annum” over six years. This fund's investment strategy also avoids banks and resource sectors, offering what she calls “a differentiated approach” for Australian investors.

John Goetz of Pzena Investment Management brings a value-oriented perspective, having pioneered a “deep value” strategy 30 years ago.

Goetz describes his approach as “grossly underpaying for a good business,” targeting the cheapest 20% (first quintile) of stocks using a proprietary screen.

According to Goetz, value often involves finding “good businesses selling at low prices” due to temporary setbacks or shifts in investor sentiment.

“Even good businesses can sell cheaply when something bad has happened,” he explains, citing Pzena’s ability to buy strong names like GE and Alibaba at significantly lower prices after market corrections.

The key, he says, is to discern between “temporary or permanent” issues, avoiding stocks with long-term structural problems. Goetz’s approach to quality involves patience and timing, buying when the market is pessimistic but when his team sees durable long-term value.

China as an investment destination

Desmond explains that Claremont avoids direct investments in China due to limited local expertise.

“We’re just not experts. That is not our circle of competence,” he says, pointing to China’s unique political and cultural complexities.

Instead, Claremont Global favours developed markets and high-quality global companies with a presence in China, like LVMH (EPA: MC), which it previously owned.

Desmond screens out cyclical and leveraged industries, including banks and commodities, and avoids sectors where “things are complicated and fast-changing,” like semiconductors and biotech.

The portfolio focuses on “five sleeves”: financial services like Visa (NYSE: V), “tech staples” such as Microsoft (NASDAQ: MSFT), business services, niche industrials, and healthcare. These choices ensure stability and “predictability in customer relevance” over five years.

Cook shares a similar conservative approach, noting that they avoid emerging markets, including China, to minimise fundamental risk.

She explains that Fairlight’s screening process excludes high-risk sectors, such as property trusts and infrastructure, which can be highly leveraged. This approach ensures Fairlight’s portfolio of 30-40 companies consists of “the best operating businesses in the world” that don’t rely on leverage to deliver returns.

Ideal investments are found in specific sectors: niche technology and business services (with 95%+ customer retention rates), healthcare, light industrials, and occasionally consumer and media, though these require a “much higher bar for quality.”

Cook states that their careful sector focus allows them to filter down from 5,000 companies to a manageable 200-250 high-quality choices, well-suited for a small team of five analysts.

The strategy provides robust risk management and high-quality investment options without needing to venture into emerging markets like China.

AI’s impact on investment strategies

In this discussion, the panel shared their perspectives on how artificial intelligence (AI) influences investment strategies, especially in relation to technology and market valuation.

While they generally agreed on AI's significance, they differed in their approaches to investing in AI-related companies, particularly tech giants like Microsoft, Alphabet (NASDAQ: GOOGL), and Amazon (NASDAQ: AMZN).

Goetz: Caution amid AI hype

Goetz emphasises caution when investing in companies heavily associated with AI. His strategy at Pzena involves capitalising on undervalued stocks affected by "fear and uncertainty," rather than riding the wave of popular trends.

"We’re fishing in the downtrodden, not in the optimistic part of the market,” Goetz explains.

Stock picks: His team focuses on finding companies where AI may be misunderstood as a threat rather than an advantage. Goetz’s firm previously invested in Microsoft during a period of low investor confidence but sold after the share price doubled.

He expressed concern that tech companies are overvalued now due to the hype around AI, which may not yield the financial returns investors expect.

“When AI hope is embedded in the valuation, it’s not going to show up in the first quintile,” he notes.

Although Goetz sold Microsoft once it hit “normal valuations,” he highlights how inflated valuations driven by AI excitement now create risks in identifying winners.

Examples of cautious AI investments: Goetz mentions Teleperformance (EPA: TEP), a call centre outsourcing business whose stock price dropped after concerns arose that AI might replace its services. Despite AI’s potential threat, he sees Teleperformance's adaptability, such as integrating AI solutions for clients, as a misunderstood advantage.

Goetz contrasts his cautious investments with highly capital-intensive companies like Nvidia (NASDAQ: NVDA), where he anticipates high valuations could become unsustainable as capital inflows into AI-related sectors intensify.

Desmond: AI as “icing on the cake” for established giants

Desmond also holds a conservative stance but approaches tech giants perhaps more optimistically.

Claremont Global owns Microsoft, Alphabet, and Amazon, but not due to AI: 

“We own them not because of AI...AI is not built into our numbers or our earnings forecasts; it’s icing on the cake for us" says Desmond. 

He views AI as enhancing the value of established market leaders with existing competitive advantages. Desmond shares Goetz’s caution about inflated capital expenditure in tech, however.

He acknowledges AI could improve the market dominance of companies like Microsoft by embedding their services more deeply in customers’ operations, but he warns against overestimating AI’s financial impact.

Desmond cites the book Devil Take the Hindmost by Edward Chancellor to illustrate historical trends where inflated capital investments, like those in AI, lead to diminishing returns as competitors crowd the space.

He sees similarities between today’s AI boom and past speculative bubbles, such as the dot-com bubble, warning that increasing capital expenditures on AI infrastructure could mirror previous booms that ultimately left investors with little return.

Cook: indirect AI exposure through value-added distributors

Cook takes a different approach by investing in technology distributors rather than the major “hyper-scalers” like Microsoft, Alphabet, or Amazon.

Her strategy involves indirect exposure to AI through companies providing value-added services, which she finds to be more adaptable and aligned with Fairlight’s focus on mid-market companies.

Stock picks: Cook mentions investing in value-added resellers, or “VARs,” who serve as intermediaries between tech giants and small-to-medium enterprises (SMEs). This exposure includes firms like Reply (MIL: REY), an Italian IT consultancy that helps SMEs integrate AI technology.

Cook explains that AI poses a complex landscape for smaller companies, and her investments in firms like Reply aim to provide SMEs with the expertise to navigate these changes.

“We find that’s a really fantastic way of exposing ourselves to some of these trends,” she explains.

Nuanced views on tech giants and AI’s long-term value

The managers offer nuanced views on the role of tech giants and AI’s long-term financial potential:

• Goetz maintains scepticism, highlighting the risk in companies like Nvidia and Microsoft, where inflated valuations rest on AI’s potential rather than established earnings. He warns investors to avoid over-reliance on AI growth predictions, particularly as excessive capital flows into the industry: 

“Not everyone’s a winner...so we’re not going to try to handicap the winner of the arms race," says Goetz.

• Desmond is cautiously optimistic, viewing AI as a value-add for companies like Microsoft and Alphabet, which already have robust market positions. However, he aligns with Goetz’s broader concern about AI hype inflating tech stock prices unsustainably.
• Cook offers a unique perspective by sidestepping the hype around tech giants entirely. Instead, she invests in companies providing AI-related consulting and distribution services for SMEs, targeting indirect benefits from AI while avoiding high capital risk.

The role and impact of ESG

Goetz emphasises a pragmatic approach to Environmental, Social, and Governance (ESG) factors within his firm’s value-oriented investment strategy.

Despite not branding themselves as ESG-focused, Goetz underscores that “ethical considerations” are integral to their investment process.

Managing over $70 billion globally, his team targets undervalued companies, often navigating the challenges created by governments, industries, or company-specific issues.

“Governments are a super big deal,” he explains, using China as an example where shifting government policies have significantly influenced valuations compared to markets like India.

Goetz’s approach to ESG is centred on gradual improvement rather than strict adherence to high ESG scores.

In Europe, where ESG regulations are more stringent, he notes that his team integrates ESG by focusing on companies willing to make positive changes, even if they currently score poorly in ESG criteria.

“What we want to know; is the ball going to get moved in the right direction?” he says, adding that they evaluate whether management teams are committed to long-term sustainability, especially in traditionally “hated” industries like steel, provided they show intent to reduce carbon emissions.

Audience Q&A

In response to an audience question on factors driving market “destruction,” Goetz discussed how government, industry, and company issues impact investments and how these factors shift over time.

Goetz reflected on historical trends, such as the dot-com boom, where “old economy” stocks like Ford Motors (NYSE: F) were undervalued relative to their e-commerce ventures, creating investment opportunities in basic materials. Similarly, during COVID-19, energy was “on death row” but has since rebounded.

Goetz highlighted China as a key area of current market volatility, with anti-China sentiment driving U.S. pensions to reconsider Chinese investments, although he noted that indirect China exposure through companies like Apple remains significant.

“Apple is massively exposed to China, both on the sales side and on the sourcing side,” he observed.

Goetz also pointed to U.S. healthcare as an area of investor concern, with questions arising around pharmaceutical advancements and treatments like Ozempic.

Reflecting on changing investor sentiment, Goetz summarised, “Perceptions change,” highlighting Europe’s energy crisis and the rise of AI as significant new themes in today’s market landscape.