Iain Fulton

The drivers of future returns on capital are shifting – as social and political change continues to create uncertainty – and investing in quality companies matters now more than ever before, says Iain Fulton, portfolio manager of Nikko AM’s global equities team.

“Many think of change in terms of technological and economic disruption.  While understanding disruption is clearly vital to understanding investment opportunities, it’s equally important to understand the prevailing social and political change that is occurring, as this also impacts on markets and returns,” he says.

Mr Fulton says that understanding popular sentiment around the world can help investors make better judgements about the quality of the companies they invest in.

“At the moment, the over-riding sentiment of the global “crowd” is anger – which is very unusual at this point of the cycle, with low rates and high employment.

“Ever-cheaper money has led to ever-increasing asset prices, and there is a perception by the many that this has only been of benefit to the few.  Low levels of real wage growth, an increasing cost of living, and high debt levels in the system overall has left many feeling they have missed out – even as markets and corporate profits accelerate to new highs. This is unusual at this point in the cycle, and more in line with what we might expect to be happening in the midst of a recession.

“Adding to this, with populist politicians in charge in several countries, the risk of policy error is clearly very high.  We are living proof of this in the UK, and the risks around trade and fiscal policies in other countries around the world seem fairly clear.

“For investors, this means that focussing on quality is vital.”

Mr Fulton says that the key is to find companies that are part of the solution to many of these environmental and social challenges.

“Identifying and investing in companies that are part of the long term solution gives investors the best opportunity for good returns on capital. 

“Companies that can continue to earn high returns on capital for a long time into the future are those with a strong competitive advantage, are gaining market share in a healthy industry, and are not themselves financially stretched.

“Most importantly, their profits need to be sustainable over the long term and the company itself needs to be able to thrive in an environment of increasing uncertainty.

“While fund managers have always spent a great deal of time trying to understand the balance of power between suppliers, employees, customers, shareholders and the firm, the best businesses realise that they need to provide value to all of these stakeholders.  And this includes secondary stakeholders like regulators, governments, consumer groups and the media, which are becoming increasingly important.”

Mr Fulton points to the example of Kraft Heinz.

“Following the merger of Kraft Foods and H.J. Heinz in 2015, the business adopted the classic strategy of cost cutting its way to higher profits and improved returns on capital.  In the process, it neglected its employees by overly aggressive cuts and neglected its customers with a lack of innovation and reinvestment.  The outcome has been poor returns and a falling share price. 

“Contrast this with Unilever which disposed of traditional assets like margarines and reinvested in brands with purpose that do the right things ethically. It is seeing good returns on capital and strong share price performance.

“Businesses need to make profit but they can (and should) do it in ways which create value for all stakeholders.

“To remain high quality in the future, management of firms need to get the balance right between stakeholders and shareholders.  This is the best way to survive and thrive in the changing social and political environment which lies ahead,” Mr Fulton says.

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