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Stable, compounding returns: the ideal core of a portfolio

Macroeconomic events may have caused headlines about market volatility in the last year, but swings in global equities were largely driven by style factors. The unpredictability of these two elements is why we consider the fundamentals of stocks, rather than investing on the basis of sentiment or style. Our long-term outlook, emphasis on diversification and compounding returns make the Hermes Global Equities Fund a suitable core for a broader portfolio.

With macroeconomic events such as the vote for Brexit and the election of Donald Trump dominating conversation and turning economic sentiment negative in 2016, investors would be forgiven for thinking that global equities suffered a tumultuous year. However, markets followed a largely upward trajectory, despite persistent uncertainty for various economies globally. Instead, style factors were more influential on the markets than macroeconomic risks. These outcomes showed the folly of trying to forecast market returns on the basis of sentiment.

At Hermes, we take a long-term view on stocks and consider their fundamentals as the most persuasive indicators of future performance. This perspective enables us to avoid the pitfalls of concentrating on the macroeconomic climate and predicting the direction of markets when making investment decisions. Focusing on stock fundamentals has, time and again, proved to be a more rewarding approach: in 2016, the Hermes Global Equity Fund outperformed the MSCI World Index by 1.8%1, its eighth consecutive year of outperformance.

Focusing on the fundamentals
While it is hard to judge the direction the market may take, it is easier to assess companies and find those that are more likely to perform well in various conditions. We look for stocks with the most attractive combinations of fundamentals and which are trading at appealing valuations. These fundamentals include robust financial statements, competitive advantages and high-quality management teams.

Responsible returns
Another core component of our approach is the importance we place in the environmental, social and governance (ESG) characteristics of the companies in which we invest. Over the years, we have collected and collated extensive proprietary data, through our engagement and stewardship services team Hermes EOS and our proprietary QESG Score, which has shown that companies which perform poorly in ESG terms also generate poor financial returns. As a result, we consider a company’s ESG characteristics as key reflections of its quality. We also monitor the trend of a company’s ESG performance, as improving characteristics could signal a stronger stock price in the future.

Deliberate diversification
We also emphasise diversification in our investment process. By investing in fundamentally strong companies across a diverse range of industries, stock selection drives our returns instead of factor exposure. This helps to defend the portfolio against any sudden shifts in market sentiment, such as the volatility seen in the first half of 2016 as the oil price rebounded. We are also style agnostic, focusing on stocks that can succeed in a range of investment environments, which helps to protect the portfolio from large style swings.

Recognising risk
Although we do not prioritise macroeconomic impacts when considering investment opportunities, we do appreciate that such events can pose significant top-down risks. In response to this, we built our proprietary risk-management system, MultiFRAME, which reflects how the Fund may respond to different market environments. This allows us to mitigate the most potent risks and ensure our portfolio survives periods of instability, as it has repeatedly since it was launched in 2008. For instance, when Japanese Prime Minister Shinzo Abe announced his “three arrows” policy, our model quickly flagged the portfolio’s exposure to the falling yen, prompting us to add Japanese exporters.

Long-term view for long-term return
One of the most essential aspects of our investment philosophy is our emphasis on long-term performance. We believe that stocks with strong fundamentals outperform over the long term, regardless of market behaviour, although we use diversification to protect the portfolio from the most severe short-term swings in sentiment. In order to achieve long-term outperformance, we aim to beat our benchmark by small increments in each quarter, with these gains compounding over time. As a result of this approach, the Fund has outperformed in 73% of quarters since launch.2 Our long-term focus is also reflected in our low turnover, which averaged 23% per year for the three years to March 2017.

At the core
The combination of diversification, our emphasis on fundamental strengths, our focus on companies with positive ESG profiles and our target of achieving incrementally compounding returns makes the Hermes Global Equity Fund an appealing and consistent core exposure for a broader portfolio. The Fund’s wide-ranging exposure allows it to adapt to changing market conditions. Its style agnosticism is particularly important: even when diversified across regions and sectors, funds with a style bias can be caught out when that style is no longer in favour.

Finding the good in global equities
Amid continuing macroeconomic and financial-market uncertainty, it is clear that basing investment decisions on short-term trends is unlikely to succeed. Instead, we focus on investing for the long term in a diverse range of companies with fundamentally positive attributes, which should make them resilient performers whatever the current profile of the market. By seeking incremental outperformance that compounds over the long term, the Fund can be deployed as a valuable core equity exposure.

  1. 1Performance shown is the 1 year gross performance of the Hermes Global Equity Fund as at 31 December 2016 calculated on a geometric basis. Past performance is not a reliable indictor of future results.
  2. 2Performance shown is the Global Equity Fund USD gross of all costs and management fees as at 31 March 2017. Past performance is not a reliable indicator of future results. Inception date: 05 December 2008.

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