Investors have been expecting a swift rebound in earnings from the overall stock market during 2021, after coming off from a depressed base during the 2020 coronavirus pandemic.
But if the overall market is on track for stellar growth in 2021, the question is how it will fare in 2022 after such a high hurdle has been set?
Comgest’s Laure Negiar said: “We think it's going to be interesting to see how the benchmark does after such a strong year in 2021.”
Negiar, who manages the £931m Comgest Growth World fund, said history suggests the market cannot post double-digit earnings growth year after year.
She pointed out that the overall stock market – as represented by the MSCI AC World index – has historically delivered only mid-single digit earnings growth on average.
For the full year 2021, the market expects the MSCI ACWI’s earnings growth to be around 30% coming from last year’s 15% earnings slump.
Negiar thinks her companies will still be able to deliver double-digit earnings growth, but she doesn’t believe that to be the case for the benchmark.
“Expectations for the benchmark for 2022 is roughly 8% earnings growth,” she said. “We would put a question mark next to that 8% - it’s a tall order off 2021.”
Performance of MSCI ACWI over the past 2yrs
Source: FE Analytics
“In the broader benchmark there are companies that have really big troughs - typically during the economic recession times,” Negiar said.
“To get out of that hole you need a serious boost and it's very hard to catch up the companies that just continued to creep their earnings slowly but surely.”
When a company’s earnings dramatically drop – because of a recession or a pandemic for example – even if it recovers at a sharp pace, the company that had less of an earnings decline will rebound off a higher base.
“It is also unlikely the two companies will ever meet again on their upward trajectory,” Negiar added. “It's so hard for companies to catch up. It's not about the normal years - it's about the really bad years where then the catch up is so hard to do for the non-quality companies.”
The importance of slowly creeping up earnings can be seen in the performance of the MSCI ACWI Quality index – which tracks the performance of quality growth stocks identified by high return on equity, stable year-over-year earnings growth and low financial leverage.
It has comfortably beaten the broader MSCI ACWI index for the past 20 years.
Performance of MSCI ACWI Quality index versus MSCI ACWI index over 20yrs
Source: FE Analytics
Part of the reason why the simple quality screen enables outperformance is down to the consistency of earnings, Negiar explained.
“With quality comes consistency of earnings delivery. You're really just building on those consistent earnings over time,” she said.
“Studies suggest, and certainly we believe from our 30-year track record, that over the very long term the compounding of your fund should roughly equal the compounding of the earnings growth of the underlying holdings.
“The caveat is provided you don't buy the stocks at outrageously expensive prices, because then you risk a derating which annihilates the earnings growth.”
If a simple quality screen can outperform the index, then why don’t investors just buy a vehicle that tracks the quality index? One problem is that the benchmark is inherently backward looking.
“The benchmark tells you what has been successful in the past, it does not help you to look forward,” Negiar said.
“In 1987 if you'd been a global fund manager and you were just tracking the benchmark - you would have put 45% of your fund in Japan and 30% in the US.
“Fast forward 10 years and you're at 60% US and 7% Japan.
“You probably would not have been super happy following those weights because it told you what had done well in those prior 10 years, which is never the same as the next 10 years.”
At a more stock-specific level, Negiar highlighted American pharmaceutical firm Eli Lilly as an example of a firm that a simple backward-looking quality screen would have missed out on.
“When we bought Eli Lilly in 2017 people did not think it was a dynamic grower,” Negiar recalled. “They thought it was over. It had had a few bad years and they thought the growth was no longer there. They also thought the quality wasn't great either.
“Well, low and behold, it has been a 22% earnings compounder, super nice margins and nice profitability - it just had a lull.
“It clearly wouldn't have been included in benchmarks on quality and growth characteristics for its prior five years - but it has been an amazing stock over five years.
“It's very hard for quantitative, backward-looking detection to figure out those inflection points - which is where you can make a lot of money.”
Performance of fund versus benchmark over 5 yrs
Source: FE Analytics
Over the past five years, Comgest Growth World has delivered a total return of 101%, compared to 86.5% from the MSCI ACWI benchmark and 85.4% from the IA Global sector average. It is ranked top quartile in terms of performance over the five-year period.
It has an ongoing charges figure (OCF) of 0.91%.