Largely, the appeal of thematic funds has been in the simplicity and logic of the investment proposition – easy to explain and easy to understand.
However, many investment funds that have taken this path have been disappointed, in part due to the complexities involved with macro economic models regularly used in this approach.
It is possible to take a different investment approach.
The starting point should be the application of fundamental research at the company level.
As with us, this typically leads to a portfolio dominated by four or five investment propositions, represented by 20-35 stocks.
But this raises the question: how can fundamental stock picking lead to such a thematic portfolio?
Historically, we have looked closely at markets to isolate simple investment ideas which can be applied across an industry and then replicated globally in various economic jurisdictions.
First, we invest in good businesses at a time when their share price is at a significant discount to their long-term valuation.
Typically this means investing at a time when there is negative short-term news at a macro, industry or company level.
When a business’ share price trades at a significant discount, it often points to a broader industry-based issue.
The connected nature of global markets means on many occasions this has led to the discovery of other similar investment opportunities.
One example of a global thematic idea stemming from the bottom up, which we can comment on from first-hand and ongoing experience stretching back 12 years is, the global brewing industry.
Being a dominant brewer within a specific geography can be a wonderful business.
Consistent demand and an ability to raise prices in line with inflation can create a cash machine.
As keen observers would know, this industry has transformed dramatically over the past 15 years, from a period of flat returns due to poor expansion efforts in the 1990s.
By the early 2000s, many firms had acquired beer assets (mainly in Eastern Europe) for high prices and with significant debt on their balance sheets.
They were unable to manage the excessive costs out of the businesses they had acquired, which in turn had stilted earnings growth.
In fact, many of the beer stocks corrected up to 50 per cent, which created the initial buying opportunity.
The majority of these companies were family-controlled. So post the correction they restructured management and implemented an owner-operator approach.
This new structure successfully incentivised executive teams to reduced costs, increase free cash flow and reduce debt.
Our strategy over the succeeding years was to focus on a duopoly beer structure in a given region, with intent to purchase a business, once its price had declined to around 12 times earnings or lower.
The view was that this earnings multiple threshold indicated that investors had given up any expectation of meaningful earnings growth.
Contrary to this consensus at the time, our assessment indicated that the new owner-operator structure should allow these companies to buy out the best assets in the market and improve earnings over time.
Hindsight reveals their success in achieving this goal.
The end game: global duopoly
Over the last decade, the brewing industry has evolved from a very local trade and continues to move towards the endgame of a global duopoly. This trend has continued to result in global sales being dominated by just three firms: AB InBev, SABMiller, and Heineken.
Anheuser-Busch InBev is now the dominant player in the beer market with around 30 per cent global share.
The three majors combined now account for more than more 60 per cent of global market, up from just 20 per cent a little over a decade ago.
We have been active, patient and successful in this industry globally during this period implementing the above thesis.
The connected nature of global markets means the concept of bottom-up thematic investing is not an isolated opportunity.
It’s all based on selecting that one simple investment idea that can be applied across an industry and then replicated globally in various economic jurisdictions, subject to favourable entry prices.
Property, banking, futures and stock exchanges are other cases where we continue to implement this philosophy.
PM Capital will continue to act on ‘bottom-up’ investment opportunities as we encounter them.
Paul Moore is the chief investment officer and founder of PM Capital.
