Manager of the Super 60-rated Premier Miton US Opportunities fund Hugh Grieves sits down with interactive investor’s Sam Benstead to discuss how he invests in the US stock market. He goes into detail about his investment approach, which involves identifying companies that can grow consistently – regardless of the macroeconomic backdrop – and then waiting for the opportune moment to buy them.
Grieves gives a number of examples of the “dull and boring” businesses that he loves to buy, and argues that investing in America’s giant technology companies will prove to be the wrong approach over the next decade.
Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Hugh Grieves, manager of the Premier Miton US Opportunities fund. Hugh, thank you for coming into the studio.
Hugh Grieves, manager of the Premier Miton US Opportunities fund: Pleasure.
Sam Benstead: So, could you please tell me how the fund invests?
Hugh Grieves: What we look to do is identify the very best companies in the US market and then we wait and we wait and we wait until the valuation reaches an unreasonably low level where, if we're wrong, we've got a good margin of safety. We're not going to lose a significant amount of capital. But if we're right, from that level, we get the benefit of significant earnings growth and multiple expansion for years and years to come. Then once the stock's in the portfolio, as I said, we hold it for years and years until either the investment thesis changes, which if you hold a stock for very long periods of time, can happen. Or alternatively, the valuation rises to an unreasonably high level, at which point you look at it and say does the risk-adjusted return from here really make sense? How much money could I make? This is how much money we could lose and kind of redeploy that capital into either a new opportunity where you get better risk-adjusted returns, or sometimes it's an existing holding in the portfolio, which you want to add to.
Sam Benstead: You invest in great businesses. How do you define a great business?
Hugh Grieves: What we're really looking for are businesses that generate increasing amounts of cash over time, regardless of the capacity, what the suppliers do, what customers do, what technology throws at it. This is a business that will generate increasing amounts of cash over time, and especially relative to the amount of cash that's actually inside the business to keep it running. We're looking for a business that can generate what we call free cash, a cash that's available to shareholders either to return in the form of dividends or buybacks, or to use for acquisitions, or to carry on investing in the business to maintain the growth.
Sam Benstead: And what themes or investment sectors does this approach lead you to?
Hugh Grieves: We don't pigeonhole ourselves into specific buckets of this theme or that theme, but the consistent message across the portfolio is this idea of companies that generate consistent and predictable cash flows over time, because those are businesses which, with a reasonable degree of confidence, we can model it, we can value it and forecast it. And those are the types of businesses that we want to concentrate on, where we have this confidence in the ongoing business.
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Sam Benstead: You can invest in US companies of all sizes, but you have a bias towards mid-sized companies. Why is that the best way of investing in the US stock market?
Hugh Grieves: Right. So it's not that we're avoiding them because necessarily they are bad companies. I mean, I'm not here saying Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) or Amazon (NASDAQ:AMZN) is a bad business. Sure, it's great market share, generates lots of cash, good margins, etc, etc. But when you look at the valuations of these businesses, they're incredibly high. And part of the reason they're incredibly high is because of what's happened to interest rates over past decades, which kind of peaks at the beginning of last year where we had these companies on very, very high valuations. Now, yes, those valuations have come down and a lot of these stocks are trading at a fraction of what they were trading at maybe two years ago. But the growth rates have also come down. Many of these companies were growing at 20, 30, even more percent per year, and now they're growing at 4%, 5%, 6% growth rates. And that's the nominal [pre-inflation] growth rate. So that's very pedestrian, very average, but the valuations are still very high and that's a big problem.
Sam Benstead: So are you more of a value investor then? Or is there an even split, say between growth and value shares in the portfolio? And could you give me some examples of those cheaper shares that you like to own?
Hugh Grieves: There's been a big change in pre and post-pandemic. Pre-pandemic we enjoyed this era of 20, 30, 40 years where inflation just kept on coming down, [and] interest rates kept on coming down. And when you're valuing some of these growth businesses where the cash flows are far into the future, the valuation today is very sensitive to interest rates. The valuations of those businesses just went up and up almost effortlessly as interest rates kind of came down. That world is over. We're not living in a world of low interest rates, low inflation, low nominal growth. We're now living in a very different era, but marked by the pandemic, where we're going to have high interest rates, higher inflation, higher nominal GDP growth. And so it's a very different set of companies that are going to perform well in today's environment as performed in the pre-pandemic environment. So, yes, that takes us more towards, if you like, value businesses. We tend to think through these more cyclical businesses, which is where most of the value is in the cash flow that's generated close to today rather than cash flows way far out into the distance that are vulnerable to a lot of uncertainty, inflation and higher interest rates.
Sam Benstead: And can you give some examples of those cheaper companies you own that should do well in this higher interest rate environment?
Hugh Grieves: So, [in terms of] examples of short-duration value cyclical businesses that we own, Vulcan Materials Co (NYSE:VMC) is one obvious one. It's the largest producer of aggregates in the US. It's quarrying rock, stone and gravel for construction. It's a great business because every quarry is basically a mini monopoly because you can only ship rock so far cost effectively. Another example would be Graphic Packaging (NYSE:GPK), which is part of a duopoly, almost duopoly. Manufacturing printed cardboard. I mean, it's a very dull and boring business. We love dull and boring businesses. It manufactures Kellogg's cornflakes' cardboard boxes and Starbucks coffee cups. But you're seeing this shift, which started in Europe, but is now beginning in the US, where we're shifting from plastic packaging to fibre-based packaging. And so you've had an industry which for years has had no volume growth. It's now starting to get volume growth again. And these companies are getting great pricing power on top of the volume growth, you're seeing great cash flow generation. And that's going to hopefully persist for some time.
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Sam Benstead: And these are mid-sized companies. Is that the best place to invest in the US markets?
Hugh Grieves: It's interesting when you look at the US market, it's very unique in some ways. It's very top-heavy, concentrated in the very largest companies. When you look at, say, the S&P 500, which is still the 500 largest companies out of 3,000, Apple and Microsoft together are worth more than the bottom 250 in the whole S&P 500. And that's where most fund managers following the S&P 500 type fund, their performance is gauged against the S&P 500, and that means really not 500 stocks, but actually the top 200 stocks which make up the vast majority of the index. And they ignore the other 2,800 companies that are below that, even though some of those are really great businesses. And it's not as though they're even tiny businesses. I mean, if these companies were in the UK, they would be FTSE 100, they would be FTSE 250 companies, but because of the way the fund management industry is structured, most fund managers are just drawn to the Microsofts, Apples and Googles, etc, which is why you keep seeing them appear in all these funds, which all look the same. The problem with these companies is once companies tend to get to the top of the S&P, they tend to be the most mature companies. And if you look back at what was in the top 10 of the S&P 10 years ago, it's very different today. If you're at 20 years ago, it's very different to the next. These companies tend to come up to the top of the S&P and then mature and fade away. The most exciting companies I find are the ones much further down because they've got the runway of years of future growth ahead of them. They're not the ones that are just cresting, reaching the peak of their maturity. And if you're going to hold companies for years, those are the companies which we really need to identify.
Sam Benstead: US shares have been out of favour this year and last year they've underperformed. They had a fantastic decade before that. Why should we still look to America for our investments?
Hugh Grieves: The reason the US did so well and then did so badly was a function of interest rates as [they] came down. The S&P 500 is very dominated by growth stocks, especially, you know, the FANGs that people are familiar with. The valuations of those companies went up to absurd levels. The index went up to a very high level and then it's rotates back again. And that's why we went up and why we went down. But more broadly, when you look at the US market and the US economy as a whole, the US economy is a great place to grow a business, and it's therefore a great place to be a part owner of a business, which is shareholders, that's what we are, we're part owners of a business. And I can't think of anywhere else in the world where I'd rather invest money because it's got the most business-friendly environment that creates these wonderful companies that we get the opportunity to invest in.
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Sam Benstead: Have you been very active over the past couple of years? We've seen this change in environments. So what have you been up to? Have you sought to profit from this new regime?
Hugh Grieves: So as I referenced earlier, we had this pre-pandemic world which was very much driven by rising interest rates and growth stocks did very well. We now live in this different world, which is going to likely persist for at least a decade. And the portfolio has changed through this period to reflect that change. We have very much shifted from, if you like, jam tomorrow-type companies where the most growth-like businesses, where cash flows are all in the future to, as I said earlier, much more businesses that are generating cash flows today and much more certain cash flows today and companies that tend to be much more cheaper and less vulnerable.
Sam Benstead: Hugh, thank you for coming into the studio.
Hugh Grieves: Thank you very much.
Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can like, comment, and subscribe. See you next time.
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