Future Quality Insights
Investment Insights from the Global Equity Team

February 2022

By Iain Fulton and Will Low

History rhymes
Have you ever stopped to imagine what would happen if the world’s central banks spent just over a decade pouring
USD 25 trillion of liquidity into the economy with more than 60% of that liquidity created in the last two years? If
you are like the overwhelming majority of people, the answer is almost certainly no. The good news is you don’t
have to imagine as this is exactly the situation we are in today! Take a step back, look around and see the results foryourself! In this article, we’ll try to assess what has happened and think about how investors should navigate thenext phase of the greatest financial experiment of all time.
USD 25 trillion is almost an unimaginable amount of money so what has happened to all of this liquidity? Well,rather inevitably, a lot of it has found its way into asset markets. The value of almost everything has gone up –considerably. From wine to whisky, growth stocks to digital gold, the returns to asset owners have been
extraordinary since the depths of the financial crisis in 2009. Younger generations have gone from occupying WallStreet to trading Bitcoin on margin and buying meme stocks on trading platforms as if it were a video game. Old
people “just don’t get it” and lack the imagination to see just how enormous the returns will be.
Make no mistake, there are many aspects of this that have the trappings of a bubble. This is nothing new. In late
1636 in the Netherlands, the Viceroy tulip bulb sold for four fat oxen, eight pigs or 12 fat sheep. As many bulbs
flowered in 1637, prices crashed and by early 1638, the government decreed that tulip contracts should be annulled
in return for the payment of 3.5% of the original price.

Source: Charles Mackay. Extraordinary Popular Delusions and the Madness of Crowds, 1841.

There are many other examples of financial speculation littered throughout history and interestingly several ofthese are also linked to technological innovation. Investors in railway bonds in the 19th century enabled theconstruction of vast networks in Europe and the US which enhanced productivity and had a huge impact on theway people lived and worked. Investors in railroads typically made little profit however, and most of the long-term

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Future Quality Insights

gains were arguably made by the businesses and people in cities which grew up as a result of their newly connected
status.
The dot-com internet bubble of the late 1990s had a very similar story at its heart. Investors in the companies who
built the internet networks and operated them thereafter either lost everything or made very poor long-term
returns. The real beneficiaries of the networks created in the bubble were businesses like Apple, Google, Facebook,
Netflix and Amazon*, who used those networks to sell us the products and services that meant we got the most outof them. They were effectively the hotel at the end of the railway line which stood to gain most from thepassengers arriving on the newly constructed network.
Is there a bubble today and if so, where is it and how will things pan out from here? The first thing that strikes us isinvestors’ very long-time horizons and the sheer number of companies who are forecast to make significant losses
for the foreseeable future. This is dangerous. The future is highly unpredictable, and far more things can happen
than actually will happen. For example, if you were asked in 1969 what would be the greatest innovation in 40
years’ time, you’d be forgiven for answering that humans would have colonised space and we would all be going on
holiday to Mars (given Neil Armstrong had just set foot on the moon). Instead, the reality in 2009 was that the Apple
iPhone was being rolled out which effectively placed the sum of all human knowledge in your pocket! We should
be wary of people selling us a version of the future based on science fiction rather than practical and applicable fact.
This unpredictability makes today’s stock market dangerous indeed. If a company is asking you to think 20 to 30
years out to generate an investment case, be careful! Especially if this business is forecast to make losses and burncash flow for the foreseeable future. The dramatic unwind we are seeing in markets is the first phase of these time
horizons shortening as central banks withdraw the liquidity which has fuelled such excess. US electric vehicle
company Nikola achieved a USD 35 billion market capitalisation with zero revenue!
Given the dangerous nature of speculative businesses with heavy losses which are burning cash, what should we dofrom here? For us, understanding the drivers of cash flows and the returns on investment being made by thecompanies we invest in is critical to the long-term health of our portfolio. By investing in businesses with strong
competitive advantages who remain disciplined around their capital allocation, we aim to find the next set of hotels
at the end of the railway line who will benefit from the new activities created by this latest bout of speculative
excess.
If lesson one is to avoid loss making, cash burning businesses chasing a pipe dream of market share and focus on
profitable companies with sustainable competitive advantage, what else should investors beware of? In our
opinion, lesson two is “beware the wolf of cyclicality wrapped up in the sheep’s clothing of growth”. The journeyfrom growth stock to value stock can be seriously damaging to your financial health. It strikes us that in industries
such as digital advertising, investors may be mistaking a maturing industry which has seen a pull forward of
demand for one which still offers enormous secular growth. As discussed, the pandemic saw an enormous amountof liquidity added to the system and many speculative businesses received funding and/or very high valuations
which they may not have otherwise. It’s worth noting that a good amount of these new companies’ costs (aftergenerous option packages for senior staff of course) are spent on IT infrastructure and services as well as digitaladvertising to gain market share. When you add in the pull forward of time spent at home/online for consumers in
the pandemic, it is perhaps no surprise that digital advertising in all its forms may face a more challenging outlook
over the next few years. (Not to mention the inflationary pressures many businesses face which will put pressure on
discretionary advertising budgets).

Navigating choppy waters
If we have established a few things to avoid, the obvious question remains around where are the opportunities? In
our opinion, there are many businesses which have been left behind from the speculative excess of the last two
years because their businesses have been negatively impacted by the pandemic in the short term. In the provisionof home nursing care and patient rehabilitation, companies such as LHC group and Encompass Health havesuffered from a dramatic rise in costs due to a shortage of nurses exacerbated by the need for staff to quarantine
following exposure or even potential exposure to COVID-19. As the pandemic ebbs, the staffing situation is
expected to normalise, and we see the companies benefitting from improving pricing as the Centers for Medicare
and Medicaid Services (CMS), a US federal agency that administers the Medicare programme, has passed*Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in the strategy’s
portfolio, nor constitute a recommendation to buy or sell.

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Future Quality Insights

reimbursement rates which begin to take account of these near term challenges. This should position thesecompanies for a better 2022 while many in the digital advertising industry may face exactly the opposite scenario.
A second area we feel remains underappreciated is in the provision of contract catering. Punished by the stringent
lock downs and a shift away from working in office locations, these businesses were forced to raise capital andadapt quickly to a very new reality in the pandemic. As it turns out, as healthcare providers, schools and universities
grapple with rising costs and labour shortages, it has meant that they are now outsourcing their catering operations
at a record pace and the pipeline of new business for a company like Compass has never been better. Also,
consumption at stadiums where the firm has many concessions is booming as people make the most of attending
live sports and cultural events which have been off the menu for two years. These businesses are reinvesting forstructural growth, but many investors perceive them to be too old hat to be interesting. Boring old improvements
in return on capital might be just the menu item investors should choose in what may continue to be a challenging
2022.

Valuation rationality and margin for safety
We have highlighted already in this article that we have been experiencing some speculative excesses within partsof the equity markets for some time and there have some clear parallels to historical bubbles. Our philosophy isfocussed on compounding clients’ capital over time rather than being slave to the shorter-term gyrations of themarket and as such we have always been focused on the following:•

Invest only in companies that can grow and attain and sustain high returns on invested capital are the bestsource of long-term superior returns. The path of sustaining, or even better improving, returns in capital tends
to be dictated most by an individual company’s unique franchise and its management team. In most cases
therefore the Future Quality investment case is not dependent on shorter term economic cycles.

•

Valuation is one of our key pillars, as the pricing of future growth can sometimes swing notably towards highpessimism or optimism and therefore justify either larger weightings or the exit of a position in favour of better
ideas.

The latter point has been more relevant for portfolios in the last 12-18 months, as we have been in a period wherevery easy monetary policy has encouraged investors to price future growth very generously. This has resulted in
reductions in some holdings or a complete exit on valuation grounds, with the proceeds being recycled into Future
Quality companies that have much better valuation support. We are comfortable paying a premium for companies
that deliver better and more consistent growth, can attain and sustain high returns on invested capital and havestrong balance sheets—but that premium needs to be appropriate and fair. The following history from styleanalytics shows that we have indeed stuck to that discipline.

Chart 1: Cash Flow Yield

Source: Style Analytics as at 31 December 2021

Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in the strategy’s
portfolio, nor constitute a recommendation to buy or sell.

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Future Quality Insights

Looking forward our best guess is that we have entered into an unknown period of tightening liquidity, with theevolution of supply related inflationary inputs and central bank responses remaining the dominant drivers for
returns from and within equities as an asset class. History would suggest that after an unwind from periods ofexcess the prior winners typically don’t retain leadership again. Given the lack of profitability of many companies in
the cohort that some have described as concept finance, this makes sense as over the long term the delivery of
cashflow and growth is the key determinant on share prices.
Chart 2 highlights that the growth versus value debate that is dominating many conversations is becoming lessimportant for most companies other than those with very high growth expectations. The path of future growth andprofitability will likely soon start to dominate again as the key driver for individual share prices once the current
period of unwind and rotation has exhausted. We believe our portfolio of Future Quality stock picks should be wellplaced when that day arrives.

Chart 2: Group Median Market Implied Yield (MIY) Spread vs Market

Source: Credit Suisse HOLT, Data date 2/4/2022. Universe: Top 2000 Global companies by TTM Market cap.
Market Implied Yields for Financial firms on the HOLT CFROE model are trimmed by 150 bps throughout this analysis to preserve comparability.

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4Future Quality Insights

Top ten holdings

Source Nikko AM as at 31 December 2021.
Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in thestrategy’s portfolio, nor constitute a recommendation to buy or sell. Any comparison to a reference index or benchmark
may have material inherent limitations and therefore should not be relied upon.

Strong ESG credentials* Underlying score is the MSCI ESG Quality Score, Carbon Footprint is Weighted Average Carbon Intensity Data supplied as
per the MSCI definitions. Fund is a representative account of the Nikko AM Global Equity Strategy. Benchmark is the MSCI
ACWI.
Source: MSCI ESG Research December 2021

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5Future Quality Insights

Global Equity Strategy Composite Performance to December 2021
Cumulative Returns October '14 to December '21
200%
190%
180%
170%
160%
150%
140%
130%
120%
110%
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%

188.2%

Sep-14
Dec-14Mar-15Jun-15
Sep-15
Dec-15Mar-16Jun-16
Sep-16
Dec-16
Mar-17
Jun-17
Sep-17
Dec-17Mar-18Jun-18
Sep-18Dec-18Mar-19Jun-19Sep-19Dec-19Mar-20Jun-20
Sep-20Dec-20Mar-21
Jun-21
Sep-21
Dec-21

107.7%

Nikko AM Global Equity

Nikko AM Gross Annualised Returns(USD) %All Countries World Index *Global Equity Strategy Composite

1 year
17.36

2 years
24.32

3 years
26.30

5 years
20.18

Since
Inception
15.72

All Countries World Index*

18.54

17.39

20.38

14.40

10.61

Excess Return

-1.17

6.92

5.92

5.79

5.11

*The benchmark for this composite is MSCI All Countries World Index. The benchmark was the MSCI All Countries
World Index ex AU since inception of the composite to 31 March 2016. Inception date for the composite is 01 October
2014. Returns are based on Nikko AM’s (hereafter referred to as the “Firm”) Global Equity Strategy Composite returns.
Returns for periods in excess of 1 year are annualised. The Firm claims compliance with the Global Investment
Performance Standards (GIPS ®) and has prepared and presented this report in compliance with the GIPS. GIPS® is a
registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it
warrant the accuracy or quality of the content contained herein. Returns are US Dollar based and are calculated grossof advisory and management fees, custodial fees and withholding taxes, but are net of transaction costs and include
reinvestment of dividends and interest. Copyright © MSCI Inc. The copyright and intellectual rights to the index
displayed above are the sole property of the index provider. Any comparison to reference index or benchmark may
have material inherent limitations and therefore should not be relied upon. To obtain a GIPS Composite Report, pleasecontact GIPS_inquiry@nikkoam.com. Data as of 31 December 2021.

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Future Quality Insights

Nikko AM Global Equity: Capability profile and available funds(as of December 2021)
Target return is an expected level of return based on certain assumptions and/or simulations taking into account thestrategy’s risk components. There can be no assurance that any stated investment objective, including target return,will be achieved and therefore should not be relied upon.
Past performance is not indicative of future performance. This is provided as supplementary information to theperformance reports prepared and presented in compliance with the Global Investment Performance Standards(GIPS®). GIPS® is a registered trademark of CFA Institute. Nikko AM Representative Global Equity account. Source:
Nikko AM, FactSet.
Available strategies

Global ACWI, Global EAFE, Global Developed, Global ex specific country, Sharia, Dividend

Available vehicles

UCITS-SICAV, Country domiciled mutual funds, unit trusts, investment trusts andsegregated accounts

Key Features of Global ACWICurrent Positioning

Investment Objective+3% vs MSCI AC World

No. of holdings

41

40-50

Active share

89.6%

90-95%

Cash

2.6%

0-3%

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Guidelines

7

Future Quality Insights

Nikko AM Global Equity Team

This Edinburgh based team provides solutions for clients seeking global exposure. Their unique approach, acombination of Experience, Future Quality and Execution, means they are continually “joining the dots” acrossgeographies, sectors and companies, to find the opportunities that others simply don’t see.

Experience

Our five portfolio managers have an average of 24 years’ industry experience and have worked together as a Global
Equity team for eight years. In 2019, two portfolio analysts, Michael Chen and Ellie Stephenson joined the team andthey are the first in a new generation of talent on the path to becoming portfolio managers. The team’s deliberate
flat structure fosters individual accountability and collective responsibility. It is designed to take advantage of thediversity of backgrounds and areas of specialisation to ensure the team can find the investment opportunities others
don’t.

Future Quality

The team’s philosophy is based on the belief that investing in a portfolio of Future Quality companies will lead tooutperformance over the long term. They define Future Quality as a business that can generate sustained growth incash flow and improving returns on investment. They believe the rewards are greatest where these qualities are
sustainable and the valuation is attractive. This concept underpins everything the team does.

Execution

Effective execution is essential to fully harness Future Quality ideas in portfolios. We combine a differentiated processwith a highly collaborative culture to achieve our goal: high conviction portfolios delivering the best outcome forclients. It is this combination of extensive experience, Future Quality style and effective execution that offers acompelling and differentiated outcome for our clients.

About Nikko Asset Management

With USD 282.5 billion* under management, Nikko Asset Management is one of Asia’s largest asset managers,
providing high-conviction, active fund management across a range of Equity, Fixed Income, Multi-Asset andAlternative strategies. In addition, its complementary range of passive strategies covers more than 20 indices andincludes some of Asia’s largest exchange-traded funds (ETFs).
*Consolidated assets under management and sub-advisory of Nikko Asset Management and its subsidiaries as of 31
December 2021.

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Future Quality Insights

Risks
Emerging markets risk - the risk arising from political and institutional factors which make investments in emerging
markets less liquid and subject to potential difficulties in dealing, settlement, accounting and custody.
Currency risk - this exists when the strategy invests in assets denominated in a different currency. A devaluation of
the asset's currency relative to the currency of the Sub-Fund will lead to a reduction in the value of the strategy.
Operational risk - due to issues such as natural disasters, technical problems and fraud.
Liquidity risk - investments that could have a lower level of liquidity due to (extreme) market conditions or issuerspecific factors and or large redemptions of shareholders. Liquidity risk is the risk that a position in the portfolio
cannot be sold, liquidated or closed at limited cost in an adequately short time frame as required to meet liabilitiesof the Strategy.

Contact us
EMEA – Nikko Asset Management Europe Ltd.
Level 5, City Tower, 40 Basinghall Street, London EC2V 5DE, U.K.
Phone:
Email:+44 (0) 20 7796 9866
EMEAenquiries@nikkoam.com

Important Information: This document is prepared by Nikko Asset Management Co., Ltd. and/or its affiliates (Nikko AM) and is for distribution
only under such circumstances as may be permitted by applicable laws. This document does not constitute personal investment advice or apersonal recommendation and it does not consider in any way the objectives, financial situation or needs of any recipients. All recipients arerecommended to consult with their independent tax, financial and legal advisers prior to any investment.
This document is for information purposes only and is not intended to be an offer, or a solicitation of an offer, to buy or sell any investments orparticipate in any trading strategy. Moreover, the information in this document will not affect Nikko AM’s investment strategy in any way. The
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9Future Quality Insights

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