Uncorrelated bets and resilient returns

I’m sure you’ll get NVIDIA, the AI chip leader, which tops the list. You’ll probably also guess its other giant US tech stock peers, such as Apple and Amazon, which make the top five and the rest of the Magnificent Seven, Tesla, Alphabet, Microsoft and Meta, which all make the top 1 per cent by returns. 

All seven, to varying degrees through those 20 years, share the hallmarks of the archetypal growth stock: exponential return, a tech-driven growing end market, rapid revenue growth, a mercurial founder or leader and a pricey historic valuation. 

However, if you guessed all the winners were futuristic growth stocks, you’d be dead wrong. 

Despite two decades of digitisation and technological progress, many seem much more grounded in the past. AutoZone has delivered a 42 times return from selling car parts. Sherwin-Williams, a 31 times return from paint. Cintas, a 27 times return from uniforms and cleaning supplies. 

Each of these disparate businesses has delivered returns that are many multiples of the five times you would have earned by investing in the index over the past two decades. More significantly, these three are also comfortably inside the top 1 per cent of returns from index constituents, alongside (and in some cases ahead of) the returns delivered by the seven famously magnificent US technology stocks.

All these winners may have operated in decidedly different areas, but they all have had one thing in common: the ability to multiply their earnings. It is just that they’ve done this in very different ways.

The 20-year sampling above underlines our strategy’s core beliefs: first, earnings growth drives return, and second, great growth companies come in many forms.

The practical implications of this second belief go far beyond ensuring we don’t miss the winners. It enables us to remain reward-seeking growth investors and construct a portfolio that delivers across a range of different market environments. 

In the concentrated market rally over the last two years, it has been easy to view diversification as sacrificing returns: for us, it is resilience and strength. 

It provides a basis for a stronger portfolio, but it also makes us better investors through the lessons learned from investing across the entire growth spectrum. 

All are as important now as they have ever been to navigate a skittish market backdrop rife with uncertainty about what happens next. 

Uncorrelated bets

Global Alpha’s historic winners tell a similar story to that of the index. Yes, companies such as Amazon and electric vehicle leader Tesla top the list, but companies as idiosyncratic as Atlas Copco (industrial pumps), Moody’s (financial ratings), and CRH (concrete) make the top 10, and Richemont (jewellery), Elevance (health insurance) and Schindler (elevators) make the top 30 as shown below. 

We believe it’s the combination of these diverse companies in the portfolio that has given it a strong foundation. 

Global Alpha's top 30 returning stocks by absolute return since inception

Take Amazon and AutoZone, which are two current holdings.

Amazon’s success has been built on its incredible determination to win in a series of growing markets. Amazon weathered a dot com boom and bust that almost drove it to bankruptcy and intense competition to build a formidable logistics network in ecommerce.

It also expanded into cloud computing (Amazon Web Services), video streaming (Prime Video) and advertising. The share price ebbed and flowed through each demand cycle, leading to frequent stomach-churning drawdowns of 25 per cent or more.

AutoZone’s growth is built on something entirely different: steady growth in an established market.

Both do-it-yourself warriors and professional mechanics buy AutoZone’s parts to repair cars. It has tapped into this demand to double its store count over the last 20 years to over 7,000, while also delivering strong same-store sales growth that has improved returns.

Importantly, its growth is relatively economically insensitive, as you can only put off repairing your car for so long. This doesn’t mean AutoZone has not seen drawdowns in its history, but they have been more gentle and often uncorrelated with Amazon’s product cycle.

This is why, when we consider adding a new holding, we ask the explicit question: ‘What does this add to the portfolio?’.

Companies aren’t viewed in isolation. We’re looking for those that meet our high bar for entry but also bring something different to the portfolio. This provides more uncorrelated bets and more paths to growth.

As the tools we use to assess how differentiated a company is from the rest of the portfolio improve, so does our ability to utilise them to our advantage.

Amazon and AutoZone share price

Correlation mapping

The correlation mapping tool developed by our risk team is one example of an improved input into our portfolio construction process. This tool assesses the extent to which each company’s stock price moves relative to another. 

The output, as shown below, is a map of companies in the portfolio that have some level of active correlation. The nearer each company is to another, the higher the level of correlation. 

This map allows the investment team to see several clusters of holdings, some obvious, such as semiconductor companies, and some not, such as outdoor goods brand Yeti’s correlation with landscape supplies company SiteOne. 

These clusters can also be used to test the portfolio against certain scenarios and to assess the correlation of new holdings.

Arguably, more revealing than the map itself is the over 40 per cent of holdings it doesn’t show, ie, the ‘diversifiers’. 

This list includes companies such as Japanese discount drug store Cosmos, Brazilian fintech Nubank, or US funeral business Service Corp. 

Each has its own distinctive growth drivers that add differentiated characteristics to the portfolio overall.

Global Alpha portfolio active correlations

Flavours of growth

Categorising this diversity of growth into groups provides a helpful model to aid portfolio construction. The framework we use is our three growth profiles: Compounders, Disruptors and Capital Allocators. 

Compounders, such as AutoZone, are often durable franchises with robust profitability that grow steadily over time. 

Disruptors, such as NVIDIA, are fast-growing innovative companies challenging incumbents in existing markets or creating new ones. 

Capital Allocators, such as building supplies company CRH, have structural trends underpinning their growth, but are more sensitive to the economic cycle, and they have excellent management teams to capitalise on it. 

The market inefficiencies we look to exploit and the characteristics of companies in each profile are different. This means they serve as useful complements to one another. 

Since we started using them in 2009, each category has shown strength in different periods to help the portfolio navigate an evolving environment. 

When economies were recovering from the GFC from late 2009 to mid-2013, Capital Allocators outperformed the market in over 80 per cent of quarters. 

From that point onwards over the next five years, technological change drove the Disruptors to outperform in 85 per cent of quarters. 

Compounders, true to the profile’s name, have delivered more consistent and regular returns over the last 16 years.

In the past, we have sought to utilise this complementary performance to our client’s advantage, leaning into certain profiles. 

Compounders’ consistency means they provide a source of funds when markets are fearful, while Capital Allocators can deliver accelerated returns during economic or industry recoveries and Disruptors in periods of strong growth. 

However, we’ve also learned through experience that maintaining an appropriate balance in the portfolio is vital. 

We were reminded of this in the post-pandemic inflationary period, where our overexposure to Disruptors, just as their valuations fell, led to a level of capital loss that our portfolio should be set up to avoid. 

The controls we have introduced for our risk profiles and improved portfolio construction and monitoring tools following this period will ensure we won’t make the same mistake again.

Most importantly, combining the triad of profiles has provided more consistent returns than each alone. 

Since their formation in 2009, the portfolio has outperformed the market for more quarters than each individual profile. As a portfolio construction framework, this proves they have been both valuable and effective. 

Outperformance rates by growth profile

Seeing patterns where others don’t

Valuable lessons also come from our patient ownership of these distinct companies. This has granted us a ringside seat to see companies ‘grow up’ and often, with that, graduate from one growth profile to the next. As they do, so do our expectations. 

As a company matures, its growth may slow and with it the potential upside, but the consistency and quality of returns should rise, as should our assessed probability of its success. 

For Instagram owner Meta and Amazon, this is exactly where the companies stand today, which has come with sometimes painful, heightened regulatory scrutiny and shareholder return expectations. 

What we’ve learned about the enduring edge of a company such as Mastercard can be incredibly useful here to put each case into context. 

The same is also true of the reverse. Amazon’s impressive rise to dominance is rich with insights on the future potential of more nascent ecommerce platform holdings, MercadoLibre, Sea and others that don’t make the cut. 

Our breadth of investment experience over the last two decades also means we can see changes emerging before they are obvious to all, and importantly, before the valuation of the shares inflects upward. For example, in identifying ‘emerging quality growth’ characteristics. 

These are companies set to see their prospects improve through a combination of cyclical recovery, changes to industry structure or management behaviour. This has been a rich hunting ground for our team in the past. 

Royal Caribbean Cruises was the poster child for this change during our holding period from 2012 to 2019, where a continued economic recovery, tighter cruise capacity, and a focus on returns led to a 400 per cent return in seven years.

We saw the same story play out successfully in chip testing (Teradyne), aggregates (Martin Marietta) and health insurance (Elevance). 

Recent additions to the portfolio, such as power chip maker Onsemi and portable storage space supplier WillScot, may deliver our next wave of emerging quality growth. 

The value of diversification today

Admittedly, much of the case made above is backwards-looking. The important question for our client is, why do we think the diversified growth approach I’ve described is more relevant now than ever? 

This view might feel odd considering that an elite group of the index’s largest companies dominated its returns in 2023 and 2024. Relative performance in this period often came down to whether we were under or overweight the group of companies caught in a wave of positive momentum. 

Firstly, if history is a useful guide, this trend is unlikely to continue and these companies’ performance will materially diverge in future. We’re already seeing signs that this is happening. 

Secondly, the world looks very different today than at any point over the past 20 years: geopolitical tensions continue to rise, AI adoption gathers pace, and governments struggle to cope with ballooning debt burdens. 

It is possible that the ‘long decade’ of low interest rates and relative stability since the GFC is replaced by unpredictability and volatility. This may bring greater separation between the best and the rest, and future winners emerging from unexpected areas. 

Although the market area they appear from may surprise, the company characteristics they show, such as strong competitive advantages and adaptable management teams, will not. 

An uncertain environment will enhance their importance, and both breadth of expertise and selectivity will be vital, two hallmarks of the Global Alpha approach. 

This is why we’re doubling down on our second core belief. 

The foundation of outperformance today will be continuing to find and harness uncorrelated bets, retaining balance across our growth profiles and utilising our insights across varied companies and industries. 
We know that diversification provides resilience and strength for our portfolio and for our clients. 

We believe the winners of the next 20 years will be found both in futuristic areas such as quantum computing or AI chips and in more traditional areas such as mining quarries. 

We will continue to cast the net widely to find the best. 

Back to Global Alpha 20 

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Source: Baillie Gifford, MSCI. US dollars. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite. 1 year figures are not annualised. *Inception date: 31 May 2005

Past performance is not a guide to future returns.

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