Global Equities: How to judge a company’s competitive advantage

Warren Buffett’s “economic moat” isn’t what it used to be. Investors need to ask new questions about competitive advantage, says Pendal Asian Share Fund manager SAMIR MEHTA

• Old competitive advantages may no longer apply
• Outsourcing, globalisation now a weakness
• Find out about Samir’s Pendal Asian Share Fund

WARREN Buffet popularised the idea of the “economic moat” to describe a company’s competitive advantages.

But with geopolitical conflict, government sanctions, supply chain disruptions and a new sweeping deglobalisation, companies’ economic moats are not what they once were, says Samir Mehta, who manages Pendal Asian Share Fund.

“The years of seamless globalisation are behind us,” says Mehta.

“Disparate systems with built-in redundancies mean higher costs of doing business going forward.

“It is prudent is to assume lower profit margins and much lower returns on capital for most businesses.

“We might need to reassess what we pay for businesses once thought secure due to their moats.”

Rethink competitive advantage

Sustainable competitive advantage has taken many forms — it could be the ability to produce goods cheaper due to sophisticated outsourcing arrangements, the ability to source low-cost raw materials, or access to less-expensive labour.

“But in a deglobalised world where supply chains are disrupted and sanction risk is real, new questions need to be asked,” says Mehta.

“Where are your email servers based? Which cloud computing software do you use?

“Are you dependent on Visa, MasterCard or Amex for your corporate credit cards?”

Some of the fundamental technologies that investors take for granted have geopolitical connections that can make companies that rely on them vulnerable, says Mehta.

The US government owns the GPS (global positioning system) which powers location-based services like maps on smart phones. American and European banks control the SWIFT international payments system.

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“These are all things which we just take for granted,” he says.

Mehta says the end of the era of just traditional economic moats is another example of change in some of the core factors that investors have taken for granted for decades.

“These are cyclical changes in a long business cycle,” he says. “From the 1980s, we witnessed falling interest rates and lower inflation – but at some point in time, we know that this economic cycle will likely turn.”

Mehta says investors should look to the past to gain insights into what the new world might look like.

“Cycles last decades; we’ve had many instances in the past where we’ve lived in inflationary environments or seen changes in the way economies are managed.”

He recalls the changes Asian economies went through after the crisis of 1997/98 as the International Monetary Fund and western governments imposed sweeping change across the way economies were managed in return for bailouts.

Look for new clues

With some of the basics of investing under threat, Mehta says investors need to look for new clues to find success over the next decades.

One particularly important change is to watch for the effects of the re-engagement of government in economies.

This is typified by Beijing’s deep intervention into Chinese business to reduce inequalities and help contain cost of living pressures, but it is also noticeable in the west as governments deepen their involvement post-pandemic.

Mehta says this re-engagement of government is something of a return to the past for some Asian economies, where the state has a history of “managed capitalism” and favouritism in service of advancing national goals.

“In the past we looked for markers such as higher returns on capital from competitive advantages, but now I have to reorient myself – are there companies that derive their moats from protectionism?

“Where are the companies that will benefit because a government wants them to benefit? “You have to think hard and reassess the level of vulnerability for companies. In that sense, we are heading back to the future.”

About Samir Mehta and Pendal Asian Share Fund

Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

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About Pendal Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

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