Global Quality Strategy

Overview
Investment Approach

Overview

Strategy Facts

Capability:	Active Fundamental Equity
Strategy Inception:	June 2013
Benchmark:	MSCI World Net Index

Strategy Facts

Capability:	Active Fundamental Equity
Strategy Inception:	June 2013
Benchmark:	MSCI World Net Index

Summary

The Morgan Stanley Global Quality Strategy is a concentrated global equity strategy. To achieve the investment team’s aim of compounding shareholder wealth at attractive rates of return over the long term, the Strategy focuses on high-quality, resilient, well-managed companies.

Investment Approach

Philosophy

The team believes there are two key tenets to investing: first, that the best route to long-term returns is through compounding and providing a measure of relative downside protection; and second, that high quality businesses can generate strong returns over the long term. Such businesses are typically built on dominant market positions, underpinned by powerful, hard-to-replicate intangible assets that can generate resilient, high, unlevered cross cycle returns on capital. Other characteristics are: resilient revenue streams, pricing power, typically low capital intensity and the opportunity for organic growth.

These companies are rare. High quality management is critical. When evaluating the quality of a management team, we seek evidence of disciplined capital allocation and distribution practices, as well as remuneration or incentive policies aligned with their shareholders.

The team’s primary worry is about permanent loss of capital rather than relative risk; losing money is worse than missing the chance to make it. The team does not worry about tracking error, short-term macro noise or the latest fad. Instead, risk is managed first and foremost at the company level, aiming to avoid companies where any form of franchise, regulatory or management risk that could result in diminishing returns. The team also believes there is an inherent risk of overpaying for high-quality companies. Consequently, the team uses ongoing and rigorous fundamental analysis to assess the fair value of each stock. According to the team's research and their investment philosophy, only 200 to 250 companies meet their quality standards.

Differentiators

DEFENSIVE CHARACTERISTICS, COMPOUNDING POTENTIAL

The team’s research shows investment in high-quality companies, which exhibit characteristics such as strong franchise resilience, high and recurring cash flow generation, low capital intensity and minimal financial leverage, have historically generated strong risk-adjusted returns across various market cycles.

TEAM OF PATIENT INVESTORS

The team’s long-term investment horizon seeks to allow these rare, high-quality compounders to capitalize on their financial characteristics, leverage their well-managed intangible assets and compound shareholder wealth over time. The average annual turnover of the Strategy is expected to be 20% to 30%.

WE FOCUS ON MANAGING THE RISKS THAT MATTER

The team believes that quality compounders are less vulnerable to economic volatility, while indices, in their view, are inherently risky. They believe that relative measures of risk fail to capture the chance of losing money. Accordingly, they seek to minimize loss of capital and focus on the resiliency of a franchise, while trying to avoid any company which exhibits any deterioration in management quality, its financial health or its valuation.

A STRONG HERITAGE

With an unchanged and disciplined investment philosophy stretching back well over 20 years, the team knows quality when it sees it.

Investment Process

How Quality Works–the Power of Compounding

How We Identify Compounders

1	Identify High Return Companies
	High unlevered returns on operating capital employed (ROOCE) High gross margins (pricing power) Capital-light business models driving free cash flow (FCF) generation Strong balance sheet
2	Make Sure Returns are Sustainable
	Ability to remain relevant through powerful intangible assets including brands and networks, sustaining high barriers to entry Returns sustainable against material threats or improvable through material opportunities, including Environmental or Social factors Dominant market shares helping to protect against new entrants Stable sales – often repeat business driving recurring revenues Geographic spread Steady organic growth and geographic spread
3	Confirm management's commitment to sustaining returns
	Focus on returns on capital rather than sales or EPS growth Capital discipline (reinvest at high returns or return the excess capital to shareholders) Commitment to innovation and investment in franchises Review management incentives Sound Governance structure Engagement on material issues or opportunities where relevant, including ESG factors
4	Valuation
	A focus on free cash flow, not accounting numbers FCF yield, DCF, EV/NOPAT

RISK CONSIDERATIONS
Past performance is not indicative of future results. There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market value of securities owned by the portfolio will decline. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this portfolio may be subject to certain additional risks. In general, equity securities values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging-market countries are greater than the risks generally associated with investments in foreign developed countries. Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility. Investments in derivatives can magnify volatility, can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolios’ performance. Stocks of small- and medium-sized companies entail special risks, such as limited product lines, markets, and financial resources, and greater market volatility than securities of larger, more established companies. ESG strategies that incorporate impact investing and/or Environmental, Social and Governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result, there is no assurance ESG strategies could result in more favorable investment performance.

¹There is no assurance this expectation will be met.

This communication is only intended for and will be only distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Past performance is no guarantee of future results.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment manager, please refer to Form ADV Part 2.

Any views and opinions provided are those of the portfolio management team and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring. The views expressed do not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

All information provided has been prepared solely for information purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

DEFINITIONS
Return On Operating Capital Employed (ROOCE) is a ratio indicating the efficiency and profitability of a company’s trade working capital. Calculated as: earnings before interest and taxes/property, plant and equipment plus trade working capital (ex-financials and excluding goodwill).

Free cash flow (FCF) is operating cash flows (net income plus amortization and depreciation) minus capital expenditures and dividends.

OTHER CONSIDERATIONS
The MSCI World (Net) Index is a free float adjusted market capitalization weighted index that is designed to measure the global equity market performance of developed markets. The term "free float" represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends. The index is unmanaged and does not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

The information presented represents how the portfolio management team generally implements its investment process under normal market conditions.