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|Alex Donald||Good morning, everybody.
Thank you for your patience, just waiting for everybody to get online.
Good morning, everybody. Thank you for joining us this morning.
For those of you who don’t know me, my name is Alex Donald, I’m the Head of Funds Management at Ironbark Asset Management. And I’m delighted to be joined today by Peter Rutter, who, most of you will know who’s the Head of Equities at Royal London Asset Management, is also the head of this global equity strategy. And as you know, has been running it for close to 20 years.
We, as you know, are very keen to keep all of our investors and potential investors up to date with how markets are behaving, but I think particularly through the lens of the strategies that we have in market and for those of you who joined our original Royal London global equity strategy, and the effects of COVID and maybe a differentiated way to look at markets. We spoke about a theme of Survive, Consolidate and Thrive. So surviving the initial impacts of the virus, then how do we, you know, use this opportunity to consolidate and ultimately thrive within the portfolio?
And so with that, and so we wanted to continue on that theme and sort of touch on how we got out of that survival stage, what stage are we at now and give you a real lens into how the portfolio is positioned, and the thoughts for the future. And with a touching a little bit on how we see things developing in markets.
The call lasts about 45 minutes in total, there is a chance to ask questions along the way. Now there’s a question panel on your, the pop up window on the GoToWebinar window. So please, I do encourage you to be interactive. We had lots of questions last time. So please do type any questions there and I will pose them to Peter throughout the process. But with that, Peter, I will hand over to you so welcome Peter. I know it’s reasonably late in London, but so welcome and thank you.
|Peter Rutter||Thanks very much, Alex. And good morning, everybody. Thanks for joining the call.
So we flip through to the next slide, just a brief introduction. As to myself, I’m Head of Equities, Royal London and been running involved in this strategy for nearly 20 years and strategy I’m about to go through,to go on one slide, just highlights from the get go -the proposition we have with the Royal London Ironbark Global Equity strategy. It’s really about differentiated stocks, with a valuation focus, and a portfolio that’s balanced across sector region and lifecycle. And I’ll go on to explain how we apply that proposition or how that proposition works in the current market environment with everything that’s going on with COVID.
But as Alex mentioned that as shown on the next slide, the real structure I’d like to run through today is really how we go about managing through crises in the investment markets. We’ve had a few of various magnitudes over the course of this strategy, the most notable being the GFC. But there’s been the eurozone crisis, there’s been China shock, there’s been some emerging market blowouts along the way as well. And clearly now we’ve got COVID. And over the 20 years as an investment team, we’ve developed a methodology for approaching crises with this process. And we’ve paraphrased that on this slide, the initial phase of immediately checking the portfolio as you go into a crisis, but the, how the survivability of certain investments and stocks and therefore the overall portfolio, and then a period of consolidation, which I think we’re in now around COVID, and often there’s a paradigm change or major structural changes that emerge as part of the crisis.
|Peter Rutter||And it’s the consolidation period is really a moment to think about how things are going to change coming out the other side and making sure your portfolio is positioned for that.
So I will build that out in a bit more detail. But that’s the framework for how we approach any kind of investment crisis, or market crisis and having a stock picking valuation driven approach, gives us some differentiated and unique things we can do to try and exploit additional value for our clients over the course of a crisis and for the long term.
But before I go into that sort of three stage model that we apply, I just wanted to give a quick recap, and I’ll keep this quite brief because I’m sure everyone’s been hearing a lot about all of this as to what exactly has been going on. So the first thing to talk about on the next slide is really there’s an unprecedented slowdown hitting the global economy. You can see one way of seeing that, this is the global earnings revisions for the world index in the last decade. And even if you took this graph back even further, that the recent shock to earnings, which is a manifestation of the slowdown hitting the global economy is pretty unprecedented. And that’s the result of lock downs.
So major slowdown. On the next slide, another major feature is evidence, which is the recent massive gap up in credit spreads. So really the reemergence of solvency and liquidity risk to balance sheets for corporates and businesses around the world. You can see how that gapped up dramatically at the start of this year. But it’s actually about half of the increase in credit spreads has been recovered as central bank and government stimulus is thought to bail out and help many businesses that are hugely impacted and are at huge risk of bankruptcy. It doesn’t mean no one’s going to go bankrupt. But to some extent that bankruptcy and credit risk has been reduced. It is still elevated, but the spike up was again fairly unprecedented. Not quite as bad as the GFC, but about 60% as bad as what we saw in the GFC. It is still very significant. Another feature to highlight on the next slide is that, clearly with the uncertainty and the risks out there and the slowdown in growth, there’s been a flight to safety in government bonds and you can see this in US Treasuries with a 10 year yield, which had been trending around 1.5 to 3% and suddenly gapped down to about 60 basis points.
So clearly a huge risk off the environment. And again, we were already in unprecedented US government bond yield territory, but that has moved down dramatically even further, in terms of the low yield seen in 10 year Treasury. But another way if you invested 100, Aussie dollars in US Treasuries, currency hedged, you would get 60 cents a year in income off those which is extraordinary low level of income from a risk free rate in the US Treasury market.
So, we just move on to the next slide. What does this mean? Well, I’ve highlighted these three things, because when you look at share prices through the lens of a discounted cash flow model, which is shown here, so, the price of any asset is the price, the current value of all future cash receipts you might expect from that asset, discounted back at a discount rate. When you break that down into the slides of just showing the future cash flows coming out of corporates are hugely uncertain, and subject to very high levels of volatility in terms of expectation and what could happen next. At the same time, I’ve just shown you pretty, you know, once in a decade tight volatility in credit spreads, and also an unprecedented gap down in bond yields and really quite significant volatility in bond yields with a sort of risk on risk off environment, and everything going on with fiscal policy and monetary policy.
What does this all mean? Well, if you’ve got huge volatility of corporate earnings, bond yields and credit spreads, you’re going to get huge volatility of share prices in the stock market, as investors wrestle with what happens with all of these different dimensions that impact the long term valuation of both individual equities and also the share price. And also, the stock market as a whole. So, you know, this has made clearly a very volatile time and although things have calmed down a bit, I think we’re still quite likely to see volatility in expectations and predictability of corporate earnings, government bond yields and credit spreads and that is likely to cause ongoing volatility in share prices.
So I’ve summarized that on the next slide really. So I won’t dwell on that but really that the volatility going forward will probably be driven by the volatility on these three key factors. And that makes for an interesting time for investors across all asset classes, and independent of what kind of goals they have and background.
|Peter Rutter||So I’ll move on now to how we’re approaching the crisis in this kind of environment. Because in many ways, although every crisis is different, they’re quite similar in terms of being periods where you have volatility around the factors I’ve just discussed, but also potentially paradigm shifts in how those factors move coming out the other side. So phase one, which is shown on slide 12, is really going into the crisis is how would you survive and what did we do at RLAM Global Equities? Well, as soon as it became apparent in middle of February, this was potentially a major issue. Our” survive phase” of managing through a crisis as an investor is to go through every stock in the portfolio. And in this particular case, assess it for the changes. Well assess it for the changes that are emerging. And in this particular case, it led us to look at three things.
The first is the revenue impact potential of COVID-19.
So really, if we looked at it from a stock by stock basis, can the stock survive? We’ll build up the say can our portfolio as a whole survive this turmoil.
I will just give you a couple of examples, really in talking mid February here, one company we did own at the time with Daimler, which is the owner of the Mercedes brand amongst other things. And when we ran through this checklist, this bottom up checklist, clearly buying a car is a discretionary item, it’s very deferrable. The operational leverage in a auto manufacturer is exceptionally high. They’re very thin margin businesses highly reliant on significant capacity utilization to absorb fixed cost. And in the case of Daimler, the balance sheet was not great as significant debt and also huge car leasing and finance business has built up over the recent times. Now when we updated our valuation scenarios for the virus and how that might affect demand in a bear case, we got a scenario relatively easily where the company may well go bankrupt without major support from a government. There’s still clearly upside potential to the share price. But building in that new bear case, completely changed the attractiveness of the payoff for the company. And we subsequently sold the position as a result of running through the survived stage of our crisis management playbook.
In contrast, I just jumped to another stock on the next slide, which is Progressive and progressive is a North American is a US based car insurer. And people may well be aware of this, but it’s incredibly fascinating thing that happens to car insurance during a crisis. And we learned this in the financial crisis itself as an investment team. But if you go through that playbook of sales, operational leverage and flexibility and balance sheet car insurance is really quite an interesting area. We also in another car insurance company in the UK and the portfolio.
Firstly, car insurance is legally mandated in most countries, and it’s a non discretionary item. So it’s incredibly sticky. And not only is it legally mandated, most people have already paid their car insurance in advance so they can’t get their money back just because there’s a crisis typically. So very stable sales.
Secondly, interestingly, because of the COVID crisis, there’s a lot less cars being driven on the road. The main expense for car insurance company is the cost of claims when there’s accidents, and the rate of accidents is likely to decline significantly this year, as a result of less traffic on the roads and less people driving, less density of traffic. So actually, profits of car insurance companies are likely to explode northwards. Because about, typically about 80% of the car insurance company’s revenues goes to paying claims. So if you have you know, half the level, three quarters the level of claims, it’s hugely transformational for cash generation that business and in Progressive case, it had a particularly strong balance sheet.
So if we move to the next slide, in the middle of April, sorry, in the middle of February, we sold Daimler and we had a very small position in Progressive which we increased dramatically. It’s one example of the kinds of trades we did going into the crisis by running through the bear case for each and every stock and seeing how that affected our investment thesis and acting accordingly.
|Peter Rutter||You can see at one stage that the gap in performance between progressive and Daimler was about 55%. So if you rotate 3% of the portfolio with these two stocks, that’s worth 150 basis points of alpha making that kind of decision. That gap has kind of settled down a bit towards about the 30% range. But nevertheless, you can see the benefits of really kicking the tires on your portfolio with a survive phase.
So that was a while ago. I’ll just move now on to the next slide, which is the next phase and I think this is where we are now for investors. We’ve gone through the initial shocks, the initial volatility, and it was incumbent that we, so it was vital that we did the preparing the portfolio for what could happen because in many ways the bearish scenarios have emerged. From where we were in February, the portfolio has outperformed in that context, because we’ve taken the steps to check its stock by stock for how the crisis may affect it. And we’ve reacted and traded accordingly.
But now we’re in a very interesting stage, which could last some time, which is really about consolidating our investments. And again, we do this stock by stock, we’re looking at the long term impacts of COVID-19 as best as we can understand them, for every company in the portfolio, from a positive basis and neutral basis or a negative basis. And we think there are market inefficiencies that emerge at a time like this, because people can be very focused on the short term news and miss some of the long term changes, both positive and negative, that can be going on with companies at a time like this. It’s also often very hard to see the structural changes that are going to occur in industries and economies. And so most of our work is really now on, now we’ve got to the survive phase, which was about near term analysis of revenues, costs and balance sheets. we’ve switched our fundamental analysis to the long term assessment of really how is the long term valuation of these businesses we own changing and businesses we might want to own? And what are the structural changes that we may well see in the economy and in the industries in which these companies operate?
So it’s a very difficult piece of analysis. But again, having a stock picking approach with a valuation focus really lends itself to conducting this analysis, because rather than sort of speculating on the big macro, which is, in our view, incredibly difficult, we can go brick by brick through the portfolio, we can engage with businesses directly, and we can begin to understand some of the long term changes, feed those back into our valuation work, and make portfolio adjustments accordingly.
But just to give you a couple of examples that I approve interest. The first is our ownership in Safran. Safran is a French business. It is in a joint venture with General Electric. And they both have a 50/50 stake in one of the two main engine aircraft manufacturers in the world for short haul aeroplanes.
So anytime you get on a plane Melbourne to Sydney or around Australia, there’s a people or to New Zealand there’s a 50% chance that the engine is made by Safran. And they’re clearly very complex pieces of equipment as we’ve shown here. Now Safran is an engine manufacturer, makes money from both selling the engines but also aftermarket from servicing engines that are on planes and clearly right now, it is a disastrous market for being an aerospace engine manufacturer and aftermarket service business. Nevertheless, though, we have done our analysis and met with well, had the conference call with a CFO two weeks ago and Safran definitely has the operating flexibility and cash flow and balance sheet to get through this crisis.
So it definitely makes our survive list. Currently the share price is halved because of a massive slowdown in global travel and flights. Now, there is definitely a major short term impact on Safran. But interestingly, for the long term, the crisis is actually potentially quite beneficial for Safran. Firstly, it consolidates the duopoly that exists around the engines, there is absolutely no chance of a new entrant coming to the market now given everything that’s going on, and that’s great if you’re a duopoly, it increases that long term mode. Secondly, speaking to management, this gives them a really, they’re in a sort of French unionized workforce, so much of their labor in the current environment gives them a chance to make some structural changes to that workforce that we wanted to do and they they can’t do in normal conditions. But that the chance to re-examine how they structure their whole business, which will improve long term efficiency. And I think the third thing is really interesting. The company is awash with cash, and has still got access to cheap finance given the long term quality nature of the business. And there’s the potential for Safran to buy off and
|Peter Rutter||vertically integrate any of its suppliers that are struggling. Now, some of these suppliers are very high margin niche businesses. And there would be wonderful long term economics if Safran was able to buy some of them up.
So it’s an example of a business that has got major near term issues as a result of what’s going on, but it has got the balance sheet to survive. And if anything, it’s long term structural value is actually increasing at the moment. If you really take the you know, if you’re there for the long haul, excuse the pun, around air travels, and so we just observed that long term value is probably going up and one day we will get back to flying a lot. Although it could be several years away. And so not only is our long term value going up, but the share prices also go up. So that’s an interesting kind of consolidation example, that can be thrown off in a crisis like this.
Just briefly on the next slide, another example would be Micron,
it’s been hit by the general sell down in markets, it shares down about 30%. Micron is one of the world’s leading manufacturers of semiconductor memory chips, NAND and DRAM chips. And actually, if anything, this crisis is causing massive increase in demand in memory chips, although there’s a bit of disruption in the near term. Clearly, the end demand looks very strong given all them, working from home the acceleration in cloud, given mobile devices, given the emergence of 5G. So it’s another example of something that’s caught up in the general sell down in markets. But actually, if anything its long term structural dynamics have improved given what’s going on.
So in Safran and Micron, I’m just trying to throw up examples of in amongst the chaos of everything going on, in amongst the really big hit for some companies like Safran and the short term earnings, if you take a long term perspective, you can find in a crisis like this, that you get wonderful long term buying opportunities in what are truly fantastic businesses that have got great long term prospects. I say that, the critical thing is going back to phase one is they must be able to get through the crisis in tax from an equity perspective. But if they can, markets like these can throw out wonderful long term opportunities for businesses that get caught in a downdraft. So just moving on to the third phase, which were some way from yet, but it comes out of, if you can consolidate well in a period like where we are now. Now our approach in the Royal London Ironbark Global Equity Strategy is unchanged for over 20 years and is focused on superior shareholder wealth creating businesses in the portfolio.
So businesses run well for shareholders with great long term dynamics that are very attractive long term valuations. And we build a portfolio that’s balanced across sector region and life cycle as a form of diversification for many of the unknown unknowns that might lie out there like COVID-19 in the future, or similar things, that diversification is valuable to predicting clients over time. And by having this consolidation phase, and given all the volatility in markets, the key for us and for any investor is to use this volatility, use all of this change, use all of these structural challenges and near term versus near term noise and structural opportunities versus near term noise to double down on identifying the superior wealth creators with attractive long term valuations and also making use of the current environment for where these attractive long term valuations have opened up as we feel is the case in companies like Safran and Micron. So it’s more about looking to the long term rather than reacting to the short term noise and pressures. You can see the portfolio on the next slide which is diversified across the corporate life cycle, which is early stage growth companies on the left all the way through to value and deep value businesses on the right. So it’s a very diversified portfolio of stocks specific opportunities. And although there’s some household names in here, there’s a lot of differentiated holdings as well.
|Alex Donald||I just got a, just a question around Portfolio. From the audience is that how is the portfolio over time? I think it looks like names in the compounding and slowing [inaudible]
|Peter Rutter||Oh, Alex, I am not sure. I didn’t get all of the question I’m afraid.
|Alex Donald||Did you hear me?|
|Peter Rutter||It’s clicking in and out. I’m not sure if that’s just for me, but-|
|Alex Donald||Okay, I’ll let you go on, I thought that might happen.|
|Peter Rutter||Okay, I think yeah, I’ll look out for the question further on Alex. So sorry, I didn’t quite get that|
|Peter Rutter|| I’ll just jump on a couple of slides please to the back to the overall proposition.
And this is really now thinking about the proposition to the consolidation and thrive phase. So, I talked about how the process is really about identifying differentiated stocks that are wealth creators, long term shareholder wealth creators with very attractive valuations and finding those opportunities across different sectors, lifecycles and regions.
Now that for us, I think it creates a very robust opportunity for clients going forward. But if I just focus on the differentiation we’ve just shown on slide 23, the next slide, it just shows how differentiated our stock holdings are in terms of driving performance.
So we have outperformed in the last few years, we’ve got strong numbers and track record. But in a world that’s been dominated by global growth and US growth companies and healthcare and technology stocks, we’ve achieved our outperformance not through that global growth exposure but through a completely differentiated set of stocks. So, if you just look at Bandai, Namco, Safran, Old Dominion Freight, TIS Inc, Bechtle, Constellation software, Maeda Road, even very differentiated winners that we’ve picked that are completely independent in many ways of, the big global growth and tech theme that’s been dominating markets. You can see on the right that we still had a significant allocation to what you might call value stocks with a very balanced portfolio. Nearly all of our detractors in the last three years are what you might call value names.
So we’ve achieved our performance despite having exposure to value that outperforms has been driven by differentiated stock picking. And our ability in this and you know, we’re excited in this environment that with all the turbulence in markets, there is an increased opportunity to find differentiated stocks at fantastic low valuations. So we’ve been able to do that over the last three years before COVID-19. But we’re also thinking this is an environment where there are more and more individual stock opportunities opening up.
I just want to talk about another thing for the future on 24 which is that we do have a valuation exposure. We’re a valuation exposed fund without being a value fund. We are invested across the life cycle, so in growth and what you might call traditional value stocks on the right, but we achieve valuation focused not by being overweight value stocks, but by having a valuation discipline at every single point in the life cycle.
So the typical P/E of stocks in our fund is lower than the market. But we achieve that not by just going out and buying the latest turnarounds and mature businesses. We achieve that by having a valuation discipline at every point in the lifecycle. So typically, our growth stocks are cheaper than the average growth stocks. Our GARP stocks are cheaper than the average GARP stocks and are mature and turnarounds, value stocks are cheaper than the average value stock.
So that’s how we achieved the valuation discipline. And I think that’s particularly valuable right now given the huge outperformance of growth that we’ve seen in the last decade, but also recently this year as well.
I’ll just go through the next few slides quite quickly, but just to reinforce the point that we are very well diversified by sector and country. So region on this first slide and sector on the next slide. And this is really important right now because you go back to my earlier points about the volatility in cash flows, the volatility we might get in credit spreads and bond yields. There is major value to being diversified from a client perspective. We got very high stock specific risks, but we are diversified. And that’s because a lot can happen from here, there could be a lot of volatility in the overall market and there could be a lot of volatility and difference between different sectors and regions.
So that diversification, I think, from a strategy like this is very valuable at a time like this. It is potentially a chance to be a hero on sector and country allocations or value versus growth. But it’s also potentially a chance to have a very torrid time relative to the benchmark and in absolute returns, if those positionings are wrong. So we prefer to focus not on making big bets around sector life cycle and style and region but by diversifying that risk away and being very focused on long term valuation and the superiors wealth traders and differentiated stocks. You can see that in the overall metrics for the portfolio on the next slide, the result of our process and all of this consolidation work is to have a portfolio that’s higher quality than the market. It’s got better valuation metrics than the market. And at the moment, it’s got slightly better momentum characteristics than the market as well.
|Peter Rutter||Hi Alex|
|Alex Donald||I’m back and I’m on the phone. We had a large thunderstorm came through the area. So I lost my connection apologies to everyone.
And I just said, we had a couple of questions and one of them maybe we’ll answer second which is around the portfolio makeup. So you talked about the life cycle weightings, or that you showed the slide of the names and the life cycles, I think there’s been a bit more of a concentration of names into compounding and slowing and maturing and I’m just wondering whether that was on purpose and sort of looking at, you know, sort of not being at the extremes of deep value and sort of, you know, and high growth businesses. And the second one was, are you currently holding extra cash to take advantage of the opportunities you see?
|Peter Rutter||Yeah, thanks, Alex.
So we haven’t intentionally targeted increasing our weighting to any particular life cycle category because we started from a position of being relatively balanced across the different categories and we’d like to remain that way. In our methodology and algorithm that creates these classifications, more of the benchmark has become slowing and maturing and so is our portfolio. So there are more stocks in the slower maturing category, partly because of the cyclical slowdown. But more of the index is also in the slowing maturing category as a result of the slowdown.
So you will see more in that part of the life cycle and three months ago, six months ago, but our relative positioning in that part of the life cycle hasn’t particularly increased and it just reflects some of the cyclical slowdown that’s underway. Life cycle classifications are very long term in nature, but they are influenced to some extent by the revisions and changes in supervised that are associated with the economic cycle as well.
So that there’s no targeting of any particular sector, or any particular category at the moment. We value that diversification.
It is an interesting question about cash, because we don’t have anything in the presentation on this. But we’re in a fairly, one of the things are really amazingly interesting position for investors. And we’re actually very bullish on equities at this juncture. And as a result, we’re fully invested. And we’re conducting this consolidation phase, looking for these particularly mispriced opportunities thrown up by all the volatility. We’re funding those through rotating money out of existing holdings, where maybe the long term dynamics getting a bit worse or they’ve just got a bit overvalued relative to other stocks in the portfolio. So it’s an interesting consolidation phase, and it’s a very volatile market. But structurally we’re very bullish on equity prices. We base that off our long term valuation model. And really the reason for being bullish on equities right now, is that bond yields are virtually zero globally.
So equities are very attractive for long term investors, they pretty much now represent the only way for most global investors to generate a real return for the long term from here, basically. And I think that’s why the markets have rallied and are likely to continue to rally not because the world economy is getting better but because people are calling it the TINA trade, There Is No Alternative TINA and I think that’s hugely supported to export markets, the markets, the fiscal and monetary stimulus we’re seeing. So that’s an interesting question about cash. Whilst we think they’ll be a lot of volatility, we are fully invested and we’re funding our most attractive valuation opportunities by other holdings, rather than holding cash because we think there’s quite a lot of risk to holding cash at the moment, given the relative attractiveness of equities versus other asset classes.
|Alex Donald||Peter, we’ve got the question, which could be easy to answer or could be subject to another whole presentation, I think, but it’s one which is, I think, leads a little bit to the use of your portfolio versus other managers in portfolios.
But it’s about you know, you have a valuation, talked about a valuation bias. I think it’s obviously different to a value bias. But your performance, doesn’t you know, there’s been value has been a difficult style to perform in growth has obviously continued to do very well. And you talked about that in your first presentation about long duration cash flows. How is it? You know, it’s basically how should we see you in that spectrum? And because also your returns don’t reflect, you’ve managed to outperform even with this valuation style versus value style.
|Peter Rutter|| Yeah, so when we attribute our risk dynamics in the portfolio using a variety of models, about 70% of the risk in the portfolio is stock specific, idiosyncratic stock risk from owning very differentiated names like those I talked about earlier, you know, TIS Inc and Maeda road construction businesses that they’re not, they’re not so micro cap or small cap, but there’s 4000 Global opportunities in the investable universe for global investors. So 70% of our risk is stock specific. And that can drive performance in any market. Of the remaining 30% of our risk, our valuation exposure is a big chunk of that. Our valuation exposure and our conservativeness in our balance sheets are the main systematic risks in our investment strategy for the long term.
So when value is underperforming, it is a headwind for us. But the bulk of our risk is around differentiated stock picking. So if we do a good job, with differentiated stock picking across the lifecycle, we can punch through that valuation headwind. In the long run, we think valuation is a very good place to be, it clearly has been a tough place for quite a period of time, but it’s that differentiated stock picking that has helped us and we may well get a tailwind from value valuation. But even in that scenario, really, it’s the stock picking that drives the returns and I think that’s what’s most attractive to our clients. Is that they get exposure to a portfolio that blends well because It’s well diversified, but they get access to a very differentiated set of long term wealth creators with attractive long term valuations.
|Alex Donald||Thank you Peter|
|Peter Rutter||I’ll just pause for a couple of seconds in case there’s more questions.
Great, nothing at this stage. We’ll all keep an eye out, as I’m sure you will as well, if you see them come up, Alex.
But I’ll just move to the summary then.
So, you know, we have a massive cyclical downturn that’s underway at the moment. Fiscal and monetary stimulus that’s come to the fore and really what’s driving markets and I think some, I’ve mentioned some of that monetary stimulus is actually very supportive of long term equity prices. I think we’re going to have volatile times ahead. I know that’s a fairly obvious statement. But, you know, we clearly have high levels of uncertainty around the predictability of corporate cash flows, credit spreads and bond yields given the major sweeping fiscal and monetary events are sweeping through the economy. And that volatile times ahead on those inputs will lead to volatile share prices. And our approach to this crisis through normal markets and any previous crisis is unchanged. It’s the advantages of our investment process around the Economic return framework lifecycle to identify long term shareholder wealth creating businesses with very attractive long term valuations.
The first thing has been to get through the survive phase, which we did early in the middle of February, in late February. But now is a time when a process like ours really comes to the fore because I’ve been focused on long term wealth creation and long term valuation, in a market with huge price volatility, and significant volatility and short term noise. We do feel as though there’s already been some particularly attractive long term opportunities thrown up, and we would anticipate that more emerged.
So it’s been a very busy time. But really, we don’t need to change our approach to this environment, we just need to keep turning over the rocks and updating the work faster, given all of the changes that are going on. So we remain focused on differentiated stock picking, remain focused on those long term valuation opportunities. And we remain focused on balancing our portfolio across the lifecycle, across sectors and across regions, because we’re likely to see huge volatility in some of those factors. They’re very hard to predict, but by diversifying that risk away. We let the stock picking do the talking, which can enable us to have the performance potential in up markets, down market, value market, great markets, when different sectors are doing well when different regions are doing well, that diversification and focus on stock picking creates a portfolio that has the potential to do well across a broad range of environments.
And again, using our playbook of survive, which is now through as the investment community but the consolidation and thrive phase, we do think investors in any asset class and equities have a very interesting consolidation phase around how they adjust their portfolio positions given everything going on. And there will be major structural changes, there will be paradigm shifts that occur in the economy, in individual stock dynamics and individual sectors and industries. And by taking the stock by stock approach is a very interesting time for us to consolidate the portfolio around some of those changes in amongst the short term noise and to attempt to benefit from anticipating and valuing some of these changes correctly in terms of driving long term outperformance and returns for our clients. So an interesting phase for stockpickers, one of that’s definitely kept us very busy and, you know, consolidation phase will possibly go on for some time. But I think it’s a very interesting time for a differentiated stock picking approach.
|Alex Donald||Here, we’ve got a couple of questions. I know we’re sort of getting towards the end of things.
But we’ve got a question about, one question about your increased weighting to emerging markets. Because I think in the past, you’ve had sort of a low weight to EM, and I think there’s obviously that’s crept up over the last 12 months. And then another one, which is unrelated, but do you, what do you anticipate as far as an increase in how you’re thinking about increasing political risk over time, if we do start to see you know, continued China, trade wars, Hong Kong, all those types of things? How do you builds that into the model? Does that come through in your stock specific risk?
|Peter Rutter||Yeah, that’s, the second question is particularly interesting and difficult.
But I’ll start with the first. We’re about 6%, 7% overweight emerging, sorry about 6%-7% overweight emerging markets. It’s predominantly made up of investments in Samsung and TSMC, both of which are world leaders in what they do but trade on emerging market type valuations. We haven’t seen these kind of differentials between the USA and emerging markets since the mid noughties, actually, when there was a great kind of carry trade for value investors by owning emerging markets over developed markets. There’s an interest you know, long time ago now, but we’re at that kind of valuation differential. So we’re overweight emerging markets, and it reflects the fact that we can access world class businesses at a significant discount to what you pay for them in developed markets. And, you know, Samsung and TSMC are clear leaders in what they do, especially TSMC. So that’s driven by bottom up stock picking that is way to emerging markets. And it leads me to-
|Alex Donald||I think it’s worth, it’s probably worth mentioning what the weight of emerging markets is in the world index. So whilst it’s an overweight, it’s not as sort of, it’s not a strategic play in emerging markets. It’s a stock specific weighting versus a zero benchmark weight.|
|Peter Rutter||Yes, yes. So firstly, is there a benchmark weight, but it’s yeah, it’s driven by the stock picking. Yeah, rather than the strategic bets on emerging markets. Yeah. And, as I say, Samsung and TSMC, they’re not, they’re global US dollar denominated revenue businesses, rather than it’s an emerging market holdings that are, you know, like a local utility or something like that in Malaysia or things like that.
So yeah. It’s driven by that global stock picking. But it does lead on neatly to the question about trade wars.
Our base case is that trade wars will get worse. Our base case is that it’s quite irreconcilable differences in the western version of capitalism and the Chinese version of capitalism, and that is going to cause major issues for global supply chains and trade for many years to come. We may be wrong on that and so we do have a more bullish scenario. We do have more bearish scenario as part of our analysis. But our base cases that trade wars and that geopolitics are here to stay for some time, and could be quite significant.
How do we build that into our work? Well, again, we come back, there is a huge advantage of being stock pickers and doing stock by stock analysis and stock by stock valuations. Because what we do is we build the Bull case, the bear case and the base case into our individual stock holdings. It doesn’t affect some of those holdings much, you know, the company might be a US domestic business, it doesn’t really affect it at all. But to some companies building in that potential trade war disruption can either be hugely bearish or hugely bullish. So we just build that into a stock by stock analysis, that consistent base case that things get gradually worse. And that means we’ve got an ability to compare across the world. So we built it in stock by stock and our base case, is that thing can get gradually worse from here.
|Alex Donald||Thank you Peter. I think we’ve answered all the questions. There’s no other questions that come through. Just in the interest of time, please. I think we’ve covered a lot of ground and and thank you for answering those questions.
So I might just wrap things up there Peter, thank you for joining us from the UK. I know it’s late there and we will definitely come back and sort of talk more about the consolidation and ultimately the thrive phase but a great detailed presentation. Thank you.
And to everyone who attended, thank you for attending. I hope you found the webinar useful and as always, we will be, this is one of a number of webinars we’re doing in a series to keep all of our investors up to date during this period.
Peter has promised me that he’s desperate to get on a plane and come to Australia.
So I said to make it a long trip because you may have to quarantine in a hotel, but we’re hoping to get Peter out as soon as borders open and things resume so that we can have face to face meetings.
But we will continue to do many webinars over the coming weeks.
Thank you all for joining us and there will be a recording of the webinar on our website. So please do go there if you would like to hear the webinar again. Thank you.
|Peter Rutter||Thank you.