Huge divergences in share prices mean you need to know your manager
Where the market is overly optimistic returns are borrowed from the future while areas where there is pessimism can deliver good future returns
There were wide divergences in share prices around the world, with some market sectors reflecting huge investor optimism and others huge investor pessimism, asset managers said at a recent asset manager conference.
Optimism is delivering extraordinary returns for some investors, but active managers speaking at the Collaborative Exchange’s Meet the Manager conference said it came with the risk of prices falling and investors losing money.
Unloved sectors of the market where investors were pessimistic, however, provided managers with a “fertile hunting ground” for opportunities, said Gavin Wood, CEO at Kagiso Asset Management.
Many managers agreed that local shares were cheap but said there were risks of what they called value traps: shares that could remain cheap because their earnings would not recover until the government acted to make the economy more sustainable.
This made it all the more important to understand your manager’s investment approach.
There was an increasing disconnect between economic reality and the valuations — share prices relative to expected earnings — reflected in some asset classes globally, said Allan Gray portfolio manager Rory Kutisker-Jacobson.
While the world was facing a pandemic of uncertain duration, the worst contraction in the US economy in history and unemployment higher than during the great financial crisis, the US stock market as measured by the S&P 500 had reached a record high, he said.
“It is an interesting dichotomy. You have blood on Main Street and champagne flowing on Wall Street,” Kutisker-Jacobson says.
The index was buoyed by the six most popular tech stocks, which went up 50% through the crisis, Wood said.
But he warned that optimism, like this one on tech stocks, increased the chances of losing money. Only deep analysis of the companies and their valuations could tell if the prices were overoptimistic, he said.
Besides US tech stocks, other global and local market sectors showing signs of investor optimism were online retail, gold, platinum and iron-ore miners, global consumer staples such as food, cigarettes and alcohol producers and SA pharmacy retailers such as Clicks, Wood said.
Market areas subject to a high degree of pessimism included property companies owning shopping centres, energy and oil companies, global industrials (particularly heavy industrials in Europe, carmakers, US and SA banks and local construction companies.
Wood said that in each case you had to determine if the pessimism was overdone. In areas where the market was overly optimistic returns were borrowed from the future, while areas of pessimism could deliver good returns in the future.
Rob Oellermann, CIO at Tantalum Capital, said the huge price dislocations were a result of perceived acceleration of existing trends or changes in behaviour arising from the pandemic. Some were transient and some permanent.
Some managers at the conference said that the Covid crisis was likely to accelerate the inevitable long-term decline in using carbon-based energy and the rise of electric vehicles. But despite these trends, oil companies and carmakers might be trading at prices that did not reflect future earnings.
Besides the huge outperformance of tech stocks relative to industrials and financials and hard and precious metals relative to softer commodities such as oil, paper and wheat, Oellermann said there was a dichotomy between recovery in shares listed in developed markets vs emerging markets.
He said the price dislocations presented big opportunities and risks for managers.
Tech stock fundamentals were really sound, but their future performance depended on whether regulators broke up monopolies, pushback on advertising for companies such as Facebook and Google, and whether future earnings justified their high prices, he said.
Oellermann says tech shares were strong and attractive but not invincible. Not all the issues were reflected in their prices. There was some merit in protecting your investments, he said. Tantalum had used derivatives to protect its portfolios from a fall in elevated prices of these shares.
Passive managers had to ride the cycles of over and under optimism especially those tracking indices based on the size of the share in the market. As large share prices rose, it made up more of the index and passive managers owned more of it.
While active managers argued that they managed the risks better, their decisions about when to get in or out of shares might be too early or late.
Managers guided by valuations were opposed to paying too much for shares and typically sold shares when prices reached levels they did not believe were justified to avoid participating in a potential price drop.
Fund information for the Global Equity Fund managed by Allan Gray’s offshore sister company Orbis, for example, showed the manager did not hold any of the six most popular tech stocks in its top 10. It still owned Facebook and Apple and admitted that it had some of the others, but sold them too early.
Tantalum also saw opportunities in local banks that could be unlocked if there were positive surprises in the local economy arising from the oil price fall affecting our biggest imports and rising precious metal prices.
“We are not all in though, and have some exposure to banks on call options because we fear near-term downside,” Oellermann said.
Andrew Vincent, portfolio manager at ClucasGray Asset Management, said that while ClucasGray was still invested mostly in larger capitalisation shares (companies with shares that made up more of the market), valuations among smaller capitalisation shares were compelling.
There were extraordinary opportunities to buy good businesses priced inappropriately for expected earnings recoveries in 2021 and 2022, he said.
Active vs passive
Managers needed to identify those investment opportunities among them and to wait patiently for the good returns they could offer in years ahead, Vincent said.
Wood said capturing good returns beyond those to be got from tracking an index required a high-conviction manager who took investment positions that were meaningfully different to the index that was a benchmark for the portfolio.
This was measured as the manager’s active share, the total of the percentage differences between each stock pick and its weighting in the index.
Wood said a large manager with R200bn or more in its equity portfolio had a choice of only 16 large shares in which to invest a meaningful 5% of the portfolio, while a smaller manager with just R10bn in equities could invest 5% in any one of 89 shares.
He said international research showed that what you really needed to outperform the market were stockpickers who ran concentrated portfolios because they had high convictions about a few select shares performing well.
Magda Wierzycka, joint CEO of passive investment manager Sygnia, said managers’ track records of underperforming major indices and rotation of top-performing managers from one year to the next, made the odds of picking a manager that could outperform near impossible.
She asked if you would play at a casino if she gave you the odds of 80:20.
Wierzycka said that you are better off bringing down your investment costs with a passive manager and managing risks in markets with active asset allocation.
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