With markets currently nervous and also expensive, we reached out to a panel of fund managers to ask: “What strategies or techniques allow you to remain invested even if valuations appear stretched?” Read below for individual responses from Nikko AM, Schroders, Monash Investors, and an exclusive interview with Giselle Roux, the CIO of Escala Partners.   

Our top strategy is 'avoid'

Simon Doyle, Head of Fixed Income & Multi-Asset, Schroders Australia  

Investors are kidding themselves if they think there are strategies that allow you to stay invested in “stretched” assets and avoid the carnage that follows. Sure there’s things you can do at the margin, like options and volatility based derivative strategies, but they are expensive and ineffective, particularly in size. The only sure fire way to avoid loss is to not own the assets that are the most at risk – particularly those that will do the most damage to a portfolio if the valuation risks are realised. The top strategy on our risk mitigation checklist is “avoid”. This means don’t be afraid to go to cash if you’re likely to lose money on other assets. Yields may be low, but they are certain (at least in the short run), liquid and they are an effective call on option on future opportunity. When valuations improve is when you want to be able to take risk. 

The 3-point checklist

Simon Shields, Portfolio Manager, Monash Investors Limited  

We look to invest in stocks that provide a buffer against a volatile market. So when it comes to the assumptions that drive our price targets, there are a number of things we look for. 

• Insight – what we think the market is misunderstanding and how it will be resolved. We look for reoccurring business situations or patterns of behaviour to help inform our judgement.
• Growth – ultimately share prices are dependent on returns to shareholders, so we want to see strong rates of growth in revenues, cashflow and earnings per share.
• Value – we want to see large upsides to our price target for stocks that we own, so that we can have confidence to hold them through volatile periods. 

At a portfolio level we have a variety of risk controls, from stop loss for thesis violations, diversification at stock & sector level, and reducing portfolio exposure through holding cash and shorting. 

Some cyclical stocks look undervalued

Jason Kim, Senior Portfolio Manager, Nikko AM 

At Nikko AM Australia, we are an intrinsic-value manager.  When we value companies, we come up with fundamental valuations using our assessment of mid-cycle earnings of each company as well as mid-cycle long bond yields within our valuation framework.  

Right now, while the bond-proxy part of the market looks very expensive to us using mid-cycle bond yields, we believe, that certain stocks in the more economically sensitive part of the share market are significantly undervalued as they are on below mid-cycle earnings.  This select group of economically sensitive, or cyclical, stocks may not look cheap on a basic PE ratio, but if we use a mid-cycle “E”, they are in fact very undervalued. 

When companies are at the bottom of their respective business cycle and are therefore on very low earnings, they may appear stretched using rudimentary ratios like PEs (Price to Earnings), but when we allow for the fact they are at the bottom of their cycle, and incorporate their mid-cycle earnings, they can in fact be very cheap and are therefore an attractive investment for those investors with patience and conviction.  

3 risk mitigation strategies for expensive markets

Giselle Roux, CIO Escala Partners

In this exclusive interview, Giselle Roux, CIO at Escala Partners, discusses this issue of how to approach expensive markets. She told us: “You don’t want to sell risk assets because they are giving you terrific returns. Trimming positions is a good way to have some discipline”. She then goes on to outline three potential risk mitigation strategies.  

High risk of significant correction 

In the first part of this series, we asked a selection of fund managers: From your perspective is there a heightened level of risk to current valuations? Our respondents told us that current valuations across most assets point to a high risk of a significant correction, that the bond-proxy stocks look very vulnerable, and that the high PE across industrial stocks are a concern. You can access this here.  

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