9 fundies on the most important thing in their asset class for the year ahead
After 18-months that has seen retail investment soar to previously unimaginable highs, it's obvious that many are chasing the next big idea.
We’ve all heard the terms by now: “stonks”, “meme stocks”, “moonshots” – individual companies, or baskets of them, tipped to capture huge share price gains from a new trend. Australian buy now pay later company Afterpay (ASX: APT) is, arguably, one of the most prominent local examples of recent times. And there are many others that have enjoyed various levels, and lengths, of success – both locally and offshore. Gamestop, anyone?
At Livewire, we're more interested in delivering actionable insights, and, in pursuit of them we recently caught up with 9 portfolio managers from funds in the stable of multi-affiliate investment management firm Pinnacle Investment Management. In the wire below, the managers, whose asset class specialisations span local and global equities (including large, small and micro-caps) listed property, infrastructure, and credit markets, reply to one key question: What is the one most important thing in their asset class in the next year?
The managers were speaking ahead of the Pinnacle Investment Summit 2021, which takes place on Thursday 5 August.
SMALL CAPS - “High-water marks just keep rising”
“At no time in the past few years have we seen such a broad swathe of listed small and micro-cap companies that have never made a profit,” says David Wanis, CIO and portfolio manager at small-cap equities fund manager Longwave Capital.
“Today, more than 50% of small caps listed on the ASX have never made a profit, and of those, around 300 have market caps of more than $100 million.”
He acknowledges that there have also been many bigger-scale resources companies listing locally to capitalise on the long-running mining boom spurred by elevated iron ore prices. “So, I know a lot of people will say it’s not just a small or micro caps issue, but I don’t see many companies in the ASX100 that have never made a profit,” Wanis says.
“Speculation in small caps is currently at 30-year highs. We talk about speculative high-water marks, and it just keeps moving higher.”
Alluding to a couple of fintech firms that lie at what he regards as the more speculative end of the market, Zip (ASX: Z1P) and Sezzle (ASX:SZL), Wanis says, “It’s not like we’re shorting these stocks.”
“But with big parts of the markets so consumed with these types of speculative stocks, it creates opportunities in small caps that others are ignoring.”
SMALLER COMPANIES - A bubble to rival the tech wreck
Spheria Australian Smaller Companies Fund portfolio manager Marcus Burns expresses similar views. He also argues that beyond the more speculative part of the market, many of the more attractive companies within his small and micro-cap space are being scooped up.
“Not by investors, but they’re being bought out by foreign companies – private equity and other corporates – that are coming in. There’s been a litany of stuff like that going on in our space since around September and October of last year,” Burns says.
Burns also refers to a phenomenon he’s seen unfolding in the market over recent years, where sometimes brokerage companies’ choice of the firms they cover is being influenced less by quality and more by scale.
He suggests this is driven partly by movement in the broking industry, such as the banning of stamping commissions that took effect in the first half of 2020.
This means retail investors get less visibility of potentially promising small-cap stocks.
“Why cover a stock with a $90 million market cap when you can cover Brainchip with a $800 million market cap and make money by raising capital consistently for them as the market is completely enamoured with it” says Burns.
A couple of examples he names from within his portfolio are taxi payments group A2B (ASX: A2B) and MaxiTrans (ASX: MXI), which manufactures and sells road transport equipment. A2B, formerly known as Cabcharge, also owns a large portfolio of property which Burns believes is not reflected in the stock’s current valuation.
“That company will make, in a normal non-COVID year, $20 million of EBIT, and it trades on about 5-times EBIT. So, I could borrow money at 2%, buy that stock at 5-times and make a 20% return,” Burns says.
“And MaxiTrans trades at 4-times EBIT. That’s a cyclical business with more than $300 million of revenue.” But the first of these, Burns explains, only has one broker analyst covering it and MaxiTrans isn’t covered at all.
“The radar has now moved to a place where the banks can make money and shifted away from what’s fundamentally good for investors, and it’s ‘in extremis’ right now.”
“I would’ve said this about a year ago, and probably a year before that too, but it’s now even more extreme than it was in the year 2000, which in itself was a huge bubble.”
REAL ASSETS - PE sharks on the hunt
This uptick in M&A activity is something also called out by some other Pinnacle stablemates as an area of interest currently.
Jan de Vos, portfolio manager for the Real Assets strategy at fund manager Resolution Capital, notes the large number of private equity funds weighing into the local market.
“Every other day, it seems we see bids for some companies in my sector. At the beginning of the month, it was Sydney Airport (ASX: SYD), which we thought was rather cheeky in the way it was priced. It's being done when clearly there is uncertainty around when international travel will recover,” de Vos says.
“This is a very long duration asset, so this period doesn't really impact the valuation much. So, I think this was a very opportunistic time to lob in a bid. We support the Board in rejecting the bid at the offer price,” he says.
De Vos also points to another recent bid for a large infrastructure firm, in this case regulated utility Spark Infrastructure (ASX:SKI). The almost $5 billion offer from a consortium led by private equity giant KKR and North American pension fund Ontario Teachers’ Pension Plan was also ultimately rejected by the board in mid-July.
“I think the key thing in my sector is that there's a lot of private equity funds trying to take those companies private and they're willing to pay a significant premium,” says De Vos.
“What investors can take from this is that while the COVID pandemic has bought about short-term disruption to some sectors such as airports and toll roads, the long-term value proposition of these assets remains intact.
AUSTRALIAN EQUITIES - Strategic industrial assets the next M&A targets?
At Australian equity fund manager Firetrail Investments, Blake Henricks is a portfolio manager looking for high conviction investment opportunities. When asked about some of the key themes in markets over the next 12-months, Henricks says he expects M&A to play a big role.
Henricks called out high demand for infrastructure assets, referring to the SYD and SKI bids alongside local telecommunications firm Telstra’s (ASX: TLS) successful sale of its mobile towers business late last month.
“I think one area that is flying under the radar are strategic industrial assets. These are companies that may be described as boring, they probably haven't done particularly well, and they may not provide explosive growth,” he says.
One example Henricks provides is fuel retailer Ampol (ASX: ALD), which rebranded from Caltex in the middle of last year.
“In February last year, there were two bidders for the Ampol business, back when it was known as Caltex. So, while everyone's looking for the next big infrastructure play, we think there are some strategic industrial businesses that could be of interest.”
“The same can be said of Insurance Australia Group (ASX: IAG) in general insurance. It has a very low churn of incumbent customers. There’s no explosive growth here… But it’s a very attractive asset at a very good valuation.”
INFRASTRUCTURE - What's in a name?
Also in real assets, the CEO of Palisade Investment Partners, Roger Lloyd, describes a “redefining” of infrastructure assets as one of the most interesting developments in his corner of the industry.
Lloyd alludes to the point de Vos makes about greater interest in the sector from the likes of VC and PE firms, referring to “the volume of capital in the market.”
In line with this, he says the definition of infrastructure has been expanding.
“In the pre-financial crisis times, we saw people investing in things that were perhaps on the edge, such as airport trolleys or telephone directories. And I think we’re again seeing an expansion of the definition of infrastructure, which might raise the profile a bit,” Lloyd says.
“It's not something we’re getting into – we’re staying in pure-play infrastructure – but I think there is a case for infrastructure adjacencies where we'll source other pools of capital in the future.”
INCOME-GENERATING EQUITIES - “Cash and fixed income are expensive”
Dr Don Hamson is the managing director of specialist equity income fund manager, Plato Investment Management. He and his team keep a close eye on current and up and coming dividend darlings.
One of the things they’re most interested in currently is the widespread view that equities are expensive now that they’ve rebounded from the rapid crash of last March and again hit all-time highs.
“But when you look at the way equities are priced versus other assets, starting with the risk-free rate which is also near record lows along with bond yields and with a cash rate of just 0.1%, cash and fixed income are now the expensive asset classes,” Hamson says.
“The PE of cash at the moment is about 1,000, so you need to put $1,000 in the bank at 10 basis points to get one dollar.”
He also points out that Commonwealth Bank (ASX: CBA) is currently sitting on a price-to-equity ratio of 27.
“That looks pretty rich but it's actually quite low. According to my system, Fortescue (ASX: FMG) is trading on a PE of 9 and a dividend yield of 14%. And bank interest is at a PE of 1000 – so, which is expensive?”
GLOBAL EQUITIES - US market dominance feeds “stagflation” fear
Zooming out to global equities, Jacob Mitchell, CIO and lead portfolio manager at Antipodes Partners, isolates the dominance of the US within the global benchmark as a defining feature of his asset class today. The US currently comprises almost 60% of the MSCI All-Countries Weighted Index.
“The US has had a good reopening. But we think most of the stimulus, let's call it the economic impact of the stimulus in the US, is likely to peak at the end of this year,” Mitchell says.
“The US is overweight companies that have had tailwinds in terms of cloud and eCommerce adoption. But then there are two other areas where I think those tailwinds are very transitory: in the Trump era tax cuts and the US’s outsized COVID stimulus.”
He suggests that with the US market currently trading at an estimated 65% premium to the rest of the world, its valuation multiple is vulnerable particularly if the job market hasn’t fully normalised when the last stage of income stimulus expires in September, “the stagflation scenario.”
“We don’t see US core inflation peaking until the end of 2022.”
“I’d also emphasise the extraordinary retail investor participation in the US. You must look at where we potentially are in that cycle. Are we at the point of peak euphoria? I think we might be,” says Mitchell.
“People have been at home trading or even if they’ve been at work, they’ve had surplus savings that they’ve put into the market. That can quickly reverse and we’re not seeing that same level of risk in other parts of the world given lower starting multiples and a better fiscal backdrop.”
“As this all unfolds some very resilient businesses around the world across the growth and value spectrum – those that are market leaders and in a better position to manage inflation through their cost base and pricing power – continue to trade at relatively attractive valuations.”
FIXED INCOME - QE embrace marks a changing of the guard
Zooming out further still to the more macro-oriented credit markets, the shifting policy stance of central banks including the RBA is highlighted as one of the most interesting developments of recent times by Ying Yi Ann Cheng, portfolio management director at Coolabah Capital Investments. She points to the widening yield spreads between state government bonds and their federal equivalent.
“We think state government bonds are quite attractive and there’s been a recent blowout in spreads, which has been driven by the NSW funding shock,” says Ying.
“The irony here is that government bond rates have moved lower but so too have state government bonds – we call it the G-spread – the spread over the government bond term.
“And something that we think is going to allow that is the fact that the RBA has stated that quantitative easing is no longer an “unconventional” option but is now a more permanent part of its toolkit, given the success of its QE programme in helping manage the Aussie dollar and setting the borrowing cost,” she says.
“This will become something the RBA will use more often, in conjunction with traditional overnight cash rate labour, to influence both short and long-term interest rates.”
COMMERCIAL LENDING - Why debt securities are thriving
Higher rates of commercial lending are one of the most interesting features currently for Metrics Credit Partners managing partner Andrew Lockhart. Metrics packages up debt securities from Australian corporate loans to borrowers, who are drawn from a broad range of sectors and various parts of the credit quality spectrum.
“Commercial lending is the big one for us, along with M&A activity – they're the sorts of things that create opportunities for us to lend for new transactions,” Lockhart says.
More broadly, he’s also interested in the solid performance of his asset class. “Over the last 12 months, we’ve seen a lot of companies completing deeply diluted equity raisings and destroying value for existing shareholders. We’ve also seen companies that were subjected to cuts in dividends and distributions.
“So, unfortunately for investors that have been heavily weighted to equity in times where markets are volatile, our asset class delivered exactly what it was expected to do. It provided stability of capital, effectively correlation to equity, and continued delivering income.”
Register for the Pinnacle Investment Summit 2021
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