How eight fund managers are tackling the great regime change in markets

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They say the only constant is change. Markets are, once again, going through a season of change. But this time, the change is being seen as more of a "reshape" than just a pivot.

The post-GFC, more than decade-long, unprecedented monetary policy experiment that the world embarked on is finally being unwound. Long overdue inflation has arrived with a vengeance, and interest rates are rising. Asset classes are going through major pivots, with bonds finally looking attractive for the first time in more than a decade and equities taking a leg down. 

And this is to say nothing of the socio-economic transformation the world is going through. Climate change, new technologies, demographic shifts, changes in the way we work, eat, play.

Indeed, the great reshape will be the topic de jour at the Pinnacle Investment Summit taking place this week. With all this in mind, we took the opportunity to ask six managers from the Pinnacle stable to give us some insight into the big opportunities they are excited about over the coming 12 months.  

Dr Don Hamson, Plato Investment Management MD on the once-dividend darling making a comeback

Hamson has been in the investment game a long time. Ever since he started as an analyst at Brisbane-based QIC in the early 1990s, he says there has always been one constant in his investment career - the desire for income. The only problem is that the best sources of income change all the time. Hamson argues this is why active management is so crucial, even if you plan to passively live off dividends for years to come.

"You only need to look at the performance of fallen so-called dividend darlings to understand that a set-and-forget approach to dividend investing doesn’t work," Hamson says.

A perfect case in point? Telstra (ASX: TLS)

It was historically a dividend darling. In 2017, the final dividend dropped by four cents to just 11 cents per share. That caused Hamson to pull the plug on the Australian giant because it was looking like a dividend trap. All that has changed.

"Right now we think Telstra might once again be looking like an attractive company for income investors after a strong annual result which included strengthened FY23 guidance and increased final dividend," Hamson says.

But, as is the case with all investments right now, inflation is the top concern on investors' minds. Interest on cash may have ticked up from historic lows, but the purchasing power of that extra income is nowhere near as valuable as it used to be. Hamson argues that means it's time to take a look at the companies paying out the dividends, rather than simply the number.

"Dividend investors need to be cognisant of the impacts of inflation and rising interest rates on different companies and industries and consider if their investments have pricing power and the sort of business resilience needed to withstand the potential for a lengthy period of inflation volatility," Hamson says.

So what's an example of a long-term theme that can also pay sustainable dividends going forward? Look no further than the net-zero trade.

"We believe that the decarbonisation of the global economy is the mega-trend that will define the next thirty years, upending markets in much the same way digitisation and the internet disrupted industries over the last thirty years," Hamson argues.

Blake Henricks, Firetrail Investments on the investment that can keep on giving

The one constant in equity markets is that there are always opportunities even when market conditions are tough. At Firetrail, we believe that every company has a price. And the recent market uncertainty has created opportunities to buy select companies at discounted valuations. The biggest factor to consider this time around is cost - namely raw product and labour costs. 

So what's the secret to nailing great returns in this market? Being nimble and clever.

A lot of investors believe that buying quality or high growth companies will always outperform over a cycle. But the reality is that investing with a style bias can result in long periods of underperformance.

But a style bias to investing doesn't mean you can't have long-sector or stock-specific positions. Blake's most bullish position is a bet that he thinks could last for years to come - ASX energy companies.

The winners will be high quality energy companies, with low-cost operations, and a plan to help with the transition to renewables. The good news for Australian investors is that the Australian market is home to world class energy companies, which are trading at compelling valuations.

David Wanis, Longwave Capital Partners CIO shares two ASX small caps with the quality to weather the storm

Small-cap investors know their field intimately, especially the companies in which they choose to invest in. As we enter this changing world order, Wanis says small-cap investors need to remember the one key constant: quality comes from experience, not from businesses actively jumping on new fads.

"Remaining disciplined in ensuring your investments are in real businesses, generating and growing cash flow, with strong balance sheets and managed by capable and aligned executives is often harder than it seems," Wanis says.

This is particularly true in the world we now live in. As interest rates begin to rise steeply around the globe, so does the cost of capital and servicing debt. After more than a decade of free money, companies with large debt holdings and small margins on their balance sheets are being tested more than ever.

Change also brings uncertainty - and if there is one thing investors unilaterally hate, it's uncertainty. However, investors also love chasing the next great prediction but Wanis argues that this consistent chase is a sign of investing bias. 

"Overconfidence remains a stubborn behavioural bias. Portfolio concentration sounds like something that should work - after all, who wants to invest in their 26th best idea?" He adds that be it running an extremely concentrated or diversified portfolio, it's the skill of the manager rather than the number of stocks in each fund that separates the good fund managers from the great.

So, if skills are so important, then where are the best small-cap opportunities going to be found from the end of 2022 onwards? Wanis says it's all about finding companies that deliver real value while still bearing a cheap price.

"Two stocks that are examples of this opportunity are New Zealand transport company Mainfreight and Australian mining technology company Imdex," Wanis says. 

"Mainfreight (NZX: MFT) has delivered to shareholders everything the disrupters promise but few achieve. After 45 years in business, they still have a huge runway of growth in front of them as their North American business is today the same size as their NZ business, in a market more than 50x as big," Wanis argues.

"Imdex (ASX: IMD) shows that innovation can successfully be done inside a profitable and growing business," Wanis says. 

"If successful, their investments will lead to 1) much larger revenue, 2) sustainably higher margins and 3) a more predictable business. Success in any one of these will create meaningful value not currently reflected in the stock price. Should they deliver two or all three outcomes, the upside is significant," Wanis adds.

Michael Bell, Solaris Investment Management CIO on negotiating old world and new world investment ideas

Spoiler alert - there will always be bull and bear markets. A group of investors always believe we're in an uptrend or due for one. Another group will say a downtrend is nigh. Where are we in that cycle now? We're sure you have your own opinions formed by research and personal sentiment. But Michael Bell at Solaris is (politely speaking) not interested. 

"We don’t worry about where we are! In fact, we enjoy volatility and the opportunities it presents," Bell says. 

But there was one event this year that almost no one could have foreseen coming - the Russian invasion of Ukraine. The war, now six months and counting in length, has demonstrated the importance of global energy and food security. It's also brought along a new step in the deglobalisation story as countries seek to secure their own gas and oil supplies away from the major players. All this is happening in the face of old-world energy underinvestment in favour of renewables. This, in Bell's view, will make for an interesting medium-term.

"As Europe pivots from its dependence on Russian oil and gas, alternative supplies require enormous investment, which may take years to develop. In the meantime, the energy cost for companies and consumers will remain high, and there will be winners and losers," Bell says.

"It’s almost impossible to pick the next unknown but what’s important is protecting the portfolio from unknowns," Bell adds. That explains why Solaris' approach is to create a portfolio that can weather as many unknowns as possible. While crude oil-linked stocks have certainly had its time in the sun this year, there is no reason the decarbonisation megatrend cannot pick itself up again. As a consequence, Solaris remain bullish on the energy transition thematic.

"There is significant capital investment required to facilitate the transition across many sectors. Our portfolios have exposure through companies that produce, invest, advise, develop, and finance the commodities and products that will facilitate the transition," Bell adds.

Andrew Lockhart, Metrics Credit Partners Managing Partner on the growing private debt market in Australia

As this latest period is reminding everyone, volatility and uncertainty hurt investment returns - so a little defense never hurt anyone. But fixed income asset prices have also struggled in the post-GFC era, only coming back to life in recent months. Indeed, it's taken a rush in easy money unwinding to make government bonds more attractive again. Only for bonds to record its worst first half since 1990.

Andrew Lockhart of Metrics argues this highlights why traditional bonds are no longer reliable - sending investors into the search for alternatives. So what do you need to know? Not all debt is created equal, nor are the people and companies who issue them.

"If you are going to invest in this space you need to know what drives the borrower’s cash flow and how much control they have over it through the business cycle," Lockhart says.

"Private markets represent a huge opportunity for investors. Australia is one of the fastest-growing markets for private capital, as it catches up to gains in European and US markets," he adds.

Andrew Parsons, Resolution Capital on why broad assumptions about real estate are dangerous

The last time interest rates had a 10 in front was the early 1990s, but that doesn't mean the story has changed from that time. The REIT space is still a sector considered to be vulnerable to rising interest rates, especially when supply is in excess. But Andrew says this argument is too broad-brushed.

Whilst long-term interest rates do affect the cost of capital, provided there isn’t excessive property vacancy levels, a growing economy should drive higher tenant demand to compete for limited space.

The secret, he says, is to look for specific properties and assets that can weather inflationary environments. His formula is three-fold:

  1. attractive supply and demand characteristics that can help create pricing power 
  2. strong balance sheets to ensure the debt load is manageable through the cycle and 
  3. quality management teams that are capable of extracting the most value

...and the unofficial fourth part of the formula: location, location, location!

In the immediate future, Parsons says the best opportunities will be found in counter-cyclical REITs. This means finding assets that have less exposure to economically sensitive areas of the market, with the intent of creating a more resilient portfolio. The good news is that many of these REITs are accessible on share markets. The only catch is that some, like Parsons' preferred pick, may require a global lens.

A company enjoying favourable trends is Welltower Inc (NYSE: WELL). Welltower is the largest diversified healthcare REIT in the US, with approximately 63% of its portfolio is concentrated in seniors housing. Seniors housing is benefiting from both cyclical and secular tailwinds.
Welltower is expected to see occupancy recoup the 13% lost during the pandemic by the end of 2023, all the while growing rents above inflationary levels as prospective tenant demand for this demographically necessary housing format remains strong. 

Marcus Burns, Spheria Co-Portfolio Manager on why unique research pays off

The free money build-up over the last ten years has not gone unnoticed. The COVID-19 pandemic helped accelerate this build as governments paid out billions in stimulus payments to keep economies afloat when no one could work. But instead of stimulating the economy in the traditional sense, the pandemic created a new kind of spending as a new influx of retail traders flooded the market. 

These traders sent certain stocks into the stratosphere, with only the unwind of free money bursting their bubble. Marcus Burns at Spheria argues that this is one thing investors cannot ignore - and he has a guess as to where the next bubble is being created.

"We have seen the vocation sector come and completely go, BNPL which got hugely overvalued on growth prospects that were begging for an actual business model and now we believe the lithium sector is experiencing the same hype unsupported by likely longer term fundamentals," Burns says.

So how is he preparing for the great reshape when others, including his own colleagues, are harnessing the energy transition trend with such high conviction? Burns says it's not about predicting when the rain comes, but building the proverbial tents to shield them. 

"We manage this by looking for low gearing, consistent cashflow generation and valuation upside," Burns says. 

"The most exciting areas to us are the least researched ones. This is where we believe bottom-up research with sound disciplines can generate excellent returns. To this end, microcaps remain an attractive area," he adds.

Jacob Mitchell, Antipodes Investment Partners CIO shares his three favourite global megatrends

Antipodes Chief Investment Officer, Jacob Mitchell, notes that there has been a seismic shift in the economic landscape, which means that “winners of the past will not necessarily be winners of the future”.

He points out that the last 30 years have been defined by falling interest rates and inflation, low volatility in GDP growth, and supportive central banks. Most notable of them all is the US Federal Reserve - which stepped in at the first sign of asset price volatility. This created the "Fed put" which is now so closely watched in markets.

But now we are faced with multi-decade high developed world inflation and central banks tightening as economic activity slows.

Mitchell goes on to say that “The one constant in our asset class is the importance of starting multiples.” He feels that starting multiples were ignored by too many investors during the multi-year bull market who chased secular growth at any price, but now that we face greater economic uncertainty and higher discount rates, the market will be more focused on valuations than at any point in the last decade.

“Investors will need to be selective against a backdrop of inflation”, says Mitchell, adding that equity markets will become more stock specific, and tight credit conditions will see the market revert to favouring resilient businesses with strong balance sheets.

As for advice, Mitchell is all about quality. “It is important to have exposure to owning resilient businesses, that have the ability to take profitable market share in a backdrop of higher inflation and those better positioned to weather a tougher economic environment, that is market leaders that aren’t under the threat of disruption.” 

So, with that quality overlay, which trends have Mitchell most excited? He cites supply chain strengthening, decarbonisation, and infrastructure as the areas of focus.

“These are all areas where we are finding good long-term opportunities for global equity investors, and our portfolio is well positioned for these trends,” says Mitchell.   

Recapping The Key Ideas

  • All roads lead to quality investments
  • Decarbonisation is a thesis that continues to remain intact despite the war in Ukraine
  • The places to find real value change all the time
  • There are still asset bubbles out there - beware those

Learn More

Since 2016, Pinnacle Investment Management’s annual Summit has been showcasing the best investment ideas from across Pinnacle’s global multi-affiliate network. This year the event is being held across Australia from August 29 – September 8. It features insights from Antipodes, Coolabah Capital, Firetrail Investments, Longwave Capital, Metrics Credit Partners, Plato Investment Management, Resolution Capital, Solaris Investment Management, Spheria Asset Management, and Netwealth.

Financial advisers, researchers, and other wholesale investors can register to access replays here, or contact distribution@pinnacleinvestment.com to enquire about attending or to hear more about Pinnacle’s affiliated asset managers.

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