How Fidelity's Anthony Srom uses sentiment to generate value
"High Conviction" is bandied about a lot in the investing world. But how does one actually find stocks that fit the bill?
For Fidelity’s Anthony Srom, in large part, it's a function of misguided sentiment.
"The process for me revolves around looking at fundamental sentiment and valuation for every company," he says.
"Negative sentiment is a very good filter for me in terms of idea generation in the first instance."
When market sentiment swings too far, opportunities arise. It's from here that Srom is able to identify the companies that have a shot of making it through his filters.
In this wire, Srom takes us through this process and backs it up by identifying some stocks in Asia-Pacific that have been dismissed by the market - in his view, unfairly.
"It's just a question of when will the market reward such a company," he added.
He also dives into China's property crisis and what that means for investments in the Middle Kingdom.
What is your approach to investing across the Asian region?
Anthony Srom: My approach to investing across the region is very much focused on companies that will make a difference to fund performance. It is very much bottom-up stock selection, rather than looking for thematics to invest in or countries that you think are more favourable than others and delving into them.
Each company has got to stack up on its own merits for inclusion in the portfolio and meet a return threshold. The portfolios I manage are relatively concentrated between 20 to 35 stocks, and they are very much portfolios of pure stock selection rather than thematics.
How do you identify your high conviction stocks?
The process for me revolves around looking at fundamental sentiment and valuation for every company. Negative sentiment is a very good filter for me in terms of idea generation in the first instance.
You can see which country, industry, or stock is either loved or hated. When the market is dismissing something, I want to know why. Is it just giving up? Is it overlooking potential alpha opportunities? That's how I filter in the first instance.
The second instance would be very much working with the analysts to identify the companies they hold favourable views of. The analysts internally at Fidelity have a good track record of generating alpha on their buy recommendations, so I'll also listen to that.
Are there commonalities across the trades in your portfolio?
The consistent one that I've seen through time is a gravitation towards quality companies, and long-term structural winners which have been oversold (i.e. placed in the sin bin for whatever reason).
That is the ideal candidate that I look for. Over the years of managing money in Asia-Pac ex-Japan, there have been a number of opportunities to have companies included in the portfolio that meet that criteria.
Could you discuss your two highest conviction investments?
Firstly, Focus Media (XSHE: 002027) in China, and Tectronic (OTCM: TTNDY) that's listed in Hong Kong. Just stepping through Focus Media, why is it a top five overweight? Basically net cash balance sheet, good management, duopoly industry structure, and rational pricing.
This industry is digital display advertising. Which again has favourable long-term structural underpinnings, coinciding with a very deep down cycle at the moment in China. We think that the trough has passed in China, in the sense that revenue growth was comping minus 80-90% in March/April when they had severe lockdowns. That's much more like minus 30% now. Last quarter the result was a 30% net margin.
Even in very challenging operating conditions, financial metrics are favourable. Now it's just a question of when the market reward such a company. Not just yet, but for me looking multi-year into the future, it has an asymmetric payoff profile that the fund is looking at.
The other idea referenced was Tectronic. That's a power tool manufacturer with a decent amount of production in Vietnam, China, and increasingly North America. It has negative sentiment, as the market hates anything US home builder related at the moment.
Markets are overly focused on 30 mortgage rates going up, house affordability is decreasing in the US. Why would I want to buy a company like that? My perspective is okay, that's one part of the equation. That's the negative sentiment, but favourable underpinnings would be things like a shortage of housing stock in the US, and infrastructure spending in the US over the next three to five years.
Tectronic is very much tied into the professional segment of the market (tradesmen). A lot of their competitors slashed their R&D budgets, so they're lagging on the transition from corded to cordless.
What we're seeing is constant market share gain. They didn't cut R&D, their margin is improving, and so we try and look through this cyclical downdraft that the market is overly fixated on at this particular point in time.
What have the challenges faced in China's property industry meant for China and Chinese investments?
Obviously, the epicentre of the impact on investments is the property market within China. I think the leadership of China had good intentions in terms of reigning in the property market. We've seen a lot of speculation, and a lot of elevation in terms of pricing.
The ramifications have turned out worse than anticipated. This time last year, when they brought out the three red lines policy to reign in gearing with the developers, I don't think they would've foreseen property construction down 45% 12 months later.
What are the ramifications? Well, I think there's a lot of hope in the market that there's a big bang stimulus going to come out of China to address the economic softness. I don't think that's going to be the case.
I think China can't afford the massive stimulus packages that they did in the past. We're going to see much more targeted support for the economy and certain sectors. And I don't think one of those sectors is going to be the property developers.
I think for reasons around control, they want to try and rationalise and push development more towards SOEs. There are still opportunities in the supply chain for properties, and property developers. Paint companies, waterproof companies, pipe companies, etc. I see them as being decent beneficiaries of the industry's shakeout that we're seeing right now in China - in the sense that the strong will survive.
You're going to see more marginal payers going bankrupt, and therefore once we pass through the cyclical trough, more concentrated industry, more pricing power, better margins, better returns, and so on and so forth within China.
In terms of the region, what are some of the knock-on effects that we're seeing? Obviously softening in commodity prices is one thing that comes to mind. Commodities are not a sector that the fund has invested in directly year-to-date.
There's a lot of optimism in the first half of the year around Ukraine/Russia and elevated commodity prices, but we didn't buy that view. Another ramification from all of this would be if there's further softening in some of the commodity producer share prices, then that would be fertile hunting ground for ideas.
A growth opportunity to big to ignore
In the last two decades, Asia has become a powerhouse of the world's economy, contributing more than half of global GDP. Led by China's rapid growth, this trend is likely to continue. Visit Fidelity's website to learn more.
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Sara is a Content Editor at Livewire Markets. She is a passionate writer and reader with more than a decade of experience specific to finance and investments. Sara's background has included working at ETF Securities, BT Financial Group and...