How much cash are you holding right now?

Chris Conway

Livewire Markets

When markets go sideways, there are numerous levers equity fund managers can pull to dial down risk.

Almost all can change their sector weightings and stock selection to be more defensive, departing companies with nosebleed PE’s and no earnings.

Mandate permitting, some might actively short-sell or use derivatives to capture and profit from the volatility and downside moves.

There is one other, more elementary way to reduce exposure (and therefore risk), and that is to simply cash up. You can’t lose money on capital that isn’t exposed to the market.

With markets enduring a rough 2022 so far and volatility picking up recently, the Livewire team have been reaching out to fund managers for their take on some of the big questions all investors are asking themselves right now.

In that vein, I reached out to two fund managers, Nick Griffin who runs the Munro Global Growth Fund (and who we will be featuring in an upcoming Expert Insights), and Oscar Oberg, Lead Portfolio Manager at Wilson Asset Management, for their take on the current market conditions, how they are thinking about risk, the cash levels in their respective portfolios, and a stock they are liking right now.

A difficult environment for equities

Things are tough and getting tougher was the general sentiment when asking Griffin and Oberg about the current macro environment and what lies ahead.

Griffin notes that the Fed started behind the curve in terms of tightening and that they are still playing catch up, saying “it’s clear that they are not finished yet.” Munro have been mindful of this since earlier in the year, when they flagged rate increases as the key driver of multiple derating, particularly in growth stocks. Whilst Griffin believes the rate increases are largely done, as shown on the left-hand side of the graphic below, “we are now awaiting earnings downgrades to play out in more cyclical areas of the market,” he says, noting the right-hand side of the graphic below. 

Oberg takes a similar line when talking about the macro environment, noting that since January 2020, the world has been a very volatile place and that what we’re seeing more recently is merely an extension of that volatility.

“This is almost the new norm now with markets. It has been an incredibly volatile period. I'd say it is slightly more volatile recently than what it has been over the entire period, but it feels like this is the new norm, and it will definitely stay like this for some time”, says Oberg.

It is all about company earnings

In terms of what is driving how Oberg and the Wilson Asset Management team are viewing markets right now, he says not much has changed from a process perspective. Yes, markets will whip around and the inputs will change, but the ultimate question will always be whether or not companies fit Wilson Asset Management’s investment process.

“We're looking at earnings growth, the stability of that earnings growth, and the strength of management. And if we tick all those boxes, then we’ll buy the stock”.

If that seems straightforward, that’s how it should be, according to Oberg.

“I think the mistake we can make, being focused on stock picking, is to try and call the macroeconomic environment. That’s not in our DNA. It’s not how we have invested over the past 25 years. So we’re sticking to our process.”

As for Griffin at Munro Partners, they are paying close attention to the US 10-year yield, noting that the terminal rate expected by the Fed’s tightening cycle is now ~4.20% (much higher than earlier this year).

“We believe the Fed will certainly beat inflation; the question is how much damage they will do to the economy in the process”, asks Griffin.

Griffin goes on to comment that he remains uncomfortable with the level of earnings downgrades the market should be pricing in but, there is a silver lining; “we really like our core portfolio (particularly names in Healthcare and Climate) at these valuations, so it makes sense to continue buying in cautiously, while hedging actively over live catalysts”.

So, how much cash are you holding?

At last count, the Munro Global Growth Fund (ASX:MAET) was holding around 30% cash. The natural question that follows is, what are the conditions Munro would like to see to put some of that capital back to work?

On that front, Griffin has been on record for some time noting three factors he would like to see before deploying capital and they are:

  1. A peaking of long-term interest rates: While interest rates might have indeed peaked now at 4%, higher rates for longer will likely lead to a more protracted economic slowdown.
  2. Earnings estimates to come down: Higher interest rates have caused havoc to valuation multiples throughout 2022, however we have only just started to see the economic damage that higher rates will do. Earnings estimates have only come off marginally for 2022 and analyst still expect 8% earnings growth in 2023 for the S&P 500. This seems highly unlikely.
  3. Time: The average bear market lasts just over 300 days and falls 37%, and if history is any guide, it pays to be patient in this environment. We continue to be wary of further exogenous shocks that could be precipitated by the higher interest rate environment.

As for Oberg and, more specifically, WAM Research (ASX: WAX) - which hunts down the most compelling undervalued growth opportunities and is the vehicle that we focused on for this interview - cash currently sits around 16% of the portfolio. It is important to understand, however, that level is low relative to the fund's history. Oberg is also quick to point out that it could go lower; “we're seeing a lot of opportunities at the moment. Small caps are trading at 20-year lows, relative to large-cap companies. Valuations are depressed and small caps have underperformed over the last 12-18 months.”

That underperformance has meant valuations have come to levels that Oberg and the Wilson Asset Management team like, and now “it all depends on finding companies that fit our investment process and our levels of conviction on them. And if the levels of conviction are high, then the weights in those stocks will go up. Cash is a function of what we can find at the moment in the market.”

When pushed on how the capital will be deployed, Oberg shares that it is more likely to be on stocks that they already hold and have an intimate knowledge of, rather than on new opportunities – although they are open to both.

“We have a fairly strong knowledge base of those companies we hold and we do a hell of a lot of work on them. A lot of them have been mainstays in the portfolio for a very, very long time. So, we've got a very favourable view on management, we know the business model well, and we’re positive on the outlook for earnings.”

Two stocks that pass the filters

Now that we understand how Griffin and Oberg are tackling the cash-level conundrum, it’s time to get specific. Which stocks do they like and why?

Oberg nominates Tourism Holdings (ASX: THL) – the largest motorhome rental company in New Zealand and the second largest in Australia. Oberg cites the company not raising capital since COVID-19 and a valuation materially lower than what it was before the pandemic as attractive features of the business, but there is one factor that trumps the lot.

“The real kicker, the real reason to own it, is the huge catalyst in the form of the merger with Apollo – which is the largest motorhome player Australia, and the second largest in New Zealand.”

Oberg notes that in putting the two together, “you get the largest rental company for motorhomes in the US and Canada, and a growing business in the UK.”

On Oberg’s estimates, the combined business in Australia and New Zealand commands about 60% market share, and there will be substantial synergies that will come through.

“So if you put it all together and do the work on the numbers and the synergies, the combined business is currently trading on a price-earnings multiple of seven times.

“THL used to trade at 15 times before COVID-19 started, and you could argue that the business together will be a much, much stronger business. So, you could argue that it should trade at a higher valuation. If it goes back to 15 times, well, there's over 100% upside there.”

As for Griffin and Munro Partners, they are focusing on the healthcare space and, in particular, obesity treatment.

“While the rest of the market is downgrading earnings, we see Healthcare offering protections by way of earnings upgrades,” says Griffin.

Griffin goes on to highlight pharmaceutical company Novo Nordisk (NASDAQ: NVOwhich has a drug that has the ability to take large market share by helping reduce weight by ~15-20% via hunger reduction. 

“The total addressable market is massive. Novo is only penetrating by ~5% (~$1Bn USD in revenue); this market share can get as big as ~$14Bn USD by 2030 (out of a ~$50Bn total addressable market).

Novo Nordisk and Eli Lilly are the only real players in this space, so we can see a potential duopoly-like market share capture over the long run.”


Why not let us know in the comments section below. 

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Chris Conway
Managing Editor
Livewire Markets

My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them...

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