It's a three-headed Hydra: why loading your portfolio with FAANGS might no longer cut it
One is inflation, second is COVID, third is debt on both public and private balance sheets. Here we provide a few factors we've been considering at Pella Funds Management.
COVID and Omicron are obvious threats, if we were to somehow deal with COVID we would then be faced with an even more threatening inflation problem due to the demand impulse. Similarly, if COVID is persistent and further government stimulus is required, then we run into a tight supply and strong demand scenario and hence compounding the most significant problem, inflation.
If we deal with inflation by raising rates, this will impact government balance sheets by raising interest repayments and unsettle economic activity and markets generally. Therefore, we don’t see an easy way out for policymakers right now, because the “goldilocks” days of perpetually muted inflation appear to be over.
How do we deal with the next three years?
Higher volatility is bound to be a more permanent feature. Momentum, growth at any price and meme investing will subside as factors. Momentum investing (amplified by massive ETF inflows) has been a winning formula for over a decade and our sense is that many investors have simply jumped on board (with evidence of significant “crowding” in a relatively small number of very large US-based names). This will surely change.
At Pella Funds, we think the next three years will be an opportunity for truly active managers to shine. We will continue to focus on businesses that are growing/winning and we will remain very disciplined on the price we pay for those businesses.
When it comes to addressing volatility directly, we look at a company like Flow Traders in the Netherlands which thrives in volatile environments. With all the uncertainty surrounding the US Fed, you are bound to see heightened bond market volatility. When combined with lower amounts of QE, a company like CME in the US should benefit.
From a regional point of view, we feel that the European markets have been largely overlooked (vs the US market) and now offer much more attractive value. So much attention has gone towards the US market that many global markets have been largely left behind. Within Europe, we like the Nordics, due to their sustainable government debt balances (Debt/GDP <50% vs 100% for Eurozone and >100% for USA), a higher resilience to crises and their strong ESG credentials. Within these markets we own companies like Orsted, Novo Nordisk, Epiroc, Stora Enso, and Atlas Copco.
Cyclical opportunities are also on offer and right now we like materials such as copper that will benefit from the ongoing effort to introduce renewable energy sources. We look at miners with strong ESG-ratings as they will be able to attract better capital for mine expansions and exploration. We own Antofagasta in Chile and Boliden in Sweden, both copper miners with superior ESG credentials. It is also a time for us to focus on areas where further supply shortages may emerge as governments introduce various stimulus packages to deal with infrastructure, climate change and sagging economic performance. Companies we own that would benefit are Vulcan Materials and Weyerhaeuser in US and Stora Enso in Europe.
Lastly, on Omicron, we think it is still too early for anyone to say with certainty what this strain will do. However, one thing we are certain of is that the virus is here to stay and there will be many more twists and turns before this is over. Therefore, it makes sense to have some exposure to companies that will protect the portfolio from Omicron (or its cousins) disrupting life again. Stocks that come to mind in this regard are Moderna, Thermo Fisher and Teladoc.
Bottom line: More than ever, portfolio construction is going to be a key determinant of performance for active managers. Loading the portfolio with FAANGS + Tesla + Nvidia might no longer cut it.
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Joy is a founding partner and Head of Distribution of Pella Funds Management. She has built her career in funds management over the last 15 years. Prior to joining Pella, Joy was the Executive Director of Pengana’s International Equities division....