WAM Leaders Lead Portfolio Manager Matthew Haupt knows what a challenging time it’s been for investors, especially following the recent reporting season that saw a number of companies either postpone or cut dividends – in some cases by up to 30%. COVID-19 eroded many a balance sheet leaving boards overly cautious and wanting to preserve their capital.
However, in his WAM Leaders fund, not only was the dividend increased, but it was increased by 15%, a remarkable achievement in this environment. And there is a number of reasons why this occurred – not least was Matt’s customised shopping list, compiled using a simple checklist of companies’ share prices based on their GFC levels. This strategy helped take the emotion out of buying – and selling – and the results speak for themselves.
In this Q&A, Matt Haupt explains his team’s checklist in more detail along with the other factors that allowed the fund to deliver a great positive performance in a very challenging year.
The WAM Leaders portfolio is positive in a year when much of the market was negative. Can you walk investors through your investment process?
The way I look at stocks or the portfolio is a combination of a bottom-up approach but also a top-down. The macro thematics play a very important part in how the portfolio is managed. The macro is the lifeblood of the world the economies. So we really need to pay respect to some of the movements there: throughout the period we had the big fall, the crash in March off the pandemic, but it created a lot of opportunities. Quite often, markets go into oversold positions due to fear and we were able to capitalise on these and a few of the macro thematics around – especially in the steel industry coming out of China. So the China strength was really a macro thematic we played, but it was a combination of the macro thematics and the bottom-up approach, which allowed us to deliver results in an otherwise very tough year.
People often talk about short-term trading being bad. Can you describe Wilson Asset Management's flexible high-turnover strategy?
There are really two components to this. One is trading on stocks at a stock level. There's also the macro thematics. At the stock level, quite often, you'll get intra-sector moves. For example, between Woolworths and Coles. On one day, Woolworths will be up 1% and Coles could be down 1% and you try to work out is there a fundamental reason for this? And sometimes we'll trade that, if it feels like an arbitrage opportunity.
On the macro thematic level, quite often, the way a macro thematic plays out is not in a linear fashion. You'll get movements in the underlying macro drivers. And we will up and down our weight space of that.
So there are really two aspects to that trading: one at the stock level and then one at the macro thematic level.
What are some of the macro thematics, which are really standing out?
The clear one is rates are lower for longer. That has been well known, but it was really reinforced at Jackson Hole when Powell talked about the mandate change, and rates being lower for longer, trying to help overcook inflation if they can. So I think investors need to be focused on lower rates for longer. What will change is nominal rates won’t change for a long period of time – that could be three to five years of no change in nominal rates. The real rates could change dramatically, and that is for inflation. So if nominals stay low, inflation picks up, you're going to have real negative, real yields fall even more. So that's a key thematic we'll be playing and you can play that through a variety of ways, traditionally as play through long duration assets, which we're seeing with tech and the higher risk players.
But I think as time develops, this cyclical rally will pick-up, and given conditions are very supportive, very loose on the financial and monetary settings, I think cyclicals will play out. And the real way you're going to outperform now is picking that inflexion point between the long duration and switch to cyclicals, which I think will happen in the next six to nine months. But that will be a real key thematic.
What's the key signal you're looking for where you know you’ve reached the inflexion point?
I think the key thing to watch is the US 10-year rate and the spread between the two and 10 years - so the slope of the yield curve; what we need to see is a pick-up in the slope of the yield curve. As we talked about, the nominal rate will be set low, so the short end is almost anchored. What we need to see is a long end of the curve pick-up – and that's the 10-year. So if we start seeing that pick-up maybe the 10-year towards around 85 bps to 100 bps, that will be a good signal. And also the two 10 spread. If we see that around 75 going up to a hundred, again, that’ll be a real inflexion point in the market.
Can you discuss cyclicals and what cyclical stocks you’re considering?
I think the key one here is financials. They’ve been a massive underperformer for a long period of time, and the reasons are clear: economic conditions are poor and spreads are very low. So it's not the greatest conditions for financials. What we need to see is a pick-up in rates and spreads and the slope of the yield curve, and economic conditions.
I think financials are a very neglected sector and neglected for a good reason, but I think the conditions are almost right for a rebound in this sector and I think that will be a key sector to watch coming out of this.
On the cyclical front, we can talk about consumer discretionary, which have obviously had a really big, short-term impact from the stimulus. So I think that sector is not a place where you want to play but for me it says boring, value companies that will get a good kick in the cyclical upturn.
What's one boring value stock you've got very high conviction in?
There's a couple at the moment, so I'll touch on one: Scentre Group. So, shopping centres; everyone thinks the future's not so bright for these. Even before coronavirus shopping centres were seen as an old sort of antiquated system of shopping with everyone moving to online now. But what encouraged me about shopping centres is in July, August, there was a huge pick-up in activity once things opened up again, and Scentre Group is one company that we saw. They confirmed this, that there was a big pick-up. Everyone thinks Scentre Group needs to raise money. I don't think they'll raise money at this level. They've got a few levers they can pull, especially on the debt front. So they've got access to debt capital markets. They can sell down assets at the asset level and still maintain ownership. So I think there's a few levers they can pull before they would raise equity and they wouldn't raise equity at this point, cause it's too dilutive and there's about 35 to 40% upside if they get back to NTA. So for me, that is a very much out of favour, out of love cyclical.
Then let's turn to the inflation side of things as yields slope, inflation picks up, WAM Leaders has a hedge in its portfolio, which is gold. Can you explain your conviction around gold?
Gold has been a fantastic performer for us for a long period of time – since about September 2018, we were very long gold. Back then, when you look at how crowded the trade was, it wasn't crowded. We looked at the CFTC stats, which is speculative positioning and it was very much underweight. Now it's very much overweight. So the conviction is a little less, but the conditions are set up great for gold. You've got fear debasing. You've got expansive fiscal policy inflation coming through. So the case for gold is very much still around. I'm just going to see how gold trades when rates start going up, if they do go up. But I think medium to long term, gold is a huge outperformer. I just think short term, maybe there are a few headwinds. As we transition away from low rates to inflation, there'll be an adjustment period. So gold, is still very much a position in our portfolio – around 3% of the portfolio – but to get higher conviction, I just want to watch how that transpires as we go through that inflexion point.
What's a gold stock WAM Leaders likes?
We like Saracen; they’ve got a good growth profile and also Newcrest as well. Their acquisition recently of Red Chris was great. So they are the two high-conviction gold stocks I like.
What’s your view on the technology sector? Are we experiencing a tech wreck or a correction?
It's a tough call. August was clearly exuberance. There was all these external factors driving the market up – through retail call options, there's the talk of the SoftBank options as well. So there was a lot of forced buying. But one thing, I don't want to call a tech wreck because the conditions that led to the rally in the stocks, they still exist. So the conditions are still extremely favourable, but this leverage needs to unwind at this point. It feels like it will keep unwinding, but who knows how low.
I think it'd be a bit early to call a tech wreck.
To get a tech wreck now we'd need to see the US stimulus package passed. We need to see rates pick up and inflation pick up. And if that happened, then you can call a tech wreck but I think it's a bit too early. This is an unwind of the leverage in the system at the moment.
Are you finding any bargains and can you explain your positioning in tech?
We still have a very small position in technology. If you look at the Aussie IT basket, we own realestate.com and a tiny bit in Seek, as well, due to fundamental conditions. But we're not playing any of the momentum tech at the moment because there is really no floor to their valuations. And it's very much driven on momentum. And at the moment, momentum is in the online phase. So we're not playing that space.
What would convince WAM Leaders to buy into it?
If we saw another leg down in the rates environment and the slope environment, so the slope started to compress again, we would get favourable on technology. But at the moment, the rates and slope are flirting with breaking out. So we're not going to play this space cause you've got the unwind and a flirtation with some of the rates and slope. And there's a few key catalysts coming up, with the CPI in the US and also the care package we talked about in the stimulus in the US.
What are some of the signals that investors should watch right now?
I think volatility is one. So you can look at the VIX, which is the most common measure across various indices, but generally you just look at the S&P 500 VIX, and you can look at the Australian VIX as well. So this is a volatility measure that shows you people's appetite for buying risk or hedging risk. At the moment it's sitting around 30 in the US. In the unwind, it feels like we could go higher. Generally I've got a rule where if VIX hits 35,40 – in that range – and fundamental conditions aren't deteriorating, it's generally a pretty good buy signal. When VIX is sitting in the low 20s, around 20,21, 22, generally, that's not a great buying signal. But it's signalling there's a lack of, or a bit of complacency around. So I think VIX is a good signal. Also, a few of the metals are a good signal. The copper is a good one, the copper-gold ratio. So there's quite a few, but generally you'd want to watch volatility because it just gives you a signal around how people are pricing risks.
Let's turn to the commodity sector. You’re hoping to see the supply-demand equation come back into balance, which would be a good thing for oil stocks. What is the situation with oil?
Oil's tough in the moment. A lot of people were saying this latest fall in oil was due to demand, but I'd argue it was due to risk appetite. So when the NASDAQ fell apart, volatility exploded and oil, you find a lot of the time when volatility explodes people unwind risks across portfolios. So hedge fund managers might have a value-at-risk measure and it gets hit and they have to adjust and they always sell oil.
Oil always gets hit in the first liquidation event and has been hit again.
On the fundamentals, oil use is grinding up so I think the dynamics are very much in favour of energy in the long term. This short-term noise we're going through on our risk unwind will probably continue for a week or two. There is talk of OPEC extending cuts, which will be a fantastic positive cause US shale is falling apart, and the oil demand will come back. There's about 15 million barrels-odd per day to go to til we get back to normality. So I think the conditions are still very favourable for energy.
What is WAM Leaders’ weighting for oil?
The weighting is around 4.5%, predominantly through Santos and a little bit through Oil Search as well. Woodside is starting to look attractive at these levels, at around $18-odd, but again, it's got its own issues at the moment with the growth profile and some of the moving parts that need to happen in the short term. But I think Santos, Kevin Gallagher is a fantastic CEO, who has put that company in a great position to have the most flexibility and is probably one of the best operators at the moment.
Adjacent to energy is resources and you made a call on Fortescue at $8, which is now around $16. Where are we at for iron ore and resources?
Iron ore still looks quite favourable. The pick-up in China was fantastic. The use of steel; we were growing 8% year on year in a few months. So iron ore still looks pretty good. When we talked to Fortescue last year, they were talking about some of the port inventory. With the fines product, the port inventory was around 60 to 65 million tonnes. And normally that sits around 80 to 85 million tonnes. So there still was a shortage of inventory at the port for the fines product. So I still think conditions are fantastic for iron ore. Vale is obviously increasing some of their output, but the rest of the world should pick up steel production, which hopefully will soften or absorb some of that Vale supply. So iron ore still looks good. They’re producing huge amounts of cash at these levels and it still looks like a good forecast period for them.
Is there any other sector that you want to point out that you're extremely bullish or bearish on?
Insurance is an interesting one because everyone's really worried about business insurance (BI) through the pandemic and closures of business. I think there's a great opportunity here for IAG. That's been sold off aggressively. The company is taking a very conservative approach. The share price is almost factoring, you know, a $1 billion, a $1.5 billion of claims in business insurance. And I think the claims will be much, much less. So for me, IAG is a clear standout and the premium cycle is hardening very fast. So I think insurance looks good. And obviously that’ll get a kick up if rates go up as well. So you could get a double kicker here through sorting BI out and then getting a rate increase too.
How much is the cash weighting in WAM Leaders?
Cash is around 5.5% at the moment.
How's that changed over time?
It's changed a little bit, not a huge amount because the way the portfolio is set up, you balance out the risk. So sometimes we can take cash up, but the beta of the portfolio could move around a lot, too. So when we look at the portfolio beta, it’s probably around 1.05. So for every 1% the market moves, the portfolio will move 1.05%. So it's got a fair bit of beta in there at the moment.
Will the 10-year signal make you chuck in all of that cash back into the market?
I think the mix will change. We generally like to run a little bit of a cash buffer for flexibility, but the composition will change dramatically. We would take out a lot of those beneficiaries of the low rates. So a lot of the REITs, which are more priced on cap rates rather than activity will get reduced, and there'd be quite a few funding sectors: consumer staples will probably be ruled. We’ve reduced that and put them into the financials.
In a year when the market has been cutting its dividend by around 30%, the WAM Leaders portfolio has increased its by about 15%. Can you explain how this was achieved?
The way we pay the dividend is a combination of the income we receive from our positions, but also the capital gains that we make. So at the moment in WAM Leaders, we have around almost three years of dividend coverage at this level. We're in a very strong position on capital and we can keep paying that dividend at those levels for the next, I think it's 2.75 years.
Is that capital gain sitting there banked and you don't touch it or does it go into the rest of the investment pool and you're still trading it all?
No, that's in our account as a profit reserve. That gives us the ability to pay out of that profit reserve for that period of time. So no matter what happens with the markets, obviously it's a board decision, the dividend, but we have the ability to pay a dividend for those amount of years.
What's the biggest investing lesson that you've learnt or found this year?
I think it's around fear. In March when you got all the commentators saying the world's going to end, and all the companies are worthless, we did quite an easy exercise. We went back to the GFC and we printed off all those stocks and all the share prices around the GFC levels. And then we just started shopping. We had a shopping list of all the companies, which were hit. And one, for example, Stockland, was back at 1991 levels, which was our last recession. So Stockland at that price was a no brainer cause we had this massive policy support, which we could see was coming. Star Group: the casino operator was trading well below its net tangible assets. And again, they've got, you could call it not a monopoly, but it has a licence, which can't be replicated. So you're buying this business below its book value.
There were numerous examples of these through that period.
So if you keep your head, take the emotion away and just look at these share prices and push them against fundamentals and have a look.
But just don't get caught up in the greed and also the fear, I should say. But the greed similarly, like in the tech, when it's too easy, then it generally ends pretty fast.
Can you explain more about the checklist?
It was quite simple. It was an outright share price level, a PE level, and then a price-to-book level. So three columns, with each ASX 300 stock and comparing it versus the GFC as one check. Some of these companies like QBE at a time had the trifecta. It was a lower PE than the GFC, a lower PB and a lower, absolute share price: the trifecta. So when you look at it like that, it takes away some of the emotion around it. And is it as bad as the GFC? The hit was probably worse, but we knew the policy was coming and the duration would be shorter. So it's really a case of just having a few simple checklists and then going through them.
As you're going through that experience, especially with COVID, some people might think that the world's changed and we’re all going online. What business is going to go broke? Who's going to need more insurance policies, etc? How do you think about what the valuation is versus any structural changes happening to those same companies?
When you go through history, everyone overestimates the change that will happen with the world.
Like you look at the events we've gone through over history and nothing really changes dramatically. So in the midst of the event, you feel like it will be a world-changing event, but then normality comes back quite quickly. So we've been through numerous wars and pandemics and all sorts and nothing really deviates too much from the mean. So you get that initial shock, but then life goes on. But in the midst of it, it feels like it is world changing. But history has shown through many, many events, things don't change dramatically on a lot of the way humans interact and also spending patterns are incredibly sticky as well. One of the most stable things is people's consumption. The big variables are business investment, and they are the ones that swing around more dramatically, so they are the areas we have to pay attention to, but people’s spending is remarkably resilient.
What's one process improvement you're going to make to the management of WAM Leaders?
It’s probably going harder on positions when they present themselves and trying to capitalise on them more. It's a double-edged sword because if you get it wrong, obviously you'll, you lose more. But I think when you've got the high conviction, it’s really trusting your instincts and probably going a bit harder, because if I look at some of those opportunities we talked about earlier, we should have put a lot more capital into those at that period of time. We were going for those, but also trying to hedge out a little bit of the risk. But in hindsight, and even in fear periods and in greed periods, it's probably going a little bit harder in that direction, but that's probably the main thing I could take out.
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I like Matt's comments "When the money is too easy, it also ends fairly quickly,." The recent correction in the tech sector is a perfect example.