The reflation trade – fate or fad?

While there has been a recent resurgence in some cyclical sectors like mining and energy on the back of the ‘reflation thematic’, we believe the longer-term outlook for economic growth will remain subdued due to various structural headwinds including ageing populations, high debt levels, and increasing environmental constraints on natural resources.

This means that many of the key companies that comprise the major equity indices will struggle to meaningfully grow their underlying earnings. This is especially true for average quality old-world businesses with weak value propositions and legacy technology.

For example, despite a recovery in the spot prices of oil, coal, and other commodities, it is likely that oil and thermal coal businesses will face declining demand over the next decade and beyond as the cost of renewable energy, electric vehicles, and batteries continue to decline.

Equity returns are driven by the few not the many

A low growth world is generally good for our investment style because we invest into a concentrated portfolio of businesses which we have identified as being able to grow revenues and profits organically at double-digit rates for at least the next decade.

To us, it makes long-term economic sense to be selective and manage a concentrated portfolio of stocks and to not be exposed to a wide number of average to below-average quality businesses – ones that comprise most indices and benchmarks.

Beware of the index

For this reason, we believe passive styles of equity investing are likely to produce less attractive returns than they have achieved historically because the vast majority of companies will not be able to deliver returns above the benchmark.

Our base case is for global equities to produce total real returns that average around 1.5% to 2.5% pa (3% to 4% nominal) driven by very low single-digit profit growth.

Why diversify into structurally challenged old-world stocks with declining intrinsic values?

The rise (and fall?) of passive investing

Many active fund managers fail to outperform the relevant benchmark over the long term, particularly after fees. In addition, many active managers have high average rates of portfolio turnover that can result in higher trading-related costs, higher income tax expenses, and higher short-term capital gains tax expense than would be incurred using more long-term styles.

We believe this has greatly contributed to the rise in popularity of passive investing, particularly via exchange-traded funds (ETFs), but as mentioned, we think investors will struggle to achieve above benchmark growth using such strategies.

Active ETFs

So, while investors have pivoted to ETFs and other listed products, we also see a strengthening trend towards active investment strategies over passive due to the reasons mentioned above.

It is no wonder that we are witnessing the proliferation of active ETFs as popular investment vehicles on the ASX, as they offer investors the combined benefits of accessibility and ease-of-use combined with the skills and expertise of professional fund managers.

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Disclaimer –Hyperion Asset Management Limited (‘Hyperion’) ABN 80 080 135 897, AFSL 238 380 is the investment manager of the Funds. Please read the Product Disclosure Statement (‘PDS’) in its entirety before making an investment decision in the Funds. You can obtain a copy of the latest PDS of the Funds by contacting Hyperion at 1300 497 374 or via email to investorservices@hyperion.com.au. Hyperion and Pinnacle Fund Services Limited believes the information contained in this communication is reliable, however no warranty is given as to its accuracy and persons relying on this information do so at their own risk. Any opinions or forecasts reflect the judgment and assumptions of Hyperion and its representatives on the basis of information at the date of publication and may later change without notice. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. This communication is for general information only. It has been prepared without taking account of any person’s objectives, financial situation or needs. Any person relying on this information should obtain professional advice before doing so. To the extent permitted by law, Hyperion disclaim all liability to any person relying on the information in respect of any loss or damage (including consequential loss or damage) however caused, which may be suffered or arise directly or indirectly in respect of such information contained in this communication.

Mark  Arnold
Managing Director & Chief Investment Officer
Hyperion

Mark is a Senior Portfolio Manager at Hyperion. He has been a core part of the investment team since Hyperion’s inception in the 1990s and has been the Managing Director since 2019 and Chief Investment Officer since 2007. Mark has spent over 25...

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