Why this manager is backing supermarkets, miners
Few would have imagined 2020 turning out as it has done but MLC can at least claim that thanks to its investment architecture — Investment Futures Framework — the prospect of a global pandemic was always factored in as at least a remote possibility. According to MLC Asset Management’s head of investments Al Clark, the framework considers a vast number of possibilities in order to imagine what could happen, rather than trying to guess what will happen.
“We tend to think we have a fairly unique approach, particularly to asset allocation,” he said. “The Investment Futures Framework is a scenarios-based approach to thinking about how different assets are going to behave in different environments. Rather than suggesting we can forecast exactly what’s going to happen, we tend to take a humbler approach and consider the range of possible things that can happen. How do we position for that broad range of outcomes?”
COVID-19 and its related social and economic dislocations are probably no more than a 1 in 100-year phenomenon. But this global catastrophe and other ‘tail risk events’ or ‘Black Swans’ are ever-present risks whose consequences should never be overlooked by either investors or policy makers. Moreover, these kinds of events, when they erupt, cannot be nullified by social, economic or monetary policy. While the modelling includes a range of credible possibilities, including both inflationary and deflationary scenarios, it also considers the rare and remote.
“In an environment of heightened uncertainty, a lot of the scenarios are now credible,” said Clark. “For example, we’ve been in a disinflationary environment for a considerable period of time but given the reaction to the goings-on with central banks and particularly governments, some of our inflationary scenarios are starting to get a bit more credibility to them.”
He noted that governments are behaving very differently to how they did during the 2008/2009 crisis, when they got money into the economy in far less direct ways. Central banks around the world are pumping money into their economies more directly than ever, with Australia’s JobSeeker and JobKeeper programs a good example.
“This time governments have specifically said: ‘let’s put the money where it is needed, straight into people’s pockets.’ And that is, at the end of the day, going to be inflationary,” said Clark. “Now the time between when the inflation occurs and when it becomes a problem, we don’t know. But what we do know is that some of our inflationary-based scenarios are now starting to get higher probabilities because of the reaction by governments.”
The most topical example is the impact of a large, exogenous shock to global markets as evidenced by the Covid-19 pandemic and associated business disruption. As it was, MLC’s portfolios had been defensively positioned for some time when the coronavirus landed, not because the scenario planning necessarily thought that a market shock was imminent, but because strong share market returns prompted a defensiveness against the risk-seeking we saw in the market.
“Leaning into Q1 this year, that was really beneficial to us. We went in holding quite a bit of option protection. At the time, a lot of asset prices were quite high — equites were expensive, bonds were expensive, credit was expensive. We felt that it made sense to use that protection in our portfolio,” added Clark.
Fast forward to October 2020 and one of the key insights the MLC team are getting from their Investment Futures Framework is to stay diversified. The rationale behind this is simple: in an environment of heightened uncertainty, with a number of scenarios coming into play, it is hard to prepare in a concentrated way.
“Diversification gets bandied about as a bit of a catchall phrase but in this environment one of the key insights we are getting is be diversified,” said Clark. “A lot of different things could happen. Governments could change the way they feel about shutdowns, lockdowns and we don’t know how people or companies will respond to reopening.”
The MLC modelling is also looking closely at those sectors of the economy most likely to be rewarded if governments' and central banks reflation is successful.
“Cyclical assets are quite a bit cheaper than non-cyclical assets, particularly in equities,” Clark said. “So where we can we'll find pockets of cheaper or more attractively priced, cyclical equities that are going to benefit if governments and central banks are successful in reflating economies?”
However, he cautioned that the market is starting to see supply-side constraints, where inflation will be a factor. Clark noted the example of wildly inflated domestic flights by domestic airlines – where Canberra to Adelaide tickets previously available for around $100 are now priced at $550 because of capacity constraints tied to coronavirus restrictions on the number of passengers allowed.
Rising inflation is one of several potential scenarios modelled in the MLC Investment Futures Framework. MLC Asset Management portfolio manager John Woods has identified a handful of companies across two key sectors that are likely to benefit from rising inflation after decades in the doldrums.
“Inflation is quite a significant focus of ours at the moment,” he said. “What we are looking for in our equity allocation is to take exposure to inflation without it costing us too much.”
The two ways that MLC is doing this at the moment is via supermarkets and commodities.
“Supermarkets … have been a play for the longest period of time in our portfolio,” said Woods. “One of the obvious implications of bushfires was a change to agriculture in Australia and we started to see the first signs of food price inflation, and that comes through in the supermarket sector. This trend was accentuated as we went through the pandemic.”
On the commodities side, the MLC team has also spotted opportunities in mining, a global sector knocked by pandemic shutdowns but benefiting locally from China’s early recovery.
“We will hold a position in both Coles and Woolworths,” said Woods. “We also incorporate Metcash in there as well. We think that gives us the best exposure to the thematic we are looking for here: rising prices through supermarkets.
“Mining we approach in a similar way. We still hold a basket of the three main iron ore producers — BHP, Rio, Fortescue — but we’ve started to increase our weight towards Fortescue. It’s got one of the highest dividend yields across the market.”
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