Tony Cousins, CEO of Pyrford International and Portfolio Manager of the Nedgroup Investments Global Cautious Fund, shares how their strategy unfolded in 2020, where he sees markets going in 2021 and how the Fund is positioned.
Q4 Fund performance
2020 was obviously a very volatile year. The Fund achieved its objective of beating the benchmark with a total gross return of 4.8% for the year. All asset classes in which we’re invested generated a positive performance with bonds returning 3.2% and equities 2.9%. The decision to increase the equity weighting in March, as the market fell sharply and better value emerged, was positive for the Fund as equities rose sharply thereafter. The non-US dollar exposure was another positive as the USD weakened and foreign exchange gains were made in Sterling, the Canadian dollar and the Swiss franc. Not everything was positive. The currency hedging we had in place for the Australian Dollar has detracted value as the Australian dollar appreciated 8.9% against the USD. Our policy is to manage overseas unhedged foreign exposure within a 0-45% of total funding risk parameter. We could have made more money by having more aggressive stock selection particularly within growth sectors. In equities in the US and around the world, growth stocks significantly outperformed value stocks in 2020. We believe that this is now quite extended and forming a bubble. Our position in high quality defensive stocks, while producing a positive rate of return, tended to lag the market.
The key move occurred in March. We went into 2020 with an equity weighting of 25% as we believed that equities were expensive, and valuations were stretched. As the crisis unfolded, markets fell very sharply in the 2nd half of March offering more attractive valuations. We responded by increasing the equity weighting from 25% to 30% with the entry point into the additional equities favourable for the Fund. Equities recovered thereafter despite the economic effects of Covid and lockdowns. We saw strong upward movements in equity prices to the extent that by June those better valuations had evaporated, and we decided to take the profits on the additional equity exposure and reduce equity weightings back down to 25%. Earlier this week, we reduced the equity weighting by a further 5% down to 20%. This was largely as a result of excess valuations.
Earnings on the World Index
Equities entered 2020 at a level of 21 times market earnings. As markets fell, that valuation level improved and they fell to about 15-16 times earnings in March, which is when we bought more equities. Since that point, equities have risen sharply and the earnings base for those equities has declined sharply. The Price-Earnings ratio on the markets has risen very markedly since that point approaching 29 times earnings, which is very overvalued. We are very concerned, and this caused us to reduce equities again in January 2021 to 20% of the total fund
. This is mirrored in the dividend yield for global markets. At the start of 2020, the dividend yield was around 2.3% on the World Index. As equities fell sharply, that dividend yield improved to 3% at the time when we bought the additional equities. However, this valuation level has again deteriorated due to a sharp rise in equity markets and the fact that dividends were cut sharply as companies lost confidence and/or regulators prohibited dividends in certain sectors from being paid. The decline in dividends wasn’t uniform across the world. In the Eurozone, we saw dividends fall 25%. The UK fell 35% with the US and Asia falling by around 10%. In aggregate, there was a very sharp decline in dividends and by the end of 2020, coupled with rising markets, the dividend yield on global equities had fallen to around 1.8% - another measure of significant overvaluation.
The US market has been the best performing of the major markets and has been driven by huge influxes of liquidity by the Fed to what we term absurd and extreme valuation levels amounting to a speculative bubble. This market cap to US GDP measure has moved to more than 2 standard deviations away from its long-term average, indicative of a bubble that is forming in US equities. Coupled with this, the market was not going up uniformly over this time. It was very much led by growth stocks and tech companies. While these are great companies, there is a price for everything and what we’ve seen is these stocks being driven by excess liquidity to absurd levels of valuation. This has been coupled with the collapse in bond prices and this is what is being used as the justification for those valuations. We refer to these as very long duration assets because the earnings these companies will produce are a long way away. If you use a lower discount rate in the form of a lower bond yield, the present value of those earnings become much higher. We believe these valuations are very reliant on extremely low bond yields.
At the end of 2020, we had 72% in bonds (30% US and 42% non-US), 25% in equities (10% US and 15% non-US) and 3% in cash. In terms of unhedged overseas currency exposure, we are on a fully hedged basis at 44.1%. This reflects our view that the USD remains an expensive currency on the basis of purchasing power parity, our key measure for assessing countries. The USD needs to fall further and as that occurs, the Fund will benefit from having that unhedged overseas exposure. As that occurs we will reduce that unhedged overseas exposure because the money will have been made. In terms of bonds, the modified duration of the portfolio remains very low at 1.5 years. That is a very defensive position because bond yields are just too low. You cannot generate an adequate rate of return for investors unless yields continue to fall. Within equities, we have a very significant preference for Asian markets. The outlook for Asia is far more positive than any other region. They continue to have god growth and managed the Covid crisis very well in terms of restricting the virus and limiting casualties. As a result, they are now enjoying faster and more robust recoveries and the long-term picture looks good. Their demographics are better than in Europe and North America and productivity growth is faster off a low base. People still save money in these countries and these will fund private sector investment, which will drive productivity forward over the next few years. Valuations are better in these markets than in other markets. Singapore, Hong Kong, Indonesia, Australia, Taiwan and Malaysia are quality markets and have a very bright future.
We have adopted a defensive position and continue to follow a targeted value and quality driven strategy. Fund management is all about process and taking the emotion out of decision making.