Global Equity Fund - Mr. Market

By Nedgroup Investments

Andrew Headley of Veritas Asset Management, Portfolio Manager of the Nedgroup Investments Global Equity Fund, provides an overview of the Fund’s performance for the past year and what we can expect from the markets going forward.

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Fund performance overview
The last 12 months’ performance was disappointing for us. It was good in absolute return terms, but not very good in relative returns. We ended the year slightly behind the market with performance of 12.19% YTD versus the MSCI World Index at 15.90%. We had been outperforming the market for most of 2020 until the last six weeks when there was a rally in a variety of stocks that we didn’t hold. Our 3 and 5-year returns of 11.14% and 12.33% respectively both outperformed the Index. The start of 2021 looks reasonable and we hope to claw some of that back.

Q1 2020 saw the virus hit with substantial market declines. We aim to preserve capital and invest in a risk-averse way, so performed very well during the declines and were about 5%-6% ahead of the market at the end of Q1. The remainder of the year with policy makers reducing interest rates and pumping liquidity into markets led to a massive rally from the bottom with markets up 40%-45% and more and we underperformed in that rapid rise. We did well in tech type stocks where we had big positions. These were mostly communication services like Alphabet (up 31%), Google (up 31%), Facebook (up 35%) and Charter Communication (up 37%). Two reasons for our underperformance was firstly our small weighting of about 3% in IT and secondly our large aerospace exposure through Airbus, BAE and Safran. We do believe that the latter are all high quality companies, which will recover strongly over time.

Transactions in 2020
We came into 2020 with a lot of cash, so were quite active during the year. We felt valuations were broadly high so hadn’t had a lot of opportunities to deploy cash. We invested all of that in Q1 during the major declines in Abbott Laboratories, Alibaba Group, Becton Dickinson, Catalent, Cochlear Ltd, Fiserv, Illumina, Mastercard and Vinci. We felt we were doing the right thing deploying capital at cheap valuations. Many of the sales were made to fund purchases of companies that were more attractively valued and higher quality. We felt that we were increasing the quality of the portfolio and improving the rate of returns we thought we could achieve. We made complete sales of Altice USA, Capita, Cigna, Dentsply Sirona, Reckitt Benckiser and Rolls-Royce Holdings.

Portfolio composition
There has not been much movement in the top 10, with Alphabet still our top holding at 7.2% followed by Charter Communications at 6.4%. We added to Safran (5.2%) and Airbus (4.4%) at the end of August/September. Even though this sector was very hard hit, we felt that in our time horizon of 5 years, they were well positioned and that leisure travel, which accounts for 80% of this sector, would return. New positions for us in the top 10 were Fiserv (3.69%) and Vinci (3.6%). We also increased Intercontinental Exchange during the year (3.7%). Cash went as low as 1% as we got fully invested in March, but this has slowly increased as we sold stocks when valuations increased. In terms of sectoral allocation, we continue to be big holders of healthcare (29.5%). Our exposure is very heterogeneous, but is exposed to very strong themes. While it was not a strong performer during 2020, it did perform well as a defensive position during the declines although it didn’t participate in the recovery. We think over a sensible time horizon that many of the companies we hold are extremely well placed and with the change in administration in the US, some of them should do very well with an increased move to value-based healthcare. We increased IT, which is now 10% of the portfolio through fintech stocks Mastercard and Fiserv.

Portfolio positioning
The Fund is concentrated with 28 holdings invested in six ‘buckets’ - aerospace, big data/mobility, consumer staples, financial services, infrastructure/networks and value based healthcare. Our strategy is to invest in high quality companies with enduring and competitive advantages and long-term investment horizons. We conduct in-depth, proprietary, fundamental analysis and typically hold companies for 5 years. We have a real return mindset and focus on delivering attractive absolute returns. If we do this over 5-year horizons, looking to deliver CPI+8%, then we think we will beat markets over the long term, which has been the case. Over the last 5 years, we’ve been in a bull market with markets in USD terms rising more than CPI+8%. Our outperformance comes when markets become more difficult with declines or slow growth. 

Where we will and won’t invest
We only invest in companies with high barriers to entry, such as healthcare, aerospace, IT, infrastructure, branded consumer goods, dominant networks, etc. We look for companies that have sustainably delivered and will continue to generate high returns over at least five years. We invest only when there is a significant discount to intrinsic value and are absolute return focused in terms of valuation. This means we don’t invest in companies with no competitive advantage, such as commodity type businesses, companies with a limited history of high returns or companies with low returns. We don’t invest in anything that is a fad or fashion, such as hydrogen and electric vehicles nor in concept stocks or companies with no earnings or free cash flow.

Current environment
All major economies (US, EU, Japan, UK) are running huge budget deficits and we expect that to increase in the US. Short and long-term interest rates are being held very low. In the economic world, interest rates power everything, so these very low rates are driving all asset values higher.

Equity valuations in some cases are relying on sustained low rates, but can this be sustained over a 5-10 year horizon? We need to be aware of the threat of inflation and government debt getting so high that we see higher interest rates over time. As a result of this environment, we are seeing highly speculative behaviour in certain pockets with record numbers of IPOs in the US with declining quality. We’re also seeing the return of SPACs (special purpose acquisition companies), which offer a quick way to IPO and is generally associated with a lower quality IPO. We’re seeing more fraud, multi-billion $ “pre-revenue” companies and a rapid rise in cryptocurrency and bitcoin, which is quite speculative. We’re seeing high equity valuations, massive retail investor participation, which is usually a sign of speculation. No price seems to be too high for companies exposed to growth themes with large total addressable markets, such as clean energy and electric vehicles. Fear is being replaced by greed, resulting in equity put / call ratios at historically low levels. The cyclically adjusted PE ratio is 33.7. This is not quite as high as 2000 and obviously interest rates are much lower, but it is still high. The S&P 500 price to sales ratio in the US is at an all-time high. Even though interest rates are very low and we’re coming into a more intangible type of economy, it’s still quite an extreme move. The Tesla share price was up 8 fold during 2020 to an $800 billion market cap today. The CBOE Equity Put/Call Ratio, an indicator of sentiment, is at 0.34. When people are buying calls they are positive and when they’re buying puts they are negative. At the moment very few people are buying puts, so the sentiment is very high.