Steven Romick from FPA (First Pacific Advisors), portfolio managers for the Nedgroup Investments Global Flexible Fund, provides an update of the fund’s recent performance.
The Nedgroup Investments Global Flexible Fund is a fully flexible, globally diversified portfolio, which aims to provide investors with equity-like returns over the long term with less risk than the stock market with an emphasis on capital preservation. The benchmark for the portfolio is 60% MSCI World + 30% JP Morgan Global Bond + 10% US Cash.
As everybody know markets have rebounded, but the global economy has not and we won’t be getting back to pre- COVID-19 levels anytime soon. The big drivers in the market have clearly been companies that investors believe can absorb the damage to the economy and valuations. The world seems a lot worse than the stock market currently reflects. We took advantage of the extreme volatility and falling markets in Q1 to reposition the portfolio by buying into weakness, including opportunistic purchases of high yield debt. We also hydrated the quality of the portfolio as a whole. Given that we think there will be more opportunity, we continue to retain significant cash. We’re well positioned for what is to come, particularly if you take a longer-term time horizon, which is how we invest.
At the end of Q2, our weighting in equities was 68.6% with 43 equity positions, up from 62.2% in Q1. 26.8% of the portfolio is in cash and cash equivalents with 4.6% in bonds. In the last few years, the fund’s international exposure has increased from 20% to 37%, largely been dictated by lower valuations in international markets. The stock market being up has certainly taken our portfolio along with it. The Fed has taken tail risk off the table and other central banks have stepped up and are buying securities, which has created a tremendous level of support for the market. We believe that central banks will continue to throw money into economies through the repurchase of debt in some countries, purchasing of equities in other countries as well as purchasing treasuries and other sovereign debt in other countries. We think that the institutional imperative at government level is to keep rates lower for longer. Nobody really knows what the outcome will be, but there is real risk of tremendous inflationary pressures at least in risk assets. Investing in higher grade bond, which are more conservative does not make sense to us.
Q2 Portfolio activity
We were very active in Q1 amid the volatility. Most of the purchases in Q2 were not as active with new issues coming as a result of corporate actions. The only purchases in the period were a couple of high yield bonds, both in the cruise ship industry – Carnival Corp and Royal Caribbean Cruises. For the first time these companies issued senior secured loans with first liens on the ships themselves. Both of these loans were purchased at about a 12% yield to maturity. We’re hopeful that we’ll find more of these opportunities as we move forward.
The Fund has beaten the MSCI World over the full market cycle in our flagship strategy returning 14.1% versus the benchmark of 12.8% for Q2. The major trends we’re seeing are growth versus value; quality versus low volatility; foreign stocks underperforming US stocks; high yield bonds offering paltry opportunity and cash having higher yields in the past than it does today .
As value investors, we invest with a margin of safety so we’re interested in what the business value is and not just the asset value. We have found it surprising to own companies like Alphabet and Facebook where we have a 5.2% and 2.4% holding respectively and who together contributed 1.89% over the period. We continue to own American International Group (AIG) with a 2.6% holding contributing 0.72% over the quarter. While COVID-19 will be the largest insurable event in history, it will cause a company like AIG to lose only a year’s worth of earnings, which won’t change the business dramatically and will only be damaging in the short term. Other positive contributors were Analog Devices (0.95%) and Broadcom (0.89%). Detractors included Wells Fargo (-0.15%) and Swire Pacific Limited (-0.10%).
Our equity exposure moves inversely to the market. If the market is going up, we tend to be sellers and find more opportunities when the market is going down, buying when we see weakness. Value appears relatively inexpensive given growth’s outperformance in our portfolio. Quality and low volatility indices have also outperformed for much of the last decade with the relative valuation of low volume stocks versus the broad market reaching all-time highs. A lot of companies we own may exhibit volatility in their earnings stream, but are growing businesses and are good to own over a full market cycle. We don’t own much of the most extensive low volatility stocks, but prefer to own businesses that we believe over the next 5-7 years will be good performing businesses. US stocks are more expensive than the rest of the world in terms of valuation. We have therefore increased our international holdings in the past few years as the valuation gap between US and foreign continues to widen. The Fed’s debt purchase programme has reduced high yield opportunities. At this point in the cycle our portfolio would normally have a lot more debt in high yield bonds. Previously, as the default rate went gone up, the yield to maturity also went up and that is not happening today. As the yield to maturity goes down, maturity rates are going up. This explains why we’ve been focussed on high yield bonds in the new issue markets. The US Debt to GDP will soon exceed a level not seen since World War II as a result of COVID-19. Unprecedented actions have been taken leading up to this, leaving us in a very tenuous place, which is why we retain the cash that we have in the portfolio.