Andrew Headley, Co-founder and Portfolio Manager at Veritas Asset management and Manager of the Nedgroup Investments Global Equity Fund, talks about their outlook for global equities against the backdrop of a 40% uptick in the world index for global equities in late March.
The enforced lockdown adopted by most governments has led to a global recession and consequently, as investors understood this in late March, we saw markets fall substantially due to the huge uncertainty. We created two lists with a view to investing. One was a high quality list with companies like Mastercard. The second was a Covid affected list, which included travel and entertainment related companies. We found that all of these fell by 40% - 50% on about 23 March providing a huge opportunity for investors.
The recovery since then has been very sharp and much faster than would typically be suggested by a normal market discounting horizon, which is typically 12-18 months. The reasons for recovery are not surprising. Covid data is now available so we have a better idea of the infection and mortality rates, the duration and the prospect of a vaccine. We’ve seen a policy response around the world of around 10-15 trillion Dollars in the context of a global GDP, pre-Covid, of around 85 trillion Dollars.
In terms of the equity market, bond yields today are so low that equities have become the asset class of choice in this recovery. This has led to the self-fulfilling cycle that once the recovery started, there was a fear of missing out, so we’ve seen a very rapid V-shaped recovery in equity markets. The recovery was led by growth names like Apple, Amazon, Facebook, Google followed in the last few weeks by the value recovery sectors as investors priced in this V-shaped recovery. If we look at 2021 earnings consensus expectations, they are 10%-15% below the expectations of 19 February or pre-Covid. Over the last couple of weeks those earnings expectations have begun to rise, which shows that investors are pricing in the idea that economic recovery is going to come back very quickly.
At Veritas, we think the risk is asymmetric with equity markets at or near their highs. What we don’t know is the duration of the recession and how it’s going to pan out. Our view is that the recovery from here will take longer than people believe and that it will be drawn out. This is because a substantial amount of safety data will be required before a mass vaccination programme can be rolled out and that will take time. Until then, we’re likely to have some sort of social distancing and polices that will impede economic recovery to some extent. While polices aimed to bridge the gap, we think now that valuations are basically pricing in a lot. We’re expecting a mid-single digit IRR of 4%-6% for the next five years across the 250 companies that we analyse. This is a pretty low IRR given the current context and we are concerned. Yes, we think the market has travelled too far too fast. We do, however, believe there are pockets of value in the travel and entertainment sectors.
In terms of the portfolio, we came into 2020 with more than 12% in cash as we felt that valuations were high. We invested all of that during the big declines of the crisis in high quality companies with cash in the portfolio now just less than 3%. As markets recovered, we’ve seen these names do well and have just started trimming some of the more economically sensitive names, such as Facebook and Google given the advertising risk they face. We are a concentrated portfolio with typically between 25 and 30 positions. We currently have 29 positions having added a number of positions during the decline including Mastercard, Becton Dickinson, Abbott Labs, Alibaba and Cochlear. We will slowly increase cash if markets continue on this huge bull run. We feel like we’re in a market that is hugely policy driven and if we continue see substantial rallies from here we will be reducing into this.