Accelerating your equity returns
There are four categories of share that will accelerate your client’s global equity returns over the next three-, five- or 10-years, with the only caveat and / or disclaimer being that this newsletter does not constitute financial advice. Instead, it is a digest of some of the key investment themes and trends shared during the recent PSG Asset Management Winter Outlook presentation. Some of the asset manager’s investment experts shared their view on global equity selections within the so-called value investing ‘camp’.
Slicing and dicing global equity fund opportunities
The asset manager also provided a useful ‘slice and dice’ comparison of 400 international and 40 South African global equity funds to determine where along the value and growth ‘line’ each was operating. Among their conclusions, was that size was an unexpected differentiator for certain funds. “Thanks to our relative size, we have the ability to invest outside some of the mega cap companies that everyone seems to be crowding towards; this ability to be different will serve investors pretty well going forward,” said Philipp Wörz, an Investment Analyst and Fund Manager at PSG Asset Management. Another important consideration was that most of South Africa’s 40 global equity collective investment schemes (CIS) were calibrated around their benchmarks or indices.
This creates the real risk that these funds are exposed to yesterday’s winners and poorly placed to generate returns over the coming decade. The reason is that the companies that outperform between today and 2032 will be different to those that ‘shot the lights out’ over the past decade. According to Wörz, there are two important questions that should guide global equity decision making. First, are you paying active management fees in return for market exposure that is little more than tracking an index? Second, is the fund manager that you are investing with positioning its portfolio for a coming decade that is likely to be very different from the past.
“The gap between cheap and expensive companies is as extreme as it has been in the last few decades, making for an environment that is very suited to differentiated stock pickers such as PSG Asset Management,” Wörz said. He opined that investors would be crazy not to take advantage of the extreme differences in valuation exhibiting in global equity markets presently. This requires investing your clients in funds that understand the evolving market themes and trends. But valuation is not the only thing that asset managers and investors need to concern themselves with. The current obsession with all things environment, social and governance (ESG) was singled out as one of the main contributors to divergences in equity valuations circa 2022.
The capital misallocation consequence
One of the biggest consequences of a narrow ESG focus is that capital is being misallocated across the market. “The way ESG is being applied [appears focused on] ending the use of fossil fuels overnight, with money being pumped into industries that are in the green economy while at the same time restricting capital to industries that the green economy relies on,” noted Wörz. For example, one is encouraged to invest in electric vehicle (EV) manufacturers while simultaneously being prevented from investing in the myriad industries that produce inputs that the EV industry depends on. For example, an electric car requires copper, steel and plastics which require coking coal and oil to produce.
Going green comes with consequences and costs. Much of Europe is already wrestling with the clean energy conundrum as they face being cut off from Russia’s gas and oil supply. “Restricting capital to the energy industry, the oil and gas industry, ultimately leads to higher prices … whether one likes it or not, natural gas is required to feed half of the world’s population due to its use in the food production process,” said Wörz. No surprise then, that the energy sector was singled out as one of three great opportunities for stock pickers presently.
The PSG Global Equity fund likes companies like Glencore and Shell, stating a simple investment thesis for the latter: “Shell is an energy company in an energy-deficient world; they produce fossil fuels and renewables and [we believe] their energy business will prove critical to the energy transition going forward,” he said, adding that this ‘promise’ was on offer at a mere six times earnings and a dividend and buyback yield of 11%.
Four buckets to bank equity returns in
The PSG Global Equity Fund is constructed around four buckets or pillars, starting with “underappreciated quality defensive growers” that present significant return on a three-year view. Aside from Shell, Wörz mentioned the likes of US-listed Simon Property Group Inc, which offers a 7% dividend yield, and UK-listed Prudential PLC in this category: “Prudential has one of the largest life insurance businesses in Southeast Asia. It’s got a long runway of growth ahead, given the low insurance coverage in that part of the world”.
The second bucket is filled by so-called supply-constrained real assets in the shipping industry with brands like Glencore Limited getting a mention. The main motivation to own these shares is that there has been so little new investment in ships, especially in the dry bulk area, that shortages will give the main players a significant capacity and pricing advantage over the coming decade. And the third bucket is chock-full financial services firms. “These companies trade at low valuations and offer high dividend yields; we think that higher structural interest rates will lead to high profits for these companies,” said Wörz, adding that there was a ‘weak currency’ sweetener due to many of these opportunities being based in Japan and the UK.
Last but not least, bucket four is filled with companies that “kind of sing to their own tune”. These are companies that have been hard hit by the economic and pandemic malaise over the past three or four years but have clear pathways to recovery. “These companies are very cheap, offer a lot of upside and limited downside, and a high margin of safety,” concluded Wörz. “Our global equity fund is very different to the index, and also a lot cheaper at around 10 times earnings, while offering a lot of upside to our estimate of fair value; that is why our global team is so bullish at the moment”.
Writer’s thoughts:
The observations made about the global investment community’s approach to environmental, social and government (ESG) factors open an interesting debate… While there is evidence to support that ESG-focused investing can generate a return outperformance, there must be growing concerns about vital segments of the economy being throttled for being ‘not green enough’. Your thoughts? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.
