James Baxter, Managing Partner
We had the budget this week and intend to look at that in more detail next week, in particular, where it might impact our clients and planning opportunities. However, this week we thought it might be good to just take stock of our various investment fund performances and explain what is going on. After 11 months of pretty much uninterrupted gains from the middle of March 2020 to the middle of February 2021 we are finally seeing a pull-back in equity markets along with the associated rise in government bond yields highlighted in our last update.
In the recent rally, growth stocks, typified by US big tech and healthcare companies, significantly out performed value stocks, typified by energy and financial companies. The US Nasdaq, a good proxy for growth, roughly doubled in value in those 11 months whereas the FTSE 100, a good proxy for value, rose a mere 30%. We captured a good deal of this recovery along with a strong recovery in our bond and alternative funds to the extent that we have been well into new highs for all of our portfolios in the first two months of 2021. Of course, with hindsight we should have held more growth and less value but our approach is to keep diversified. These trends are easy to see in the rear window, much harder predict in advance.
As bond yields have risen in the last couple of weeks with an eye to a more normal world and economic recovery, the biggest hits have come to the growth sector. Our value managers are now back in vogue! Below are some approximate returns, year to date, for some of the funds where we have sizeable allocations across our portfolios, along with a few comparable benchmarks:
We are very pleased with how our bond funds have held up against the ‘bond rout’. Remember there are bond funds and there are bond funds and it is good to see our value and income fund managers picking up where the growth managers have stalled.
So why do growth stocks get hit harder as yields rise? Well, it’s to do with discounting back future profit expectations. The further out in time the value of your earnings sit the bigger the discount and the more your share price needs to come down as the risk-free yields and that discount increases.
It is not a good market update without mentioning Elon Musk, so at this point we should talk Elon and Tesla for a moment.
As a physicist it was great to see his latest, third attempt, rocket launch came back down and land on its feet this time! The first two did not stop and just smashed back into Texas. This third one landed on its feet having gone from horizontal on re-entry, flipped 90 degrees to vertical and then slowed to a safe landing speed, just like a comic book rocket vision. Against earth’s gravitational pull that is no mean feat! This is not a glide back to earth space shuttle style, this is - go up vertically in a rocket and land down vertically in the same rocket. Having landed on its feet, number three wobbled a bit and then exploded! But he has 16 more in production. If I was a betting man, I would say he’s going to do it. No doubt he’s already selling tickets!
But of course, this is SpaceX, Elon’s current private company and nothing to do with Tesla, which as we all know, primarily makes cars, although we now know it also owns a big chunk of Bitcoin ($1.5bn). Tesla is the ultimate growth stock, with analysts speculating how much of the growing electric car market can the company capture, both in car sales and as a supplier of, for example; batteries and software for driverless cars, where Tesla appear to have a jump on other manufacturers. From May 2019 to mid February 2021 the company’s share price went from $37 a share to a staggering $880 a share, valuing the business at $840bn. This is for a car manufacturer making 500,000 cars a year. To put that valuation in context, Toyota which makes 11 million cars a year and is pioneering hydrogen technology, which many see as actually better ultimately than electric, is worth just $200bn. So, it is clear that some growth stocks were in bubble territory in February. Tesla’s stock is down almost 30% in one month and the downside risk still remains colossal.
Hats off to Ballie Gifford for timing their profit taking in the stock to perfection and to Nick Gait for investing us in their Global Alpha fund, which has a strong risk management process and is still positive year to date versus their riskier, but very popular Scottish Mortgage Trust, down 14% year to date. We have a very miniscule exposure to Tesla now when we look through our funds and significantly less than if we held the World or US index where Tesla’s current $600bn valuation gives it a significant weighting.
In terms of pension money that we do not want to lose, it is a good reminder as to why we need to be very careful not to get carried away with Elon’s obvious excitement and lure.
Nick now takes a closer at two funds where we can see how the managers are actively repositioning the portfolios.
Since our last communication, there has been further volatility in markets as investors get to grips with the economic recovery, inflation expectations and interpretations of the potential Fed responses to inflation. The yield curve has steepened with the US 10-year Treasury now trading in a range of 1.4%-1.6% in yield terms, up from 0.91% at the end of December and up from 0.51% at its low during the depths of the Corona crisis in January. As with fixed income securities, which was mentioned in our last communication, equities also tend to suffer from rising rates, especially growth style companies.
Although TS Lombard believe a hike in rates in the US will not come until the end of 2022 with Fed tapering later this year, we think our portfolios are relatively well positioned for any pickup in inflation should inflation be larger and come sooner than expected.
Our allocations in Credit tend to be focused on the shorter end of the yield curve with most of our managers positioned between 2 and 6 years in duration terms. This both lessens the effect of the initial drawdowns and speeds up the rate at which monies can be reinvested at higher rates. Equities in general have been a decent inflation hedge over the past several decades with Tideway allocating to a mixture of investment styles, some of which will perform relatively well in a rising rate environment. Finally, our alternatives bucket, which is largely focused on Real Assets, can pass through a lot of price increases to consumers as we expand upon briefly below.
In addition to our top-down asset allocation positions, we have also allocated to active managers, who, during the depths of the crisis last year, where they sought quality assets relatively unaffected by Covid-19, are now positioning themselves more for a global recovery, tweaking their portfolios towards stocks which will benefit from a general opening of the global economy. We have had two monitoring meetings in the past week, with the managers of the Artemis US Select and Legg Mason Clearbridge Global Infrastructure funds, which will help illustrate in inbuilt flexibility in your portfolios.
Legg Mason Clearbridge Global Infrastructure:
As with last year, the managers have taken the opportunity to reposition the portfolio to take advantage of the change of macroeconomic conditions and are currently increasing exposure to transport infrastructure with a meaningful increase of c.10% since the end of September 2020, before a viable vaccine was announced signalling a global recovery and a return to normality was perhaps closer than the market had been pricing in. The rationale for the increased allocation to the sector is intuitive with a strong pickup in travel expected in 2022 as economies reopen.
Areas of transport infrastructure which are being added to, include roads, airports and ports with priority going to those companies presenting the best transparency of cashflows and thus certainty of dividends; roads and ports first to open up with airports a longer-term proposition.
The manager now estimates that they have a 32%-35% leverage directly to a reopening in the portfolio and will continue to search for these sorts of opportunities at the expense of more stable utilities. So far, disposals have included those positions where thesis has played out or compression in dividend yield has been observed; United Utilities, Edison International and Red Electrica, for example, with the team maintaining their discipline where they see unwarranted valuation points.
Furthermore, infrastructure continues to be a good place to allocate capital should one want to limit the effects of inflation with a lot of the increase in prices passed through to the consumer or earned off a regulated asset base. The correlation of the portfolio is close to zero, more specifically 0.3 for User Pays assets and -0.2 for Utilities. Although rising bond yields presents short term headwinds to performance, the corresponding decrease in prices in certain areas of the market presents opportunities to get invested in regulated long-term businesses at attractive prices. Previous instances of rising US bond yields have yielded some negative returns and neutral returns in Utilities in the short term, though once the yield peak is reached the strategy has subsequently enjoyed a period of very strong performance with changes made during these cycles contributing to performance.
We continue to like the fundamentals of the strategy based around the security of long term cashflows underpinned by regulatory asset bases and concessionary business models. With a current dividend yield of 4.71% and a projected EPS growth of 5.45% over the next 3-5 years, the fund remains a core holding in Tideway portfolios.
Artemis US Select:
The manager of the Artemis US Select is also positioning the portfolio to benefit from the opening of global economies, the opposite of what it did last year in the depths of the crisis with the flight to quality assets and to stay at home / tech Covid winners.
Although always being listed as a style agnostic strategy, this is perhaps the first opportunity in the recent history of the fund where the manager has allocated meaningful capital to non-core growth areas of the market with the impressive performance track record being attributed to investing predominantly in this area of the market with core holdings such as Amazon, Microsoft and Alphabet.
Key sector overweight positions in this fund now include Industrials (+6.9%), Financials (+5.5%), Materials (3.1%), Consumer Discretionary (+3.1%) which all benefit either directly from the opening up of economies with Industrials and Financials (Banks) moving up in value as bonds fall and yields rise; they tend to enjoy positive price increases when yields rise with Consumer Discretionary and Consumer Staples sectors having more obvious relationships with the economy. To fund these positions, the fund is now underweight Technology (-5.1%) and Consumer Staples (-6.3%). Compared to June last year the biggest changes in positioning can be seen in the following sectors: Financials (+3.5%), Consumer Staples (-4.7% and exited all positions), Industrials (+11%), Healthcare (-9%).
Have a good weekend,
The Tideway Team
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