By John Stensholt
David Paradice calls it a “golden opportunity” for stock pickers, that group of fund managers who fell out of favour in recent years as market index huggers became all the rage.
Now equities markets are falling. And while Paradice will never be known for his sartorial splendour, it could be argued he and his cohorts are suddenly back in fashion.
As another well-known Australian fund manager, Geoff Wilson, tells The Weekend Australian, “active (fund) managers have risen from the dead.”
Boutique fund managers like Paradice Investment Management, Cooper Investors, Alex Waislitz’s Thorney Opportunities and L1 Capital have beaten their respective benchmarks in the past year, amid falling share prices and plunging valuations for former market darlings such as several big name tech companies.
The outperformance has come after exchange traded funds, a basket of stocks passively tracking a particular industry or indexes or even exotic trends like digital currencies, gained major support from investors and financial advisers.
But investors have made big losses on many of the new, trendy ETFs as some markets and crypto currencies have plunged this year.
Meanwhile, stock pickers have carefully stepped through the minefield of equities and outperformed. Paradice’s funds have done well buying resources and energy shares, Cooper Investors has gained from steering clear of growth stocks – a move that hurt them during the boom times of 2020 and much of 2021, but more recently has paid off in a falling market.
Waislitz is now predicting mooted interest rate rises later in the year and 2023 may not be as high as currently feared, and equities markets could rebound quicker than expected.
Paradice says there is now a big chance for fund managers to grab cheap stocks in a subdued market, using their methodical number crunching and ‘gut feel’ investing acumen, mixed with deep information gathering skills.
“I think there is a golden opportunity now. There’s been rising interest rates, inflation, supply chain issues, the Ukraine war, lockdowns in China. But a lot of this stuff will come to an end. The issues (with the global economy) aren’t as systemic as they were in the GFC,” Paradice tells The Weekend Australian.
“(We) screen for high quality companies and avoid the highly volatile and lower quality high growth companies that can deliver in the short term, but often falter in pursuit of genuine long term competitive advantages.”
Paradice’s Australian Equities Fund returned 1.32 per cent in the year to June 30, about 7.8 per cent better than its benchmark S&P/ASX 200 Total Return Index. Woodside Energy, up about 34 per cent in 12 months, was a big contributor, as was QBE Insurance and Treasury Wine Estates.
Paradice, whose eponymous firm manages about $17bn, has been called funds management’s “Columbo” after the old TV Detective, sometimes sporting odd socks, scuffed shoes and tie askew but doggedly undertaking investigative work and constantly questioning management to find value in stocks.
He says there have been four key drivers for his fund’s good performance: being overweight in commodity stocks such as BHP and Incitec Pivot to protect against rising inflation; overweight renewables like rare earths producer Lynas and lithium miner Pilbara Minerals; overweight financial firms benefiting from rising short-term interest rates such as Computershare and QBE; and, underweight in technology stocks and other sectors hit by rising rates.
Cooper Investors has almost $12bn under management. Its flagship Australian Equities Fund has outperformed its benchmark in 17 of the past 20 years, including the year to June 30. Its annualised returns since inception is 3.64 per annum above its S&P/ASX 200 Accumulation Index benchmark and the fund generally has a concentrated portfolio of about 30 stocks.
Portfolio manager Amos Hill leads a team of six at the Australian Equities Fund, which he says looks for “value latency” in stocks, which he describes in basic terms as “the potential value creation that we see in a company over the long medium to longer term.”
It is a methodology that involves plenty of research, both of a company and the industries and regions they are part of.
“Repetitive observation at the coalface of industry is how you identify, monitor and observe changing trends. It is how you test your investment thesis,” Hill says.
Hill’s fund was overweight growth stocks, those that tend to increase quickly in rising markets, six or seven years ago, but his team believed they had run up too far. While it cost them in the bull market, it proved prescient in the past year.
“We were progressively selling what really good companies and well managed companies but they’d just got to levels which we were not comfortable with. And so we actually ended up in a position where we’re underweight growth.”
Diamonds in the rough
A similar situation could be unfolding for Hill’s fund regarding mining and commodities companies, typically seen as a good hedge against inflation. The fund’s most recent report to clients notes the industry’s costs usually rise with inflation. But labour shortages and other factors like the pandemic are pushing up costs more than usual just as commodity prices are starting to fall, and mining companies are now facing profit margin pressure and even the prospect of tax increases around the world.
“With revenues linked to commodity prices, these companies are price takers and are not able to pass through these costs to customers like many industrial companies are able to,” the report says.
Hill’s fund initiated a large position in wagering giant Tabcorp last quarter, after it spun out its better-performing lotteries business into a newly-listed ASX entity.
“The history of demergers suggests the “ugly sister” often performs well post-split,” the fund’s report says.
He also likes Treasury Wine Estates, which has been hit in recent years by Chinese tariffs on Australian wine and other price factors. Its “value latency” comes from a shift to less reliance on China as an export market and that it will eventually high single-digit to low double-digit sales growth once Treasury finds other strong markets.
“We believe the strength of the Penfold’s brand in Asia is underappreciated with an investor at a recent conference remarking that in Asia it’s “either French or Penfold’s”.
Waislitz this week said the bottom of the market was closer than many think, remarking that
“While it is very early days, we are starting to see initial signs that the worst of the global declines may be over.
“The price of many commodities are well off their 52-week highs and we are getting reports out of the US that the pressure on supply chains which has contributed to the inflationary climate is beginning to ease.”
Wilson isn’t too sure the market has fallen enough yet.
“I’m definitely still bearish. Are we even in a bear market? Well we are not even in bear market territory here in Australia yet (when a share index falls 20 per cent or more).
“I think we have to go into that and the average bear market is 1.5 years so I think we have a number of things to unwind. But there is some exceptional value in small caps now.”
Some of Wilson’s listed investment funds have also performed relatively well. A good performer for his WAM Capital fund that searches for growth stocks has been theme park operator Ardent Leisure, which “is in a strong position to capitalise on a recovering domestic and international tourism sector. Its operating cost base has been structurally lowered … which we expect to underpin a strong recovery in its profitability in 2023.” Wilson says Ardent is still undervalued relative to global peers and it could unlock more value by developing some of its land assets.”
Ardent is an example of sifting through damaged stocks trying to find a winner, but Wilson is cautious on the overall outlook for stocks.
“There’s a lot of money that people have made, particularly younger people, in markets and in crypto and it has been too easy. People have got to realise that you get rewarded by owning equities but turning $10 into $10,000 that isn’t normal.
“I just don‘t think there has been enough pain for people who have made easy money in asset prices. Usually they will revert to a mean and it hasn’t got there yet. We probably need a bit more pain.”
Which is the sort of market that good active managers should thrive in.
As Hill says, “when things are great we think more cautiously, and when things get terrible we get more interested.”
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