Outperforming in all market cycles

Olivia Harris: Thanks for joining us for our next instalment of WAM Vault. I am joined by the WAM Leaders (ASX: WLE) investment team, Matt, Anna and John. We will get right into it. What is your outlook for equities in 2022?

Matthew Haupt: Our outlook is positive for equities. The reason why we are positive is because all the factors which drive equities, which is low interest rates, risk premium and growth, will all be quite positive. There will be a few headwinds. Interest rates will get tighter but not enough to stop equities from going up. We remain very constructive. The real battle is interest rates. It is not a question of if they will go up, it is when and how fast. We are watching that very carefully but at the moment we remain very positive on equities. I think it is the best asset class at the moment. That is how we are positioned.

John Ayoub: If we bring that down to the portfolio level, as we have spoken about several times in the past, our themes and major sectors that we are positive towards remain the same. We like oil and gas. We like value over growth. We like mergers and acquisitions because we think that is going to continue so we try to identify stocks that have that tailwind. Other sectors like financials we think are positive and should carry on momentum particularly for insurers.

Anna Milne: QBE (ASX: QBE) is our top pick in the insurance sector. It has been our top pick for a while, and we think it has a way to go. When you think about insurance companies, they have two types of profits. They have their underwriting profits and they have their investment profits. For QBE their comparables in the US reported recently, and they posted really good premium rate growth, higher than the market expected, and it is outstripping the claims growth. We expect margin expansion from an underwriting perspective. On the investment book they are highly leveraged to upward rates and they have doubled the exposure of IAG (ASX: IAG) and Suncorp (ASX: SUN) so it is our favourite play in the insurance space from that perspective.

Olivia Harris: Thanks. Matt, something that is really topical at the moment is inflation. What are the main factors that you are looking at here for equity markets?

Matthew Haupt: It is a really interesting one. It is really in focus at the moment. The difference though for us is, we are not really worried about the absolute level of inflation. What we are looking at is the response from central banks. Because inflation is what it is. You have the cost push and demand pull coming through at the moment, which is going to accelerate. It is going to get higher but the market or the central bank reaction function is really what we are monitoring at the moment. For us that is key. At the moment they said they are going to let it run hot, which means more accommodative policy. The interest rate markets are saying “we don’t believe you, central banks” and actually are pushing forward the hike. So it is a real tug of war at the moment between central banks trying to push the rates out and market expectations pulling them forward. But we are really watching that response function from central banks.

Olivia Harris: John, another topic that is in every conversation at the moment. What is happening in the Australian property market right now?

John Ayoub: You can’t go to a dinner party without talking about it can you. It is a very interesting point right now. As Matt just spoke about, the Reserve Bank of Australia (RBA) are behind the curve, they are going to let the market run hot. But they are taking other measures right now to help slow it down. We are already hearing that mortgage brokers and banks have been told to rein in the capacity, pull down the amount people can legitimately borrow. What we see is a tapering of the property market in the next 12 months, potentially driven by more supply coming to the market as people start to be enticed by travel around the world again. Potentially we see more stock coming on the market which probably should settle down the rally that we have seen over the last 12 months.

Olivia Harris: Anna, how is this impacting the Australian banks?

Anna Milne: Banks perform really well in a rising rate environment. It allows them to expand their net interest margin which is a huge positive. We see net migration coming back, business confidence improving. Overall we are very constructive on the banks. Within the banks, our top pick is National Australia Bank (ASX: NAB). We really rate its management. They have a realistic cost out program which is more than you can say for some of its peers. They are overweight the small business market so they should benefit from a return in business confidence.

Matthew Haupt: I think that is a good point. To add, the financial suppression we have had has been really negative for banks. We have had the yield curve control which has fallen apart over the past few weeks. We are starting to see interest rate hikes already. Westpac (ASX: WBC) and Commonwealth Bank of Australia (ASX: CBA) have already adjusted their fixed rates. As yield curve control rolls off, we are really going to get a pickup in the rate environment, both on an absolute level and also the replicating portfolios will start to get a tailwind for the first time in multiple years. We are quite constructive on the banks.

Olivia Harris: Matt, a little bit retrospective here. How did you manage to deliver an outperformance in the WAM Leaders investment portfolio over 2021?

Matthew Haupt: The key for us is really around inflection points and getting ahead of the curve of where the market thinks it is going to be. For us the real key was positioning for a recovery. Basically a lot of the sectors which were cyclical, financials which have been under suppression through low interest rates, we went early on those as well as oil and gas because again we went through that period where oil was briefly negative on a futures roll contract and the market was way overblown with concern around that market being demand destruction, which it was never the case. It was just really economies shutting down, and then returning back on, and we positioned for that very early and fortunately we got a lot of that. It was really around picking inflection points, staying ahead of the curve, and having a process where we are nimble enough where we can position ahead of those changes and that is really how we captured those performances.

John Ayoub: To add to that. The duration of our investment is a very important thing. Although we pick thematics and we are typically ahead of the curve, we need to realise early if we need to balance the portfolio with some more shorter duration investments. Whilst the market is grappling with all the interest rate thematics at the moment, there is a stranglehold from lower-for-longer growth investors. As they start to relinquish that stranglehold on the market, we need to ensure that we pick up the basis points or our performance throughout the cycle.

Olivia Harris: So what inflection points are you looking for as we head to the next six or 12 months?

Matthew Haupt: I think the big one, we had the pickup in yields and steepening in curves which was the first move, and now we had the pause as the market digests and contemplates whether central bank policy will kill off the recovery. We think there will be a second phase. We had the pause and we think you will get steepening again because the central banks are pushing back against interest hikes, and that is going to allow the economies to grow further and further and recover further. We think you will get another steepening event. I think the real big one for us next year is potentially China. China post-coronavirus really stimulated their economy and the slowdown we have seen in China has been very much policy driven again.  They will wait until maybe first quarter or second quarter of next year. They have the Beijing Winter Olympics. They are trying to fix their power situation. But we think once they do that they will start stimulating again, and the credit cycle will go on. We think China could present a great opportunity in 2022.

John Ayoub: At a portfolio level and picking up on what inflection points we like going forward. We are starting to gravitate the portfolio more towards quality. As there is more volatility and dislocation coming to the markets we need to ensure that we are picking the best in class per sector. We are picking the good in the group, we are picking the Telstras (ASX: TLS), which are the standouts within their relative sectors. Other sectors like healthcare, CSL (ASX: CSL) which Anna will touch on in a second. These are the stocks that we have identified and really concentrating on to give us some protection, if there is more dislocation coming through.

Matthew Haupt: That is a good point because one of the things which does not get talked about at central banks is the volatility suppression that their policies have done. They have been intervening in rate markets and commercial paper markets, which suppresses volatility which extends duration. That will unwind. We can’t wait for that event actually.

John Ayoub: I think we have coined it, we are waiting for the reality to set in. Company earnings are not going to be as easy as they were over the last 12 months where you just pick anything and they go up. We are going to move from a needs-based economy to a want-based economy, which changes a lot of things.

Olivia Harris: You mentioned the healthcare space. Anna, what are your standout picks there?

Anna Milne: We are absolutely constructive on the healthcare space. It has been one of the worst performing sectors in the index over the last 12 months, largely due to CSL. CSL has very well-known headwinds that it faced with coronavirus collections and operating deleverage as their volumes have been lower. However we feel this has been really well articulated by management and is now well understood by the market. Looking past the short-term headwinds, undeniably demand for CSL’s products is very strong, and we are really excited about the research and development pipeline. To name a few, CSL112 and Clazakizumab, which is a bit of a mouthful, are both in phase three trial and we are expecting results over the coming year. We are constructive on CSL.

Olivia Harris: John, one sector that you had spoken about in the past that you were actually quite constructive on was oil and gas. What are your thoughts on that now and how are you playing that in the portfolio?

John Ayoub: It is a sensitive subject out there because there is a lot of hysteria I would say around green energy investment, no matter what it is. If you take a balanced approach, and that is what we try to do, you can make money out of both green and old energy.

Firstly if you look at the capital expenditure budgets of all the major oil companies around the world, they have yielded to the pressures of a lot of the talking groups around the world. From that standpoint if you look at those existing producers, who have got growth prospects, who have particular liquefied natural gas exposure, we think there is a positive outlook for those companies in particular over the next 12 to 24 months. Santos (ASX: STO) is one that we will call out as a standout. From the other side of the fence, from green energy, we think it is too early to get positive around energy storage. There is still way way way more investment to go before it becomes a critical mass, before an economic yield can be yielded. But we can still play it through some of the commodities, because we think copper, nickel and other commodities like that will be very much supported as this boom takes place. The boom will happen but we think you can make money on both sides of the coin.

Olivia Harris: Matt, is there anything else that you would like to share with our shareholders or a message that you would like to leave with them.

Matthew Haupt: I would just like to thank shareholders for their support. WAM Leaders celebrated its fifth birthday not so long ago. Through the multiple raises that we have done, I would really like to thank shareholders for their continued support and let them know that with our model we try and outperform in all markets. It doesn’t really matter if we are in the growth market or a value market, our process is flexible and we proud ourselves on picking those inflection points. No matter what market we go in we will always try and outperform.

Olivia Harris: Thanks Matt, Anna and John. Great to chat.

Matthew Haupt: Thank you.