28 April 2021 (pre-recorded 26 April 2021)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
[INTRODUCTION]
Sam Slator (SS): I’m Sam Slator from FundCalibre and today we’ve got a slightly different podcast. The first few months of this year have been quite eventful for investors and there’s been four notable events. One has been the yield curve rising, value’s started to form growth, social media groups have caused some stock prices to rise more than 2000% and there’s been a shortage of semiconductors. So, some of this sounds a bit technical. So I’ve been joined by Juliet Schooling Latter and Darius McDermott, who are going to explain what these things are and why investors should actually care about them.
[INTERVIEW]
[0:32]
SS: So, first of all, what’s the yield curve and how does it affect me, please?
Darius McDermott (DM): Yeah, so the yield curve, it sounds quite complicated, you’re quite right. What it means, and it refers generally to government bonds. So if you can imagine you’ve got an X axis and a Y axis ,and the X axis is the different length of maturity of those government bonds. And by that, I mean, you can buy a government bond with two years left to maturity. So you buy a government bond for, let’s just say a pound, it’s got two years to go. And whilst you hold that bond, it will pay you an interest of on the Y axis, so say a half a percent. But you can also then buy government bonds with five years maturities, 10 years, all the way out to 30 and even 50 years maturity. And it’s the differential of those rates that you get on those different maturing bonds is the yield curve.
Now, the other thing you hear people talking about is whether the yield curve is steepening or decreasing. And all that is trying to give you an indication is what is the market pricing in future interest rate expectations. Now that all still sounds quite technical, but if the yield curve is steepening, it is basically suggesting that interest rates will go up in future, primarily because of concerns about inflation. And if the yield curve is flat or moving from steep to less steep, then it is suggesting that interest rates will be falling from current expectations in the future.
So inflation is hugely important to everybody because you know, the price of your pound or your dollar today will buy your X amount of goods. But inflation means that those prices of those goods will go up. So inflation is important. But that’s roughly what we mean by the yield curve. So it is quite technical and it does affect lots of parts of the investment horizon, whether it’s for equities or bonds, but really when we’re thinking of yield curve, the first implication is for bonds. A rising yield curve is normally suggesting inflation, which will be bad for the price of my bonds that I hold today, whether they are government or investment grade.
SS: So the price will be going down but if the yield curve is going up and interest rates are going up, does that also mean that bond rates go up? So the income that you’re getting on them?
DM: So the simple, the simple equation, and it is simplified, is when rates go up, prices go down and when prices go up, yields go down. So if, as has happened in the first quarter, the yield curve has been steepening. If you owned a government bond, the prices of your bonds will have been going down and in the US government bond market, which are called Treasuries, and the UK government bond market, which are called Gilts. You’ve actually lost anywhere between 3% and 7% in the first quarter on the value of those bonds, because of that yield curve steepening.
[3:44]
SS: Thank you and just thinking now perhaps about the growth versus value. This has been a debate for a number of years now. The fact that growth has been doing so well and people have actually been questioning whether value strategies are dead on their feet. So what’s been going on to make value suddenly start to outperform?
Juliet Schooling Latter (JSL): Right, so value stocks have been unloved for quite some time. They’ve had a tough time for many years now. They’ve been out of favor as there’s been very little global growth, which means that growth stocks have been the order of the day. And value stocks have rather been shunned. But if global growth and inflation pick up, that’s bad for growth and good for value stocks. So with, towards the end of last year, the market got quite excited about the news of the vaccine rollout and the resumption of economic growth. And since then, all those unloved value stocks have finally come into their own and investors are now debating how long this value rally will last, you know, is it a temporary blip or have the tables sort of finally turned against growth?
DM: Yeah. And you know, in this low interest rate environment we’ve been in since 2008/9, following the financial crisis, companies that have superior earnings growth have been the ones to back for the last 10 years. And you know, the old adage, if you buy a cheap company, you know, where it’s maybe lower than its net asset value or its book value, if you’re a bank or something like that, or if you’re a commodity provider, you’re actually getting the value of these assets cheaply. If you buy something cheaply, you’ll make money. That hasn’t been the case in the last 10 years until November, really when as Juliet suggested, we’ve had this rotation in styles with positive inflation and the reopening trade, if you like, based on better news ahead because of the vaccine rollout.
[6:02]
SS: And the other thing we, the other anomaly that we’ve seen is social media investment groups that have been pushing up the price of some stocks. Can you perhaps explain what’s been going on there as well please?
DM: Yeah, this again is sort of, there are technicals in play, but the simple thing is you can buy a stock and expect it to go up, but you can also sell a stock, which is called shorting, and a certain portion of the US, particularly in the US, social media, were trying to attack the hedge funds that were shorting certain companies. So if you’re short of a company and it goes up, you lose money. And if you’re short of a company and it goes up a lot, you lose a lot of money.
So there was a social media campaign to try and boost some of the weakest companies in America, because the hedge funds were shorting them. And this, saw for instance, that the headline stock was a gaming company called GameStop, and that went up from something like $5 to $500, a huge increase in only a matter of a week or so. And that just meant that the hedge funds who were short or trying to make money out of the share price going down, actually lost a lot of money. It was sort of like activism in the investment world.
Now, there are a couple of other just interesting points: A) people in America all got stimulus checks and B) there’s a lot of people on furlough sitting at home, and the social media push, along with people having some spare change in their accounts and the time to actually do this meant that they, it really did become quite a phenomenon in Q1.
It wasn’t what I would call proper investing. But if you manage to buy at $5 and sell at $500, you could make an awful lot of money in very quick order, but it’s knowing when to buy and when to sell. And this was not based on traditional investment fundamentals.
SS: So do you think this will happen more and more, or…I’m just wondering, because that must make it difficult for fund managers to actually invest. If they’ve got groups of people just picking a random stock like this and changing its fortunes, if you’re a fund manager trying to invest for the long term, that must impact what you’re doing as well?
DM: Absolutely it did. We spoke to several managers who run absolute return funds, where part of their strategy is to actually short shares. What we saw is any stock that had a big portion of its shares shorted, or where people were trying to make money out of them going down, those shares actually all went up almost as a cascade following that US phenomenon. It didn’t last very long, but it certainly caused concern, not just for us as investors, but the fund managers that we speak to that do run long/short strategies.
I must just add not all long/short strategies are hedge funds in their traditional shape. Some of these strategies are really only trying to make very moderate returns of 3% to 4%, 5%, but they do so by having a balance of companies that they think, in aggregate are slightly better, and they have them in their long book and they would be then short of companies they think might do slightly less. A typical example is in say oil where you’ve got Shell and BP, they’re both affected by the oil price. And they’re both UK-listed global oil businesses. Now it may be for one reason or another, I think Shell is better positioned than BP. So I could be long Shell and short BP, hence having no oil price risk, but hoping that one will outperform the other and all these things could and were thrown upside down for a period of time, sort of somewhere between two and four weeks during that time.
[10:13]
SS: And thinking about a longer term theme, which is semiconductors, it’s not, it doesn’t sound the most exciting component to on the planet, but is it? Are these the types of shares that people should perhaps be considering? What’s the story behind semiconductors at the moment?
JSL: Well, if like me you’re not really a techie, a semiconductor is a sort of key component in sort of smart electrical devices. So phones, laptops, games consoles, electric vehicles, and even fridges and toasters, I’ve just discovered. So, over the past year, we’ve sort of relied even more heavily on many of these devices and hence there’s been an increased demand for semiconductors, which has sort of corresponded with a lack of sort of investment in them. So there’s been a shortage, which kind of started in car manufacturing, but it sort of spread to other consumer electronics, toasters even now, and so you know, as with all sort of supply and demand imbalances, this has led to the, you know, an increase in the price of semiconductor chips. And a lot of chip manufacturing is done in Asia where TSMC is the major player.
Now I’m sure the situation’s going to be resolved, but it’s gonna take time. Biden is planning to provide some funding to expand chip manufacturing in the US, but obviously it sort of takes time to build these new factories. So I think that, you know, this is, this sort of shortage and the sort of increase basically in the cost of them, it will be a temporary phenomenon, but we’ll just have to sort of wait for that to pan out really
DM: And the pandemic has added to this because you’ve got more demand for devices as people work from home – not just toasters, but computers, laptops, iPads, et cetera – and we’ve had disruption in factories because of Covid where people have had shutdowns. So it really is a supply and demand dynamic that Juliet described and the best estimate is that that supply/demand will be weak for the next six months. So yeah, it has been quite a fascinating thing, that these small parts of the devices are actually so very critical to them.
[12:54]
SS: And just taking all of this into consideration, how should investors be investing at the moment?
DM: Well, this is, I think, you know, what to buy and when to buy is always the tricky question. And I’ve used this analogy many times, but if you were a Martian and you came down from Mars on the 1st of February 2020, before really pandemic hit global markets, and really the globe, who would have known that the US market would be up 30% or thereabouts since then. And in fact, a lot of major markets, particularly in Asia, there are higher levels than they were yet we’ve had this huge global pandemic. So stock markets wobbled and quite substantially and in very quick order in February and March 2020. But since then, whilst we’ve had increased volatility, everything has gone back up. So it is difficult to know what to buy and something we talk about all the time, but also during this period of the pandemic, people have been saving more and more and there’s you know, money has to flow somewhere. You haven’t been able to spend it. So maybe people have been buying equities and hence pushing markets up. So short-term it’s very difficult to say, Juliet have you’ve got some thoughts on this?
JSL: I mean you know it’s very dull and we always say this, but a) diversification is key, because as we’ve seen, you know, we just talked about that recent value rally. And you know, if you’ve, if you’ve continued to hold a bit of value, as well as having growth stocks, that’s done very well for you recently. So I think diversification globally across sector and across sectors is good. And also, you know, don’t forget that you can invest monthly and then that way, you know, if markets do fall, you know, you effectively get more for your money.
DM: Yeah. I think the old pound cost averaging is a hugely important thing. And, you know, I’m well into my third decade in investing, and it is really difficult to time markets, you know, at the height of the fear in February and March of last year. Well, now we know that was the bottom of the end of that market cycle, but who knew with Covid? Markets could have halved again. And if you were just saving every single month, it does take away that want to try and time stock markets. So yes, saving monthly is always a good idea in my opinion.
[15:34]
SS: So given what you’ve said about valuations, where have you been adding?
JSL: Well, you know, again on the diversification front, I think global income funds look interesting at the moment because, you know, at least you’re getting some yield in there as well. So we’ve been looking at M&G Global Dividend and Fidelity Global Dividend and adding to that at the moment.
DM: Yeah. And with respect to those valuations, I mean, Fidelity Global Dividend has a sensitivity of 0.8 to the market that would otherwise be called ‘beta’. So if markets go up one, that should go up 0.8. If markets go down one, it should go down 0.8. So it’s global equity, but with a slightly lower risk profile.
SS: Both of those funds, I believe, have managed to actually increase their dividends last year amongst all of the cuts that took place, which is quite a testament to those stocks that they’re invested in, I suppose?
DM: Yeah, we were fortunate enough to meet up with the fund manager of Fidelity Global Dividend, and he actually increased his yield in that 12 month period. And I think he said only three of his stocks in total cut and the rest of his portfolio actually maintained or grew their dividend, which shows the sort of company that he does invest in those really robust, defensive, good, solid equity income payers.
SS: That’s great. Thank you very much. And if you’d like to listen to more of our podcast please go to fundcalibre.com or subscribe via your usual channel.
