190. Value tilts, inflation proofing and the private equity opportunity

21 April 2022 (pre-recorded 5 April 2022)

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]
Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. High inflation and higher interest rates, amongst other concerns, have triggered a reversal in growth stocks lately. On today’s episode we discuss the rotation to value, inflation protection and the importance of having a flexible mandate.

Chris Salih (CS): I’m Chris Salih and today we’re joined by Vincent Ropers, manager of the Elite Rated TB Wise Multi-Asset Growth fund. Thank you for joining us today Vincent.

Vincent Ropers (VR): Great to be here, thanks for having me Chris.

[INTERVIEW]

CS: Let’s start with the fund and where it’s sort of based, it’s in the Investment Association Flexible sector. So effectively you have carte blanche and where you can invest. So you could invest up to 100% equities if you wanted to. Given the environment in the past 12 months, how flexible has the portfolio been and has the asset allocation moved around with the sort of changing market sentiment?

VR: Well I think the first thing to say is that we are indeed in the flexible sector and the reason for that is that we don’t want to have to obey any constraints from a benchmark. So that’s the starting point. What it doesn’t mean is that we are moving our asset allocation around a lot from being a 100% in equities one month to being a 100% in cash the following. So it’s certainly not what we’re doing. The objective of our fund is to beat equities and to grow capital in real terms. So we’re trying to offer, at least, equity like returns to our investors, but with less downside. So in practice, that means that we’ll always have some exposure to equities. And historically our equity allocation has been between 50% and 80% in this fund.

Another thing to point out, which I think is important, is that we are a fund of funds and we use investment trusts a lot. And the great thing about investment trusts is that particularly over the past few years, we’ve seen the alternatives bucket growing quite considerably in investment trust. So you can use investment trust to access private equity, infrastructure, property and more esoteric themes, like energy storage, music royalties, etc. So we have all of that available to us for investing.

So to answer specifically your question, over the past 12 months on the face of it, our asset allocation, hasn’t moved that much. Last summer we started increasing our location to more defensive strategies. So that was the time when we added exposure to floating rates exposure in fixed income with funds like the TwentyFour Income fund, for example, but we added some infrastructure debt or exposure to renewables and utilities. But really the overall equity allocation didn’t move that much.

CS: Was it at the upper end of 80%, or where was it in…

VR: No, it’s much lower, it’s around 65% at the moment. But it is within the equity bucket that we’ve made quite a number of changes. So we’ve tilted the portfolio increasingly towards value strategies, for example, or we’ve added our exposure more opportunistically to areas that we think are particularly interesting, like biotechnology and healthcare or frontier markets at the beginning of the year.

And we’ve also added outside of equities to some of our undervalued existing holdings like private equity, for example, which was trading particularly cheaply. And as we always do, so we tend to be quite disciplined in terms of profit taking. Those new purchases were financed by taking profits on some of our strategies that performed particularly well, for example Mobius Investment Trust in emerging markets or AVI Global, a global equity manager. So you really need to look under the surface to see the changes that we made over the past 12 months.

CS: You mentioned a couple of them that have been made in sort of the start of this year, obviously, you know, we’re only sort of three, three and a half months in, how would you sort of evaluate the year and maybe talk us through some of the areas that have been out and underperforming for you so far?

VR: Sure. Well at the start of the year, we started with a relatively constructive view on the economy. So in December/January, we were adding to our value strategies in the equity space with a view that this cyclical recovery was going to continue, that valuations were looking still very attractive. So that’s how we tilted the portfolio.

Obviously we hadn’t planned for the invasion of Ukraine. So that changed quite a lot of things. Not necessarily from an asset allocation standpoint because we took the view that those things are very hard to predict. You don’t want to panic and rush into changing the portfolio around too much in the midst of a war. We’ve been making some changes or adding to some positions opportunistically in March. So dipping toes in the water, in some of our positions that had suffered the most. But in terms of contribution I think without much surprise our best performing positions were in the commodity space. So BlackRock World Mining was one of our best performers and the Jupiter Gold and Silver fund as well.

CS: You wanna go into a bit more about those two specifically and on what you like about them and why?

VR: Well the first thing to say is that we’ve owned those two positions for a number of years now with deferring weights over time. But really if we look at the mining and resources sector, the things that attracted us before we were really all talking about inflation was the valuation element. So the mining sector was and has been very cheap for a long time. This to us is an obvious way to play the transition away from fossil fuels. So all those metals or at least a lot of those metals, like copper or even silver are really necessary in the electrification process, you can’t do without those.

We also liked the fact that the sector after years of poor capital management managed to rebuild itself in a way. And most of those companies present very strong balance sheets and with rising commodity prices, this is going straight down to their profit line. And they’re able to generate very strong cash flows that are then distributed increasingly to shareholders. So all those things were things that we have liked for a long time.

And obviously now that inflation is at the forefront of any conversations we think that this is an easy hedge really for any portfolio. So we are at a time, quite an interesting time from an asset standpoint really, where you can’t use fixed income to hedge your portfolio, to hedge your equity exposure. So traditionally, you would have equity exposure you could rely on fixed income markets to hedge your positions. This clearly in an inflationary environment, rising rates environment, this doesn’t work but positions in commodities are actually playing a useful part in that hedging process. So that’s why we continue to like positions like BlackRock World Mining.

The Jupiter Gold and Silver fund is a slightly different story because well, gold is I think an asset class on its own. So it can provide inflation protection, but what we’ve seen really in February and March, it’s not only the inflation protection, but also the traditional safe haven quality of gold. This is one, I think it remains one of the asset classes that people turn to when there is a shock, like a war, for example.

CS: And you mentioned the inflation protection there, obviously you mentioned a couple there. Are there any others, you mentioned infrastructure, perhaps, are there any other sort of areas that the inflation protection where you’ve got holdings that are positioned to sort of prepare for that scenario? You mentioned the alternatives buckets growing. Are there others there as well?

VR: Yes. So commodities, infrastructure. So infrastructure is interesting because a lot of the vast majority of revenues from your traditional infrastructure play is inflation linked. So you’ve got that direct protection against inflation. Positions in renewables and infrastructure. So it’s a bit broader that infrastructure, but we’ve got two positions one in EGL, which is a trust managed by Ecofin, a global infrastructure trust and an open-end funds in the Premier Miton Global Infrastructure Income fund. Both of those that invest in the broad infrastructure theme, but via listed equities.

So naturally they are directed towards your traditional large utilities companies which are still perceived by the market as being part of the old world. But that actually behind the scene are transitioning quite actively and quite quickly, particularly in Europe, towards more renewable energy. So those types of companies again, so they play the renewables theme and the fossil fuel transition theme, but they also have a lot of their revenues that are protected directly against inflation.

And finally in the fixed income space. So while fixed income is probably not the right term because actually floating income, but the two funds that I mentioned that at the beginning that we added to: TwentyFour Income, so that’s asset backed security. So those are taking exposure in the bond market to principally to mortgage repayments. So those payments, those bonds are floating rates rather than being fixed rates. So they move in line with inflation, which offers a natural protection. And GCP Infrastructure, that’s another way to play the infrastructure theme, but through the bond market. So it’s providing debt facilities to infrastructure projects. There again those bonds have got a direct inflation link.

So we’ve got a number of pockets in the portfolio that are well protected against inflation. I should point out that none of the positions are there specifically to protect us against inflation. So their positions that are there in their own right. And we think they are interesting themes that are relatively, still undervalued that can grow from here. But having the inflation protection is definitely a bonus in the current environment.

CS: And just lastly, you mentioned earlier, the sort of shift to a few more value names at the moment in the fund. Inflation’s the buzzword in markets, but we’re seeing the word stagflation or stagflationary environments becoming more prominent in press headlines, et cetera. How will this value tilt, or will value funds in general, do you feel perform in that sort of scenario where if we do go into stagflationary environment?

VR: We’re still quite confident about the ability of those strategies to perform. Obviously inflation is gonna be difficult for most companies. So the thing that we notice with all of our value managers is well, first by nature, an equity value manager will always focus on the downside first. That’s part of the nature, as opposed to, if you want to put people in boxes, as opposed to your growth managers, that will focus on the future growth story. A value manager looks at the assets as they are now, kicks the tires, look at what the downside can be and then where we stand relative to their evaluation. So there is, I think this inherent protection against a downside with a value manager. Then value equities should perform much better in the rising rate environment than growth companies purely by the effect of the discount rates, which is used.

So growth companies that have got where you discount future cashflow sometimes many, many years or decades into the future will be hurt by rising rates. So that’s another characteristic that we like, and we think will continue to play in the hands of value versus growth. Most of our managers spend a lot of time inquiring with their companies about their ability to pass on inflation to their end customers. So their portfolio is at the moment quite heavily tilt toward those companies that can pass on price increases.

And I think for us the key is really when you look at global value versus growth it’s not a buy signal in itself, but the discrepancy between value and growth is still pretty much as extreme as it’s ever been. So global value equities have underperformed global growth by more than 50% since 2007, for example. And if you look over the past three years, we’re still 25% behind in value versus growth, which sounds like an anomaly really to us. In itself as I said, it’s not a buy signal because valuation alone is never a good enough catalyst. You just know that divergencies tend to migrate together. So to get eradicated over time you just don’t know when this is gonna happen, but to us it offers a significant margin of safety.

CS: So, just lastly given what you said, given the environment we’re in and the stuff you mentioned there about value in regards to growth historically, I guess, would it take a significant catalyst or inflection point view to reverse those positions anytime soon?

VR: Well, that’s quite a difficult one. In terms of catalyst, I really can’t think of anything that would make us change the portfolio significantly from here. The main thing would be, and that wouldn’t happen over time, but would be the continued rotation out of growth into value. And if we start seeing a lot of those names, which are still darlings, for example, in the technology space, that fall significantly from here, then they would be on our radar. And they would become attractive to us, but this is not going to happen overnight.

And the key is that despite all I was talking about our tilt towards equity value, the portfolio itself hopefully I have given you a flavour of the things we’ve got in there is well diversified. We’ve got many levers that we can pull. We do actually have got access, have got exposure to growth strategies as well, but we do it indirectly.

So I would mention private equity, for example. So if you look at the traditional listed private equity trust that are available in the UK, a lot of them have got exposure to technology, healthcare, consumer sectors. But the beauty of it is that because of the private equity model the managers are directly involved in the management of those companies. So they can tilt those companies. The valuations in the private markets are not as expensive yet as in the public markets.

And the last point is that we can access those trusts at 20% to 30% discount while we would need to pay par to access those similar sorts of companies in the public market. So we have got that exposure. It is a diversified portfolio, relatively well balanced, and we just try to tilt it towards where we find the most value at any point in time.

CS: That’s great Vincent, thank you once again for spending with us today.

VR: Thanks very much.

SW: The TB Wise Multi-Asset Growth fund has a clear, straightforward process. The focus on high quality funds, coupled with strong exposure to investment trusts, offers a valid alternative in the IA Flexible sector. To learn more about the TB Wise Multi-Asset Growth fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts.

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 the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.