Top fund managers warn more pain ahead for equities, iron ore
Markets Reporter
Australia’s best-performing fund managers warn the sell-off triggered by rising interest rates is not over, naming stricken technology stocks and iron ore as the weakest links in a recasting of the sharemarket’s winners and losers.
Top returns for the 2022 financial year were dominated by investors who backed rising commodity prices after the start of the Ukraine war, the reopening trade, and a comeback by long-short strategies after years in the wilderness.
Large falls in the share prices of tech companies sent 2020-21’s winners crashing in a dramatic reversal of fortunes reflected in the worst performers.
Morningstar data ranking Australian and global equity strategies for financial year 2022 reveals Perennial Private to Public Opportunities as the No. 1 actively managed fund, having returned 52.6 per cent. It was only bested by the BetaShares’ crude oil exchange traded fund, which rallied 60 per cent, according to Morningstar’s findings.
Bronte Capital founder John Hempton, whose hedge fund cracked the leaderboard with a 20.7 per cent return, said: “I’m very firmly in the ‘we’re nowhere near the bottom’ camp.”
Recovering from a difficult period where Reddit’s day traders took the fight to hedge funds in the GameStop mania last year, Mr Hempton said his short positions had done “astonishingly well”.
Buying opportunities
Fellow hedge fund manager and Regal’s chief investment officer, Phil King, who had two strategies inside the top 10, expects the US equity market to bottom over the next month or two, but finish the year higher.
Despite the US consumer price index claiming a 41-year high 9.1 per cent in June and roiling Wall Street, Mr King thinks inflation has peaked, and the market is littered with great buying opportunities.
The famed commodities bull asserted in 2020 that the ASX’s mining stocks were on the cusp of a boom. However, a deteriorating Chinese property sector means that is not true for iron ore, which on Friday fell 3.6 per cent to $US96.60 a tonne, according to Platts.
“It causes us genuine concern because it’s the Chinese property market that has been driving the Chinese economy, and the Chinese economy has been driving the world,” Mr King said.
For other commodities such as copper, neglected avenues of new supply and increasing demand will drive gains into the 2030s, keeping Regal’s super cycle forecast firmly intact, he believes.
“Very tight supply and rising interest rates are not going to help improve the supply situation, and even though we might see a US recession and some weakness in demand, we think the resource sector will come out the other side stronger than ever.”
‘Perfect storm’
Top returner Perennial attributes its success to valuation boosts from private growth stage businesses such as mattress and furniture company Koala, and games maker and crypto investor Animoca Brands.
Portfolio manager Ryan Sohn described the low-interest rate environment and cost blowout amid a shortage of top talent as a “perfect storm” for the subsequent falls witnessed across the market in private valuations. But ultimately, he was pleased they had come down to “more rationalised levels”.
“We had situations at the end of last year where we loved the businesses and the founders, but the valuations were two-to-three times higher than we could pay, and yet these businesses were getting funded quite comfortably,” he said.
“I think this rebasing is a healthy market dynamic.”
Mr Sohn expects a calming in the market, as the “growth at all costs” narrative shifts to the less catchy “grow with strong discipline and capital efficiency”. He warned of landmines facing businesses forced to go back to the market to raise capital to survive.
He also cautioned that very early-stage valuations remained uncomfortably high, with a fair amount of capital chasing companies with only a short financial history.
“If you’re a business that is relying on the capital market to grow, and you’re loss making, and the only way to survive is to keep getting capital in, that could be difficult.” Good businesses would always attract capital, he said.
Canva cold shoulder
Holdings in the Perennial fund are largely private, but it says it has maintained a conservative valuation policy. It has written down one unnamed position to “basically nil” over the past quarter, but is “very comfortable” with the operational performance of all the remaining businesses.
Mr Sohn said the re-rating in public equity markets was playing into the fund’s hands as it could now offer growth capital to private companies at more favourable valuations.
Australian success story Canva is the sort of business Mr Sohn is reluctant to invest in “given the valuation”, and the manager has a general aversion to a group of ultra-high-profile unlisted Australian unicorns now subject to a de-rating.
As the confidence to list via the initial public offering process waned and the IPO pipeline dried up, Mr Sohn said merger and acquisition activity had gone through the roof. Cashed-up giants were hunting for companies with great technology at cheaper prices.
He believed a number of the fund’s holdings were potential targets. “As we speak we would have at least six companies that are anywhere from early stage to late stage of interest from M&A buyers,” he said.
“It’s really quite amazing.”
It has been a chaotic, and costly, year for many investors. After enjoying mammoth returns in financial 2021, equity markets took a turn in December as it became clear central banks would be forced to raise emergency low levels of interest rates to combat rising inflation.
The S&P 500 capped its worst June half since 1970 and now faces a triple whammy of sticky inflation, recession risk and the threat to corporate profits from sinking consumer confidence.
Value managers in favour
Tech pain in public markets has infected private ones too. Buy now, pay later giant and Commonwealth Bank-backed Klarna has joined Canva in having its valuation slashed, while home-grown juniors such as health tech start-up HealthMatch and cryptocurrency payments outfit Banxa look to shore up their balance sheets by cutting staff.
This new dynamic has cost investors in 2021’s best performers losses of more than 70 per cent, as sky-high valuations unwind and cryptocurrencies fall back to earth. Today’s conditions firmly favour value managers, a style of investing largely defeated for the past decade.
Morningstar associate director of manager research Michael Malseed said value managers had the optimal tools to fight through.
“First, traditional value stocks weren’t trading at stratospheric multiples so when higher interest rate expectations pulled down market multiples, value stocks were less impacted,” he said.
“Second, value names – more concentrated in more cyclical sectors such as energy – have performed well, largely due to geopolitical factors.”
Morningstar’s performance data is net of all ongoing fees and charges.
The top of its list is also populated with infrastructure funds, reflecting the reopening theme as pent-up travel demand was unleashed on toll roads and airports, and strong M&A activity, particularly on the ASX. The public markets have already farewelled names such as AusNet Services, Spark Infrastructure and Sydney Airport.
Among Regal’s two winners, Regal Tactical Opportunities and Tasman Market Neutral, the former is a trading fund that targets things such as index inclusion and exclusion, while the latter has sought to take advantage of the gains in resource stocks and sell-off in growth stocks by going short.
On a three-year trailing returns basis, which encompasses most of the COVID-19 rebound and subsequent sell-off, top long performers include Armytage Micro Cap Activist fund at 26.6 per cent, Spheria Australian Microcap, and PM Capital Australian Companies.
Bronte Capital’s Mr Hempton said he could still find plenty of shorts. Perhaps less than in March last year, but still plenty.
“We measure the bottom, how hot the market is, by how many frauds, how many hyped stocks that are just complete nonsense,” he said.
Mr Hempton can even construct a negative outlook for a US megacap such as Google, arguing that if advertising revenues drop as they did during the last US ad cycle, and the US dollar remains strong, the company has an issue.
“I own a large slab of it, and there are plenty of ways I could lose money,” he said.
This article first appeared in the AFR – click here to read the original article.
