For a sense of where the sharemarket is going, turn to one of Australia’s best performing fund managers.
Hyperion Asset Management’s chief investment officer, Mark Arnold sums it up in one word: caution. But this plays right into the defensive style of the $7bn fund.
Hyperion’s flagship Australian Growth Companies fund was ranked number one among Australian fund managers in the Mercer Investment Surveys for the year to March, defying the worst of the COVID-19 meltdown and returning 5.8 per cent. Compare this to a return of minus 23.41 per cent for the benchmark S&P/ASX 300 index.
Hyperion was also ranked the second best performer in an extremely volatile March quarter as central banks and governments stepped in with unprecedented monetary and fiscal stimulus to offset a virtual shutdown of the global economy to stop the spread of coronavirus.
Since inception in 2002 it has returned 11.86 per cent per annum, 4.23 per cent above the index.
Speaking to The Weekend Australian, Arnold cautions that there’s still a lot of uncertainty about the depth and length of the coming recession, given that there could be multiple lifts in infection rates “over the next year or so”.
“We are still carrying more cash than we normally would … we are just looking for opportunities, so if there are further sell-offs over the next six months or so we will take advantage of them.”
While selectively buying high-quality stocks as global markets fell about 35 per cent in last month’s bear market, Hyperion still has capacity to buy more shares with its cash holdings to below 10 per cent.
Arnold, said the defensive style of Hyperion’s three funds — Australian Growth Companies, Small Growth Companies and Global Growth Companies — makes it easier for them to outperform in difficult markets.
“That’s when investors appreciate our defensive style because they are more concerned about preserving capital in difficult economic conditions like we are experiencing currently,” he said.
Indeed, it was a similar story for Hyperion coming out of the global financial crisis. Its flagship fund was also the top performer in Australian equities in 2009.
“We thought there was an increased probability of an economic downturn,” Arnold says.
“We have been saying for some time that we are moving to a low- growth world which is more disrupted — a world where buying cyclical businesses is much more risky.”
Hyperion has in recent years been shifting to stocks with stronger business models and lessening its exposure to companies that mostly depending on stronger economic growth.
“We have had high levels of cash coming into this crisis — our cash levels had been sitting in the double-digit domain as a percentage of portfolio holdings over the last 12 months,” Arnold says.
Cyclicals are too risky in his view, particularly if they might lose market share due to disruption. “Even once we recover from the COVID-19 crisis it’s still going to be low-growth world because of structural headwinds like lower population growth and high debt levels, so you definitely don’t want exposure to businesses that are highly reliant on economic growth and losing market share.
“Unfortunately a lot of traditional value investors tend to be attracted to those stocks because they’re on low PE multiples and they might have high yields, but we would argue that a lot of those things are temporary and illusory. If you get caught in those sorts of businesses that are being disrupted and are sensitive to economic growth rates, you can permanently lose capital.”
Hyperion generally shuns banks due to their financial gearing, capital intensiveness and sensitivity to economic conditions, as well as their vulnerability to disruption from new financial technology.
But while the global fund owns no bank shares, the Australian fund does hold Macquarie Group shares, as it has done for the past 20 years. “We just love the way that they innovate,” Arnold says.
The energy sector — smashed by plunging oil prices this year — is also best avoided in his view.
“We think oil is structurally challenged; we thought this before COVID-19. EVs (electric vehicles) are going to displace oil eventually,” he says. “We have no exposure to oil or gas.”
The energy sector and resources more widely don’t have the earnings predictability he’s looking for. “Commodities have been artificially boosted because of China’s big spending programs,” Arnold says. “China is turning Japanese and big infrastructure spending will get less efficient.”
But there are plenty of high-quality defensive growth companies on his watch list.
Hyperion typically bases its investment decisions on its five-year internal rate of return forecasts. Two companies recently added to the Global Growth fund are Service Now and Alibaba Group.
The Australian Growth fund bought James Hardie on the dip and has continued to hold a stake in Brambles, which fell just 10 per cent in the quarter versus a 23 per cent fall in the benchmark.
“The stocks we have recently added to the global fund had unattractive IRRs prior to the crisis but when share prices were hit it made them look more attractive from a long-term return perspective.”
Healthcare stocks including CSL, Cochlear, ResMed, Fisher & Paykel Healthcare feature prominently in the portfolio — a plus for performance since the sector held its ground in the March quarter selloff.
CSL, Domino’s Pizza, ResMed, Cochlear and REA Group were the top five holdings as of March.
“We don’t have any Australian traditional retailers like JB Hi-fi or Harvey Norman because they are mature and don’t have the rollout potential and large addressable markets,” Arnold says.
“The only traditional retailer we own is Costco — this is due to its low pricing that is disruptive with a strong value proposition and it has significant long-term rollout potential.”
This article was originally published in The Australian.