Antony Burgess from Veritas Asset Management, portfolio managers for the Nedgroup Investment Global Equity Fund since 2010, provides an update of the Fund’s recent performance.
Q2 in perspective
What we’ve seen year to date is the shortest bear market cycle ever and investors have effectively discounted a severe recession and the economic recovery before either of them have occurred. The portfolio returned 13.62% for the last 3 months versus the MSCI World Index return of 19.36% and returned 3.03% versus the Index at 2.84% for the 12-month period. The shortfall has largely been made up of an asset allocation effect and is a by-product of our stock selection. The reason for the underperformance in Q2 was firstly driven by our very underweight position in information technology (4% vs Index of 20%), which was the best performing sector. Secondly, we are underweight in materials, which performed well and lastly, consumer discretionary was another well performing sector where we are underweight (2.7% vs Index of 10.7%). On top of that, the biggest weighting in the Fund is healthcare (30.5% vs Index of 14.5%), which was the worst performing sector in Q2. The good news is that most of the companies we’re invested in are operationally doing extremely well and are not in trouble. The Fund’s 10-year returns outperformed both the MSCI World Index as well as their global peer group, the latter by about 3% per annum.
The backdrop for markets
Covid developed in January and the response of most countries was initially to go into lockdown and protect healthcare service providers, resulting in an extensive economic fallout. As a result we’ve seen the most substantial fiscal and monetary response ever. The US fiscal stimulus was up to 18% of GDP, which is more than in 2008 with the GFC. This trend was similar in other countries. Investors have latched onto this and have effectively discounted recovery and the best performing sectors are those which are leveraged towards economic growth, i.e. consumer discretionary, materials and technology.
This can be illustrated by referring to one of the common ratios looked at for valuation, particularly for tech companies, which is enterprise value over sales for the next 12 months. The ratio effectively tells you how much it costs to purchase a company’s sales. Looking at this ratio for the US tech sector, prior to the fall off from Covid, the sector reached a peak of 12.5 x EV/Sales. It then got derated by 30% and fell to 8.5 times where it looked attractive and now is at nearly 15x. There’s been a 75% multiple expansion within the sector since the fiscal stimulus and recovery in Q2. So it’s a lot more expensive on this valuation than it was prior to the fallout and even before that when we thought it was expensive.
Looking at the companies within the tech sector, companies like Zoom and Shopify are in the hyper growth group within the sector with growth expected to be more than 40%. Of the 14 companies in the high growth group (growth of 25%-40%), only two of them made a positive operating profit in the last earnings reporting season. The average earnings margin across all these 14 companies was
-26%, meaning that they’re either exceptionally overvalued or there needs to be substantial growth in the future to justify these earnings.
Portfolio activity in Q2
There were no new purchases ibn Q2. We did add to some existing positions, including Cooper Companies who look cheap on an IRR basis. The only complete sale was Amazon. We were only able to buy about 9 shares in March so sold them at a substantial profit, but unfortunately this didn’t move the dial very much.
The Portfolio currently has 29 holdings. The cash level is still low (2.2%) as most of it was deployed in Q1 and we have no materials at all. We’re very lightweight in consumer discretionary (3.2%) and information technology (4.1%), which is all in Mastercard. We have a large position in healthcare at 31%, 20.9% in industrials, 20.2% in communication services, 10.8% in consumer staples and 7.3% in financials. Some of the top ten holdings include Charter Communications (7.8%), Alphabet (6.7%) and BAE Systems (4.5%). 63% of the Fund’s holdings are in North America.