Growing capital during the big 'unwind' – positioning for growth - Angles & Perspectives

Growing capital during the 'big unwind' – positioning for growth

Global conditions are challenging – and look set to remain so for the foreseeable future. Global markets recorded their worst start to a calendar year in more than 50 years (the MSCI World Index returned -20.3% in US dollars in the first six months of 2022), and investors can be forgiven for struggling to make sense of the multiple forces shaping markets today. How can investors position their portfolios for growth?

Parts of the globe are still emerging from the pandemic. Countries such as China are still grappling with how to revert back to normal life, and many developed markets are facing an energy squeeze of unprecedented proportions. Germany’s baseload power price, for example, has risen 5-fold from €64 to €323/Mwh over the past 12 months and some German towns are rationing hot water to citizens and dimming their streetlights. It isn’t only Eskom keeping people in the dark. Uncertainty seems to have become even more pervasive and widespread since the start of the year.

How are investors to grow their capital in such an uncertain world?
Rather than obsess about the short-term noise and uncertainty, investors would be well served to focus on the longer-term fundamental forces shaping companies and markets. We have detailed some of the rationale for differentiation in the previous articles, and now more than ever, an open mind and the ability to exploit a wider opportunity set are of critical importance. Here we would flag the investment universe is wider than the strongly ingrained belief of only investing in ‘quality’ or rand hedges. Paying the right price is important to future outcomes and while large parts of markets have merely corrected to fair from previously overvalued levels, a fresh look at the definition of quality should serve investors well.

Positioning for the unwind
After the worst first half year for global markets in over 50 years, and in the wake of global market distortions, the bottom-up opportunities and wide valuation discounts we are currently being presented with suggest promising medium- to long-term return prospects. While a potential economic recession is factored into our scenario analysis over the near term, we find that opportunities tend to correlate with uncertainty. Given the large divergences in valuations we are still observing in markets today (as shown in the following graph) and the expected unwinding of distortions discussed in the article Capitalising on the ‘big unwind’ – picking stocks that are fit for the future, the abundance of opportunities currently available informs our offensive equity positioning. Importantly, the opportunities tend to be found outside of the universe many investors find themselves in, and we believe this positions us uniquely to deliver differentiated investment opportunities to our clients.

We seek out higher-yielding opportunities
Our fund positioning is skewed towards higher-yielding opportunities where a greater weight of the inherent value is reflected in nearer-term cash flows. These can be broadly grouped as follows:

• Underappreciated defensive growers: the core of the portfolio, these are our typical 3M companies where exceptional quality and growth potential are currently hidden, misunderstood or just ignored by the market.
• SA mid-cap: as mentioned in the article Capitalising on the ‘big unwind’ – picking stocks that are fit for the future, the market has come to view SA Inc. shares as largely uninvestable, and have applied excessive risk premiums to them. Our funds are not constrained by benchmarks and due to our size we take meaningful positions in these counters in our local portfolios.
• Supply-constrained real assets: after a long period of underinvestment in productive capacities of the economy, we have entered an era of scarcity in certain commodities as well as many sources of energy. Higher than average commodity prices and strong returns are likely to persist until the supply side responds, which in most cases will take several years.
• Cheap financial companies: these trade on low valuations and high dividend yields and will largely benefit from structurally higher interest rates.
• Attractive idiosyncratic opportunities: the smallest part of the portfolio is spread across stocks that have endured tough times and which are currently deeply neglected by the market. In our view, however, there is a clear and credible path to recovery and outsized return potential at acceptable levels of risk.

Many of these opportunities currently included in our portfolios did not enjoy strong returns over the past decade and may therefore be overlooked by investors. Given that we have likely entered an era of persistently higher global inflation and interest rates, in combination with low starting valuations and a highly supportive supply side, many of these could be seen as the quality assets of the next decade as historical market distortions unwind. They are also currently undervalued for a variety of reasons. Thus, we believe the future performance of our portfolios will benefit from this diversity and be both sustained and robust.

We use a single, integrated global investment process across our portfolios. Below is the positioning of the PSG Global Equity Fund as well as the PSG Equity Fund at the end of June 2022. While both funds have access to our best global ideas, our local funds also benefit from the addition of attractive local equity opportunities.

Positioned with the challenges of the big unwind in mind
Most of the opportunities we have highlighted, tend to be outside of the popular indices and mega-caps. As such, they are unlikely to enjoy significant representation in competitor portfolios.

We believe, in order to grow one’s capital in the years ahead, a differentiated perspective will be paramount.