Caroline Cai from Pzena Investment Management speaks to The Inside Network’s James Dunn for our IN60 series. The Inside Adviser
The historic outperformance of big tech stocks in the US may look like a global outlier, but many developed markets (including ours) have high levels of concentration risk. That may not be the case for long, with a likely softening interest rate environment set to re-order indexes around the world.
Momentum trade sees market at ‘extremes’
While all eyes remain focused squarely on whether inflation is “transitory” or not, “persistent” is the adjective that value manager Allan Gray uses to describe the position of the equity market. Speaking in its monthly update, the firm’s Australian managing director and chief investment officer Simon Mawhinney flagged the “exuberance for some stocks and disdain for the others” as a key source of opportunities in 2022.
Anyone who follows Allan Gray would be more than aware of its patience and commitment to taking contrarian positions in under-valued stocks and its refusal to be caught-up in “momentum” plays. By calculating the correlation between the performance of stocks this year compared to the previous three-year period, the firm seeks to identify the “crowded trades” before any selloff begins.
Recent examples in markets, not raised by Allan Gray are the likes of Redbubble (ASX: RBL) and Kogan ASX: KGN), both of which saw massive share price gains during the pandemic as they fitted the work-from-home theme, but ultimately momentum and the fear of missing out drove them well beyond their fair values.
Persistence and momentum, according to Allan Gray, is difficult to avoid because it is “self-reinforcing,” making it a powerful force in asset prices. Alhough one doesn’t have to look beyond the cohort of non-profitable tech stocks to ARK Invest’s recent performance to see what happens when it comes to an end.
The firm is delivering this warning at a time when many investors, professional and amateurs, are throwing in the towel and backing last year’s winners all over again. Value investing has been a lonely trade for close to a decade, but Allan Gray suggests that there “couldn’t be a worse time to abandon patience and value discipline,” suggesting that the market today presents “plenty of examples of extremes.”
“A major adjustment has not yet come to pass,” according to Mawhinney, although many who have already been burned may disagree. He believes it is entirely possible that momentum followers will be hurt “much more badly than they feel possible.”
After a renaissance earlier in 2020, the Australian equity portfolio under-performed in the final quarter, hurt by holdings across the energy and financial sectors. That said, the manager confirmed that it would not be charging any performance fees until the high watermark of the fund is achieved. The same cannot be said for many other managers out there.
While almost every investor is seeking to forecast and prepare portfolios for inflation, Allan Gray does not attempt to do so, believing that few have any edge in macro predictions. Rather, the firm “considers how our portfolio may perform depending upon how the inflation and interest rate environment develops in future.”
