Stephen Bruce is a director, portfolio manager and head of research at Perennial Value.
He joined as an equities analyst in April 2000 and was promoted to the role of research coordination/senior equities analyst and assumed the role of deputy portfolio manager for the Perennial Value Shares for Income Trust in 2006.
In 2011, he was promoted to the role of lead portfolio manager for the Perennial Value Shares for Income Trust and co-portfolio manager for the Perennial Value Australian Shares Trust. In 2018, he was promoted to director, portfolio management, with the responsibility of overseeing the management of all broader-capitalisation Australian equities portfolios. He also has research responsibility for the banking, healthcare, telco and agricultural sectors.
For the 12-months to March, the Perennial Value Australian shares Trust outperformed the index by +10.8% (after fees.)
The Inside Network spoke with Stephen Bruce to discuss the Perennial Value Australian Shares fund and how the “shift to value” was progressing.
Stephen, can you give a quick overview of the Perennial Value Aust Shares Trust and how it has performed in the year to date?
The Perennial Value Australian Shares Trust is a value-style, ESG-aware, broad-cap Australian equities fund. The fund commenced in March 2000 and has operated through numerous market cycles. The trust has performed very strongly over the last 12 months, returning +49.1% after fees, and outperforming the S&P/ASX 300 Accumulation Index by +10.8%.
Value is clearly more than a P/E ratio. Can you offer some insight into how you seek to identify value in a modern market environment?
There is more to value investing than simply buying shares trading on low P/E ratios. We seek to identify stocks that are trading at a discount to their fair value. This can mean looking for stocks whose earnings are temporarily depressed, but which we expect to recover. Alternatively, it can mean looking for stocks where the whole valuation does not capture the level of earnings growth they are expected to deliver. While these stocks may not be on the cheapest P/E multiples, they may be attractive on the PEG (price/earnings to growth) ratio, which compares the P/E to the expected growth rate. For example, a stock trading on a P/E of 15 times, with expected EPS growth of 10% a year, has a PEG ratio of 1.5 times. Therefore, identifying stocks with low PEG ratios is another way to identify value. However, the key characteristics of value investors like Perennial are that we place a high level of emphasis on sustainability of earnings, and prefer proven business models. This means that we are not willing to pay very high multiples for growth-style companies that are currently generating low or no profits.
How has the fund performed coming out of the coronavirus sell-off and March 2020 lows?
The post-COVID recovery has been a very good period for value investors such as ourselves, with the trust outperforming the index by +13.6% after fees, from the market low on 23 March 20. This outperformance was driven by two main factors. Firstly, the trust benefited from the strong rotation towards value stocks during the rally. Secondly, periods of indiscriminate selling, such as occurred during the sell-off in February and March last year, create opportunities to acquire quality businesses at very attractive prices. The trust was very active over this period, adding a significant number of new holdings, many of which have performed very strongly.
What two factors have created favourable conditions for value investing to flourish?
The two main factors that have led to the outperformance of value over this period are first that growth is now broad-based as the economy recovers. Over the last few years, growth has been fairly subdued, meaning investors tended to pile into a relatively small number of stocks and sectors, such as technology and healthcare, pushing up prices. The post-COVID recovery has seen broad-based growth across most sectors of the market, giving investors far more choice of where to invest to find earnings growth, including in value stocks. Secondly, the combination of increasing activity and fiscal stimulus is likely to drive inflation, which will lead to higher bond yields. This is generally positive for value-style stocks and negative for expensive growth stocks, whose valuations are predicated on earnings further out in the future, making them more sensitive to interest rates.
How is the portfolio being positioned to take advantage of the sentiment shift from growth to value?
We expect that the rotation from growth to value still has a long way to run, and the portfolio is positioned towards the more cyclical parts of the market, which are best placed to benefit from the economic recovery. This includes financials, with the major banks entering an upgrade cycle on the back of rising credit growth and decreasing bad debt charges. The resources sector also looks interesting, with increasing economic growth likely to be supportive of commodity demand and pricing. Along these lines, the energy sector also has upside. Finally, while unrelated to the broader macro environment, the agricultural sector is experiencing a boom on the back of excellent seasonal conditions. All of these sectors also tend to benefit from a more inflationary environment as well.
Which sectors or themes do you expect to benefit most in 2021 and beyond compared to those that benefited from the pandemic environment?
The pandemic benefited those sectors leveraged to the ‘stay at home’ dynamic, from supermarket retailers selling food and alcohol for consumption at home to companies selling home electronics and office equipment to tech companies running home delivery services. Moving forward, leadership will switch to the “out and about” trade. In the retail space, this means travel and outdoors, while more broadly, the property sector is very strong on the back of stimulus programs. This is on top of what we expect to be ongoing strength in the resources sector as commodity demand increases.
Could you elaborate further on whether value strategies are going to be able to maintain this momentum and continue these winning ways?
We believe that COVID has triggered a major shift in market settings. The decade post-GFC was characterised by low growth and low inflation. Monetary policy was the tool of choice, resulting in ever-lower interest rates, while governments were reluctant to undertake fiscal measures. This environment ideally suited growth and momentum-style stocks. However, the pandemic has forced the hands of policymakers and, while monetary easing has continued, fiscal stimulus has been required. The combination of fiscal stimulus driving broad-based growth, on top of a large increase in the money supply, will likely lead to inflation and rising rates. This environment will be far more favourable to value stocks going forward. So, while the outperformance of value has been dramatic over the last 12 months, we expect that it may well continue. Further, despite the outperformance of value over the last 12 months, the valuation dispersion in the markets is still at record levels. In fact, the valuation gap between the expensive and cheap parts of the market is still greater than it was at the height of the first tech bubble in 1999-2000, meaning there is the potential for very significant reversion.
What is your decision-making process for exiting positions?
Sell decisions are just as important as ‘buy’ decisions when it comes to managing a portfolio. We use an automatic sell process which means that once a stock reaches our price targets and no longer offers attractive relative value, we will begin to sell down the position. This also prevents you from ‘falling in love’ with a particular stock and ignoring valuation fundamentals.
How important are current macro trends and forecasts to your portfolio build?
At the moment, the macro environment is a key driver of the markets, and our views are reflected in the portfolio’s exposure to cyclicals leveraged to the global reopening. However, we are first and foremost bottom-up stock pickers who, above all, focus on the fundamentals of the businesses we invest in. Ultimately, we are trying to build a portfolio of high-quality, sustainable businesses with good management and sound balance sheets and whose share prices offer attractive long-term value.
What value stocks are you looking to buy that you have on your watchlist?
One sector that looks interesting and has been left behind is insurance. This sector has suffered from a number of factors such as concerns around business interruption insurance claims. However, we believe that this is largely in-the-price at these levels, and the premium rate cycle remains strong. Further, insurance companies are positively leveraged to rising interest rates. We’ve had good performance from investments in insurance brokers such as Steadfast Group (ASX:SDF) in recent times, and maybe it’s time to look at the insurers themselves. Further, given their current share prices, they should offer a degree of defensiveness as well.