Why it pays to not ignore old friends

Simon Hoyle,  Editorial,  No More Practice Education

When things change in investment markets they often change quickly. A trend that has been running strongly can come to an abrupt end, and a sector of the market that has been out of favour or overlooked can rapidly come back into vogue.

Orbis Investments portfolio counsellor Ben Preston says a fund manager’s job is to have a foot in both camps – to take advantage of a sector that is in favour, but also to monitor more neglected sectors, on the lookout for attractively priced investment opportunities. “Our job really is to position where perhaps investors are less optimistic, and therefore we can find a bit more of a bargain,” Preston says.

He says the past 10 years has been good for technology stocks, and less good for mining stocks. But to continue ignoring mining stocks altogether would be to miss some significant changes, and potential opportunities. “The miners have really changed their strategy,” he says. “They’ve now cut back quite hard and so they’re actually generating quite a lot of cash from the products they produce. It’s still an area that’s very unpopular with investors. And yet if you look at the next 10 years, it could be significantly better than the last 10, simply because they’re no longer overspending.”

Preston says he is not predicting “the downfall of technology”. But as the trend in that sector continues, the challenge for investors becomes twofold. “The challenge is to look not only for the companies that are going to do well in the future, but also to be conscious about how much one is paying for those companies,” he says. Some factors will continue to fuel longer-term investment trends. Preston says demographics, for example, will be a significant influence in economies around the world, as people of working age decline as a proportion of the total population, and more people in retirement starting to draw down their retirement savings. “In other words, [they are] going from a population that’s naturally buying retirement assets to one that’s gradually receiving retirement income,” Preston says. “That switches people from being buyers to sellers. If you look at something like Japan, where the, the population has been aging and actually shrinking for some time now, those dynamics are starting to be replicated in other countries. We see that in the US, we see that actually in China. And China’s been a, a very strong growth economy over the last few decades, but if you look at the working age population now I don’t think it’s rising as strongly as it has been.”

Trends rarely operate in isolation, however, and while the power of demographics may shift markets in one direction, other factors will be pushing in different directions. While populations in some countries transition to being sellers of assets to support retirement, central banks will also be selling assets as they unwind recent quantitative easing programs. “It’s a cocktail that’s worth paying attention to, in terms of you have the quantitative tightening on one side, then you have the demographic hump on the other,” Preston says. “And how those two interact will be quite interesting in the decades to come, and certainly we’re starting today from a point where valuations are high. And that’s something to be conscious of.”

Preston says the trend of fast-growing Asian economies, established now for “the past generation or two”, will continue to produce investment opportunities. He says gross domestic product (GDP) per capita of these economies is still significantly less than developed economies “and that implies that there’s further to go in terms of increasing the wealth of the Asian economies”.

Emerging markets also offer some attractive valuations, Preston says. “The valuations on companies in emerging markets tend to be at a discount to what we find in developed markets and so perhaps the greater returns are to be had there in the next 10 years,” he says. “We’ve been overweight some time for emerging markets. We think the valuations are more attractive.

“Not only that, but emerging markets are widely perceived to be quite risky because there’s greater political and economic risk, but the real risk in investment isn’t political or economic risk, the real risk is losing money. And where that comes from is overpaying for a share to start with. And so I would say that the risk of overpaying for shares is probably greater now in some of those developed markets, than for the equivalent emerging markets.”


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