Perspective: Long-Distance Runners | AAG Wealth Management

Perspective: Long-Distance Runners

Posted: June 30, 2014

Each month, we look at the economic and investment world from a different view point…

August 2014: Richard Oldfield from Oldfield Partners

Long-Distance Runners

World stock markets have consolidated after last year’s rally, but equity specialist Oldfield Partners believes that there is still mileage for investors. Oldfield’s long-term approach is a high-conviction, highly-concentrated strategy which looks for deep valuation opportunities, to produce a return that is well above inflation. Investment managers Richard Oldfield and Andrew Goodwin, who run the St. James’s Place High Octane fund, see further value opportunities as the global economy recovers, buoyed by ultra-loose monetary policy. “Liquidity-driven markets such as this one can go on for a while yet,” says Oldfield.

Some investors are nervous about current valuation levels, but the London-based fund managers view the present market as different to the conditions of the late 1990s. “Technology IPOs are currently highly priced but we’re not seeing the wholesale switch to tech that we saw in the dotcom bubble,” Oldfield observes. Where they see value is in Europe and Japan,
which they believe continue to offer more investment potential than the US. With corporate profitability in Europe still near its trough levels, Oldfield and Goodwin are looking to the region for potential earnings recovery. They anticipate less opportunity and lower returns from the US market in the face of corporate profitability levels and valuations that are near historic highs.

Cape Watch

Oldfield says that the valuation gap between US and Europe is best demonstrated by the cyclically adjusted price/earnings (CAPE) ratio, or the Shiller PE, which measures the  market’s price relative to average earnings over the past ten years and offers a long-term view of a market’s value. On Wall Street, the Shiller PE has only been significantly higher during the dotcom bubble at the turn of the century and before the Great Depression in the 1930s, measuring just below 25 at the end of March compared to just over 14 for the
European market.

The portfolio is on low valuations on all metrics relative to MSCI World, but Oldfield emphasises that this situation has not sacrificed return on equity. “There is a low debt to equity ratio across the portfolio,” he adds. “We don’t like financial leverage when combined with operational leverage – and this is one of the key risk factors we consider.” Stock selection is at the core of the investment philosophy, and Oldfield says he never looks at MSCI World weightings. “We choose stocks not economies,” he explains. “We don’t worry about what we don’t hold, because we have enough to worry about with what we do own.”

Goodwin highlights the advantages of the continual inflow to the St. James’s Place mandate, which allows for discretionary investment decisions. “Even in the dark days of the fourth quarter in 2008, the fund still saw inflows,” adds Oldfield. And this steady flow of funds benefits investors because Oldfield can take advantage of distressed prices as well as engage, if necessary, in ‘fire sales’. The High Octane portfolio comprises 22 stocks, all of which are large companies with an average size of $76 billion. There is a broad selection of global stocks, with US technology giant Hewlett-Packard the largest holding in the portfolio (6.5%). There are three main themes to the portfolio: Japan; companies that are worth more than the sum of their parts; and the automotive sector.

Japan makes up 22% of the portfolio, which is the same weighting as the US. The companies typically fall into two categories, according to Oldfield. There is ‘sharp end’ stock involved in industries with exciting futures, such as the multinational robotics manufacturer, FANUC (which was in the portfolio until valuations got too high).

And there is ‘dinosaur’ stock – Japanese electronics group Hitachi being the most recent example – which was the “poster boy” story prior to the two-decade Japanese slump that started in the early 1990s.

“Hitachi is king of the dinosaurs,” explains Oldfield. “The company over-extended itself and became the symbol of Japanese corporate failure.” But the arrival of new management in 2010 has seen a huge change in attitude and actions, he notes, which included axing uncompetitive product lines, such as consumer electronics, and refocusing on heavy engineering.

Hitachi’s value doubled before it was sold in the first quarter this year. Other dinosaurs include Mitsubishi and national carrier Japan Airlines (JAL), which underwent bankruptcy four times in the last decade before its operations recovered “These companies are sleeping monsters,” adds Oldfield. “If they can be prodded into life then good things could  happen.”

However, Japan remains a frustrating place to invest, concedes Oldfield, and for “every Hitachi there is a major disappointment”; for example, the optics and electronics group Olympus, which was engulfed in fraudulent accounting scandals in 2011. The portfolio also includes passenger rail group East Japan Railway (4.4%), electronics multinational Nintendo (3.9%) and telecoms group NTT (3.7%).

Oldfield is positive about Japan, despite the pace of the rally in 2013 and the level of recent market valuations. Japanese Prime Minister Shinzo Abe’s reform programme, Abenomics’, since 2012 has helped to tackle deflation and kick-start the world’s third-largest economy, as well as buoy asset prices. Despite a massive fiscal stimulus programme and aggressive monetary easing, Oldfield observes that the Abenomics programme’s ‘third arrow’ of structural reform currently looks “a bit blunt”. And the International Monetary Fund recently cut its 2014 growth forecast for Japan, warning of the need for stronger domestic private demand.

Oldfield says that French car manufacturer Renault is the best example of companies that his team deem are worth more than the sum of their parts. Back in 2011, Renault shares were effectively valued at minus €23, based on its stake in its strategic partner Nissan. Renault’s stake in Nissan now equates to 80% of Renault’s valuation, but in 2011 its investment in the Japanese car manufacturer was three-times its own value. Other companies exhibiting this sort of ‘deep value’ include Italian carmaker Fiat, French telecoms group Vivendi, NTT, US tech giant Microsoft, and Italian energy group ENI.

Value Range

Tesco is another stock in this investment category. The UK supermarket group has a £24 billion market capitalisation, but the market value of its property assets held across the group exceeded £38 billion in 2013. With a 30% market share and a dominant online market share of 49% – twice that of Ocado – Tesco also still towers over the discount stores Aldi and Lidl with their combined 7% market share. Oldfield purchased the stock after a profit warning in January 2012, and believes a programme to invest in more staff and refurbish its
stores has helped put the company on track.

Although, with a 5.5% yield, he believes investors are “being paid to wait”. Automotive manufacturers constitute a third investment category, and Renault, Fiat and General Motors make up an eighth of the portfolio. In the aftermath of the credit crunch, US car sales fell to around 10 million units a year, compared to a historic average of around 16 million.

Oldfield cites the words of Herbert Stein – “If something cannot go on forever, it will stop”, and sales have duly returned to 16.2 million units.

In contrast, the European market remains depressed with car sales in Italy down to 1978 levels, and Oldfield believes that there is scope across the European region for a 10-18% per year improvement in sales. (He has only owned shares in three car companies in 30 years, which are currently in the portfolio.) “Technological advances in car design will provide a big impetus to car sales over the next decade,” he adds.

Points and views

  • With corporate profitability in Europe still near its trough levels, Oldfield is looking to the region for potential earnings recovery.
  • The portfolio is on low valuations on all metrics relative to MSCI World, but unusually there has been no sacrifice of return on equity.
  • The continual inflow to the St. James’s Place mandate allows them to make discretionary investment decisions, rather than being forced to sell before buying.
  • The portfolio comprises 22 stocks with an average size of $76 billion.
  • Japanese companies within the portfolio typically fall into two categories: ‘sharp end’ and ‘dinosaur’ stock.
  • Oldfield is positive about Japan, despite the pace of the rally in 2013 and the level of recent market valuations.
  • French car manufacturer Renault is the best example of companies that are worth more than the sum of their parts.
  • Automotive manufacturers constitute a third investment category, with Renault, Fiat and General Motors comprising an eighth of the portfolio

 

The opinions expressed are those of Richard Oldfield and are subject to market or economic changes. This article is not a recommendation, or intended to be relied upon as a forecast, research or advice.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations.

Alexander Associates Group (AAG) is a holistic Wealth Management group and provider of a wide range of complementary services. The wealth management advice, for both individuals and corporates, is provided by AAG Wealth Management, a Principal Partner Practice of St.  James’s Place Wealth Management. Other services offered by AAG fall outside of wealth management advice and are separate and distinct to the services offered by St. James’s  Place. They are not covered by the St. James’s Place guarantee*, which is solely reserved  for wealth management advice provided by representatives of AAG Wealth Management.

*St. James’s Place guarantees the suitability of the advice given by members of the St. James’s Place Partnership when recommending any of the wealth management products and services available from companies companies in the group.

AAG Wealth Management represents only St. James’s Place Wealth Management plc (which is authorised and regulated by the Financial Conduct Authority) for the purpose of advising solely on the Group’s wealth management products and services, more details of which are set out on the Group’s website www.sjp.co.uk/products. The `St. James’s Place Partnership’and the titles `Partner’ and `Partner Practice’ are marketing terms used to describe St. James’s Place representatives.

 

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