Concerns over valuations or the broader macroeconomic outlook should not cloud investors when analysing certain sectors, according to the Hermes global equities team.
Sectors such as technology in the US have been eschewed by investors over high valuations, while low oil prices have deterred investment in producers, although Hermes Global Equity lead manager Geir Lode and deputy manager Lewis Grant remain comfortable holding both.
Indeed, the US technology sector has been on an incredibly strong run over the past five years, as the below chart shows.
Performance of index over 5yrs
Source: FE Analytics
As such, many market commentators have argued that the sector is overvalued, with many companies trading at record price-to-earnings multiples and near record-high share prices.
Yet, the fund is 16.28 per cent weighted to the technology sector (an overweight to the benchmark of 63 basis points) with US giants Apple, Microsoft, Amazon, Alphabet and Facebook making up its top five holdings.
Grant said: “We changed our approach to how we assess a company. With the large US tech companies we tend to look as far forward as we can.
“When assessing a company that is completely disruptive and changing its entire industry you have to throw out a lot of the ways of valuing a company that we have historically used.
“We need to stop looking at the past, stop looking at asset rate valuations and think about where these companies are going and the actual change they can bring to different industries.”
As such, he argued that it is wrong to base these valuations on expected earnings, instead focusing on the growth that these companies can provide.
“They have run quite a lot undeniably but equally if you take something like Amazon, it has been mentioned as disrupting earnings scores more than anything other thing in the world – more than Trump and more than wages,” Grant said.
“Everyone is talking about Amazon and yes it has run but it has run because it is casting its shadow over the entire public equity market.
“That is why for me these companies are worth the premium you are having to pay, because they are going to change everything.”
In an upcoming article FE Trustnet will look in more detail at how different managers are investing to take advantage of the emerging presence of Amazon in their portfolios.
However, the managers are concerned by some US technology companies, specifically electric car manufacturer Tesla, because it is not yet self-sustaining.
Lode said: “If you look at something for example like Tesla that is a different story because they can’t finance themselves.
“The risk for them is that they need a rising share price because the day they don’t have a rising share price they can’t get financing and for us that is way too risky. You have something that is dependent on the share price to survive.
“We like growth, we like these disruptive companies but we don’t like everything and that reflects our philosophy.
“We pick the stocks that have okay balance sheets, growth and they can’t be losing money or need financing because that can go badly, especially if you have another company doing a similar disruptive move.”
The other area both managers are keen on, despite concerns, is the oil sector, though it currently represents an underweight position in the portfolio.
Oil prices have been particularly volatile over the past few years with issues around oversupply as well as the rise in disruptive new technologies such as electric cars sending the price plummeting.
Indeed, as the below chart shows the Brent crude spot oil price has lost 59.81 per cent over five years, although it has now bounced back from the lows seen at the start of 2016.
Performance of index over 5yrs
Source: FE Analytics
“Energy is an interesting one because we have seen quite a big restructuring within the sector over the last two years,” Lode noted.
“For example, for some of the big companies like Chevron and Exxon to produce a barrel of oil at the peak it would cost them around $80-$90 per barrel.
“With an oil price around $50 they were losing money but they have been able to take their costs down to a level where actually now they can make money at those new oil prices.”
While the manager is not expecting an immediate recovery in the oil price and the companies, he expects them to begin to recover over the next couple of years.
“Our thinking is that when oil prices recover, and I don’t think they will be around current levels in 2-3 years, then they are set up with a very low cost-base and you can get a lot of cashflow in these companies that can result in huge value in these names,” Lode said.
“Typically in the market what you will see is the stocks will start to rally about a year and a half before the oil price actually recovers. I think these names, maybe not now but over the next year, can recover.
As such, the manager is looking to take his underweight position to a more neutral weighting over time in preparation of this recovery.
The $225m Hermes Global Equity has been a top quartile performer in the IA Global Sector over the last five years, as the below chart shows.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The fund has returned 118.18 per cent, compared to the MSCI World benchmark’s 105.97 and sector’s 85.54 per cent. During this period less than a third of funds (31 per cent) have outperformed the benchmark.
The fund has a clean ongoing charges figure of 0.65 per cent.