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Why New City’s Pitoun believes the impact of a trade war will be limited

30 August 2019

Veteran investor Raphael Pitoun explains why quality companies should be less affected by any potential escalation of the US-China trade war.

By Rob Langston,

News editor, FE Trustnet

The potential for a US-China trade war to disrupt markets may be more limited than some investors believe, according to CQS New City manager Raphael Pitoun, although this could change should there be an economic downturn.

President Donald Trump upset markets earlier this month by taking aim once more at China, ordering US companies to start looking immediately at alternatives to China and announcing that tariffs on Chinese goods would be raised from 1 October.

As the below chart shows, both markets have reacted badly to the resumption of a more hostile environment, with the S&P 500 down by 4.42 per cent in sterling terms and the MSCI China making a loss of 7.38 per cent.

Performance of indices over 1mth in US dollar

 

Source: FE Analytics

Yet, Pitoun – who heads up the CQS New City Global Equity fund and was previously chief investment officer at Seilern Investment Management and manager of five FE Crown-rated Seilern Stryx World Growth fund – said market reaction might have been overdone.

“I think the effects of the trade war on the real economy at this stage are very small,” he said. “And I’m talking about the real economy here.

“Just to give you a statistic the trade relationship between China and the US represents 2 per cent of the total trade in the world between countries.

“And on top of that, what we see looking at the companies we invest in, the impact on their P&L [profit & loss statement] is actually very limited.”

While the direct impact of the trade war between the US and China is limited, there are other wider impacts due to the uncertainty caused by the increasingly hostile environment.

“Because no one knows where this tension is going to end, in certain industries you see some side effects,” he explained.


 

While it is likely to affect some sectors more than others, said the manager – electronics and agriculture, for example – overall the effect will be relatively limited, however.

Although Pitoun does not disregard the impact that a US-China trade war could have on global markets, however, it is unlikely to affect the companies he invests in significantly.

As the below chart shows, the MSCI ACWI Quality style index has outperformed the broad MSCI AC World index, in US dollar terms, year-to-date as trade war rhetoric has remained elevated.

Performance of indices YTD

 

Source: FE Analytics

The universe of quality names that Pitoun builds his CQS New City Global Equity fund from are likely to have in place “some Plan B ‘if and when’ the situation deteriorates”.

“And for the other ones, typically what they do is they use their pricing freedom in order to pass on some price increases to the client,” he explained.

“For some sectors, and some industries, it’s impossible to source anywhere other than China,” the global equities manager said. “In the elevator business [for example], 80 per cent of the electronic components necessary to build an elevator come from the area of Shanghai.

“It’s very concentrated in terms of sourcing. Big elevator companies need to go there in order to find the products. But then, elevators is actually an industry with good pricing power so the impact will be passed on to consumers.”

Nevertheless, should a trade war coincide with an economic slowdown, which has become a greater concern following the inversion of the yield curve recently, may make it more difficult to pass on costs to consumers.

In China, many of the companies on Pitoun’s radar are there for the long-term and as such more plugged-in to the domestic economy.

“A few consumer companies like Nike, for example, or McDonalds and many industrial companies are in China forever; they hire a lot of local people,” he said.

“One of the companies that I’m looking at, it’s a [US] water company called Xylem, they don’t have any single ex pat working in the Chinese business.”


 

The other significant market event of the summer was a long-anticipate move by the Federal Reserve to cut rates by 25 basis points, signalling its intention to stand behind the slowing US economy.

However, while the rate cut could stir some growth, it remains to be seen whether it will help the economy in the long term, according to Pitoun.

“There is a theory that we are at the point where the returns of this loosening of monetary policy are declining. And I think it’s possible that’s the case.

“I don’t really see that monetary policy has a real impact on the on the economy,” he said. “I think the economy is still OK. But we also don’t expect a lot of upside coming from Fed action.”

As such, the global equities manager remains focused on finding pockets of growth and these remain overwhelmingly in the US than in any other region.

“In the US, that’s where I find the best companies both in terms of innovation, corporate governance, and ability to grow,” he explained. “It might change one day, but I suspect it’s going to take a very long time for this to change.

“One of the things that is more complicated in Europe, for example, is the financing of the economy. which is based on bank debt,” said Pitoun. “This is a real problem and the real challenge for the development of the European economy

“We still have some European companies, we have Asian companies as well in Japan. But, yes, the focus is and should stay in the US.”

Indeed, the fund manager said that the ambition of the CQS New City Global Equity fund – which launched earlier this year – is to deliver the right returns to investors and, as such, needs to be invested wherever the best prospects are.

“We’ve got a lot of investors in the world that are challenged by the low-rate environment,” he said. “Everyone with a long-term investment horizon these days experiences some challenge.”

However, he conceded there are some risks posed by the amount of disruption currently taking hold of markets.

“Access to money and access to capital is absolutely not a problem,” he said. “So you see some new business models emerge that could compete with existing companies quite quickly.

“Our focus is really to make sure that the companies we invest in we are invested in have the right barriers to entry, have sustainable competitive advantages and continue to innovate.

He added: “The worst thing that could happen in a company is just to rely on one or two products forever without really looking to challenge the way they serve their clients.”

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