The recent uptick in volatility heralds the return of a stockpicker’s market for the first time in nearly a decade, according to Orbis Investment’s Alec Cutler.
Equity markets have struggled during the first quarter of the year as higher volatility and concerns over an escalating trade war between the US and China have dampened investor confidence.
As the below chart shows, the MSCI World has fallen by 2.89 per cent – in local currency terms – since the start of the year following a big sell-off in February and further losses in March as US president Donald Trump unveiled a raft of tariffs on Chinese imports.
Performance of index over YTD
Source: FE Analytics
However, Orbis’s Cutler – who oversees the five FE Crown-rated Orbis Global Balanced fund – described the current market environment as “wonderful” as it means valuation is now more a reflection of fundamentals than trends.
The FE Alpha Manager explained: “After nine years of being a factor-driven market with low volatility and differentiation, and a fine gradient between attractive and unattractive or cheap and expensive, half the people in our business have never seen a stockpicker’s market.
“We’re in a full-on, old-school stockpicker’s market. The funds that are dominating flows nowadays are not looking at fundamentals, they’re looking at factors.”
Indeed, Cutler said valuations have been driven by non-fundamental factors in recent years, pushing valuations ever-higher in the post-crisis bull run.
The £30.3m multi-asset Orbis fund is benchmarked against a composite MSCI World/JPM GBI Global GBP index 60/40 benchmark index and aims to balance income generation and capital appreciation while limiting the risk of loss through a diversified global portfolio.
However, Cutler said the traditional 60/40 investment rule is no longer relevant in the post-financial crisis market environment, requiring a change in approach.
“Having a lock-step in fixed income or anything for 50 years cannot be moderate risk, there have to be times when neither one is attractive or one is wholly unattractive,” he explained.
“We think equities are on the expensive side of things, we find it impossible to find 10-year government bonds anywhere in the world to own because they look like the riskiest thing in the world to us, especially when the biggest owner is flagging to sell them.”
As such, the manager has been increasing his hedged equity exposure in the Orbis Global Balanced fund to mitigate a fall in markets, bringing its stockmarket exposure down to 56 per cent – in line with a traditionally balanced 60/40 portfolio.
“I would not call a traditional 60/40 fund right now moderate risk, I would call it high risk,” Cutler (pictured) continued. “Risk will move around depending on how those two things are. 
“You can get lucky for 20 years, which we did, where bonds were negative beta, but traditionally over 100 years bonds are not negative. They’re moving in the same direction typically, just not recently.”
He added: “The goal is always to produce the same risk profile as a 60/40 but to produce alpha and decent returns. The premise being that just because you are producing a moderate risk-profile fund it doesn’t mean you can’t perform well and provide a decent return.
“The asset allocation is purely a result of things competing with each other,” he explained. “It’s not a result of us waking up one day and saying ‘let’s dial this down’ or ‘let’s dial this up’ because of some macro thesis.
“We suck at macro theses. Our basic macro thesis is when everyone agrees on one thing, we do the opposite.”
Cutler said more recently he has been reducing exposure to consumer staples stocks which have been bid up since the onset of quantitative easing and its effect of driving bond yields lower. The manager said stock valuations in the sector appear expensive and therefore riskier.
Instead he has been adding exposure to European cyclical stocks which could benefit from more robust economic growth than what is being seen in the US.
However, he has retained some exposure to out-of-favour defensive stocks – such as oil companies BP and Royal Dutch Shell – and drug makers such as AbbVie, Bristol-Myers Squibb, Merck and Amgen.
Cutler said he had also recently been adding one-year US Treasuries to the portfolio, which have seen yield increases from near-zero to around 2 per cent.
“We hate 10-year Treasuries,” he said. “We hate the duration. We hate taking 200 basis points in interest per year for massive duration risk. If we do have inflation, you’re not getting paid for that risk.
“The one-year US Treasury has gone from a 14 basis points yield to a 214 basis points in the last year and a half.”
Against a backdrop where the valuations of so-called ‘expensive defensives’ are starting to look challenged and yields look difficult to maintain, one-year Treasuries offer a more liquid asset with more reliable yields.
Cutler said defensive companies are starting to face challenges in how they drive earnings in the current environment.
“What’s interesting is that if you buy defensives now, the yield is around 2 per cent and you pay a withholding tax on that of 30 per cent, so it’s more like 1.4 to 1.5 per cent,” he said.
The manager said the portfolio also includes some corporate bond positions, mainly in areas of high yield and other specialist areas that he finds attractive.
One such example is the Navient Corporation, which specialises in the servicing and collection of US student loans.
Cutler said as well as owning the bond he also owns the stock – describing it as the “most hated company in the US” – which yields 5 per cent, noting that the loans backed by the US Treasury can’t default.
“They’re the bad guys because they’re the ones who call [graduates to repay their loans]. It was a brilliant move by the government,” he said.
“Nobody wants to own the stock, nobody wants to own the bond. We’re looking at it and think it’s secure: it’s backed by the US government.”
Cutler has managed the fund since inception in January 2014 and oversees the much larger offshore $3.6bn Orbis SICAV Global Balanced portfolio.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over three years the Orbis Global Balanced fund has delivered a total return of 38.19 per cent compared with a gain of 16.22 per cent from the average IA Mixed Investment 40-85% Shares fund and a 25.16 per cent return from its composite benchmark.
The fund does not carry an annual management charge but does have a performance fee of 50 per cent outperformance of the benchmark.
Last year the fund charged a performance fee of 3.68 per cent.