As markets become increasingly polarised the best thing a manager can do is remain pragmatic, vigilant of changes, and stick by a sound process in bottom-up stock selection, according to Fidelity International’s Jeremy Podger.
Podger, who runs the £2.7bn Fidelity Global Special Situations fund, said this year markets have become increasingly polarised, with the valuation spreads between global growth and value indices around the widest seen since 2001.
“In many areas, the earnings trajectory of value stocks has been stronger than that of growth stocks, but at a time of technological disruption and geopolitical uncertainty, investors appear to be unwilling to commit to a view that says economic growth will stay strong,” said the FE Alpha Manager.
This has meant that the historical relationship between growth and value, which has typically been positively influenced by factors such as inflation and interest rates, is now being overridden, he said.
As such, the manager said having a clear view on how far this can go is difficult, as on a fundamental basis there is no clear and immediate catalyst for profit margins of growth companies to get squeezed down even with rising wage and input cost pressures.
Performance of value vs growth over 10yrs
Source: FE Analytics
Given that technology is now effectively removing links in value chains across all sorts of industries, he said, the simple reversion in the relationship between growth and value that many expect may not happen in a traditional way.
Podger said years of improving macroeconomic and corporate data as well as return on equity across regions and sectors has made identifying candidates that are underachieving versus their long run potential profitability “increasingly difficult”.
“While the obvious areas that stand out include Japan, energy, banking, automobiles, retail and – more recently industrials – our constant focus remains not just on value but the catalyst that may release that value,” he explained. “This is where fundamental analysis becomes key.”
The Fidelity manager said ongoing disruption to sectors calls for “a holistic approach” to company analysis as opposed to a quantitative one that is based on limited indicators.
Indeed, a pure quantitative approach can lead investors to invest in extreme outliers that are “likely to be full of anomalies and traps”, he noted.
“Close company and management relationships, constant channel checks and a deep knowledge of changing industry dynamics are crucial in distinguishing between viable candidates – good management track record, stable earnings growth, visibility of cash flows, pricing power and market positioning – and bad ones,” he said.
Japan – the fund’s second largest geographical exposure after the US – is one of the stand-out areas for value, Podger noted.
This, he said, is because over the last six years net profit margins have approximately doubled in the country, although they still remain below those in Europe and the US.
“In Japan we have found opportunities such as KDDI, one of the cheapest telecoms businesses in the world at the time which has delivered and remains in the portfolio,” he said.
“While profitability has moved sharply higher in Japan, there has been a genuine shift in corporate attitudes towards shareholders.
“Furthermore, [prime minister] Shinzo Abe’s policies and a prolonged economic recovery have resulted in real wage growth.”
Japanese GDP over 5yrs
Source: St Louis Federal Reserve
Trade and political uncertainty aside, the manager said he believes the Japanese leader’s policies could bring about further interesting opportunities, a reason why he expects to continue to tap into the market going forward.
At a sector level, he added energy stocks, where earnings recovery has lagged other sectors, also present a compelling picture.
He added: “Despite rising oil prices, many oil stocks continue to appear to price in a scenario of under $60 oil prices.
“Demand-supply dynamics remain supportive given factors such as the strength in the global economy and geopolitical tensions between the US and Iran. At the same time, businesses continue to focus on cost and capital reinvestment to improve efficiency.
“Elsewhere, the banking sector, with strengthened capital and the prospect of widening interest margins also looks interesting – albeit very selectively – in an environment of policy normalisation.”
Podger – who also manages the $2.9bn Fidelity World fund – noted that his team remains somewhat warier of areas of apparent value such as automobiles and traditional brick & mortar retailers.
“Both of these industries are in the throes of disruption and it is not immediately clear who will survive and thrive in the emerging era,” the FE Alpha Manager explained.
“Whilst having limited exposure to both areas, our portfolio has not been immune to such pressures, with auto components holdings underperforming at a time of uncertainty and some consumer-focused names being weighed down by margin pressures and increased competition from new entrants empowered by technology.”
Looking around the world today, the Fidelity International manager said he remains “cautiously optimistic” about the prospects for equities overall and noted investors may focus back on historical drivers of value underperformance – such as growth, inflation and bond yields – if there are signs of trade-related issues abating.
“However, at this point, given that investor enthusiasm and market leadership is more focused on growth, we have been concentrating our efforts on ensuring a balanced style profile, with exposure to both value and growth while at the same time making sure that the average valuation of stocks held in the whole portfolio is attractive compared to the wider market,” he concluded. “This way, portfolio risk will be determined more by stock-specific factors.”
Source: FE Analytics
During Podger’s tenure on Fidelity Global Special Situations, the fund has delivered a 163.33 per cent total return compared with a gain of 98.73 per cent for the average fund in the IA Global sector and a 116.34 per cent gain for the MSCI AC World index.
The fund has an ongoing charges figure (OCF) of 0.92 per cent.