Constructing portfolios on a globally integrated basis gives us an edge 

PSG Asset Management follows a globally integrated process, analysing local stocks alongside global ones. Given the changes in Regulation 28 of the Pension Funds Act, which now allows for up to 45% of assets to be invested offshore, we believe this gives us a substantial advantage when it comes to constructing multi-asset portfolios. Our global portfolio construction process is also managed in line with our 3M investment process. This means that we prefer to look for opportunities in uncrowded areas of the market. Because there is typically less competition in these areas, there is a reasonable chance that you will find above average quality at below average prices. In the long run, we believe this tilts the odds of success in the favour of our investors – but investors need to be patient, as it can be near impossible to predict when out-of-favour sectors of the market are due to rerate, even if the long-term investment thesis is compelling. 

How can anyone outcompete the Magnificent 7? 

Given the current market euphoria, it might seem impossible that any stock could outcompete the current market leaders. However, consider this example from our portfolio history. Starbulk is a global bulk shipping company which transports grains, iron ore, commodities and coal, and we have been an investor in Starbulk since 2016. After having held Microsoft since 2010 (when it was trading at US$25 and on a price-to-earnings ratio of 9 times), we sold our last shares in Microsoft in 2017 at $73 and switched some of the proceeds into Starbulk. It goes without saying that we watched the subsequent rally in Microsoft with some regret, and took a few learnings from the process. Today, Microsoft is trading at over US$400. However, looking at this chart, we see that shipper Starbulk has outperformed Magnificent 7 member Microsoft over the period, clearly illustrating that there is life beyond the Magnificent 7. 

The current concentration in markets holds hazards, and opportunities

Global stock markets, dominated by the US, are at their most concentrated levels in a hundred years. The graph below shows the market cap concentration of the largest 10% of US stocks divided by total market cap of the US. There are some clear parallels to the period leading up to the dotcom bubble. We are seeing extreme euphoria in the market, a fear of losing out, complacency in terms of the risks, and importantly, expectations are very high. In the midst of being swept up in this euphoria, investors are overlooking the impact of the cyclical factors which have provided a tailwind to the performance of these shares to date: low inflation, lots of liquidity and economic growth in the US. It seems unlikely to us that these conditions will perpetuate going forward, meaning that some of these lofty expectations may leave investors disappointed. However, this concentration also provides opportunities to investors – because the more crowded the market becomes, the more likely it is there are exciting and overlooked opportunities outside these very crowded areas. 

The Bank of America survey not only reveals the high levels of concentration in currently popular areas of the market (e.g. tech and US bonds), but also clearly shows us what is out of favour at the moment: the UK, energy, the Eurozone, and commodity markets. It should come as no surprise this is an area where we are finding very fertile ground for future investments.

Current market conditions bear a striking similarity to the period during the dotcom bubble. Let’s look at what happened during the five years following the peak of the market in 2000. Technology and US stocks underperformed substantially, while the sectors and stocks that did exceptionally well (emerging markets, real estate, consumer staples, materials and energy) are all sectors that global investors are currently deeply underweight to. 

Echoes of the past?

We believe the environment that lies ahead is more likely to resemble the period post 1999 than the last decade because:

On a relative basis, opportunities in the unloved and overlooked areas of the market, like the EU and UK, are the most undervalued they have been in 30 years.
Emerging markets are marking 50-year relative valuation lows vs the S&P 500.
We believe that, while investors are complacent about inflation at present, there are clear structural underpins that support our view for a higher inflation future. These include:

Chronic underinvestment in the energy sector, even as energy demand continues to ramp up (in part driven by the ramp-up of artificial intelligence (AI) data centres).
Increased reliance on fiscal spending – and complacency in running government deficits.

The end of the global peace dividend of the past 30 to 40 years.

Yet, despite this, investors remain positioned in securities that benefit from a low inflation environment (as highlighted in the Bank of America (BofA) survey). By contrast, the areas that investors are currently shunning like commodities and energy, should do well if inflation resurfaces. 

How our portfolio construction positions investors for the future environment
In assessing opportunities, we look to construct portfolios that are well poised to unlock value for investors. Importantly, the earnings forecasts for many of our investee companies are not significantly lower than those of the Magnificent 7, but they trade at far lower valuations. This means that investors can expect a similar earnings profile from many of the shares in our portfolios while paying comparatively less. Comparing our portfolios with the MSCI World Index, we see that the MSCI World Index is trading at a PE of 22 with a dividend yield of 1.8%, while the stocks in the PSG Global Equity Fund are trading on a 10.3 PE and a 2.7% dividend yield. While our holdings are compelling in the current environment, we believe that investments in some of the sectors and stocks that are likely to benefit from a higher inflation environment, like the energy sector, provide ‘cheap’ insurance should this scenario occur. 

 

Positioning for the future

By looking to the unpopular and unloved areas of the market, PSG Asset Management is able to construct portfolios with excellent return prospects (even if current market conditions continue), while also offering upside in a high inflation environment – at very attractive valuations. 

In an environment where many market players are complacent, and are positioning for a continuation of the environment of the past, the value of independent thinkers like PSG Asset Management as part of a portfolio should not be underestimated.