Below is a brief summary of the presentation our Managing Director & Chief Investment Officer, Simon Mawhinney, gave at the Allan Gray & Orbis Investment Forum in May 2023. If you would like to watch the presentation in full, you can watch a recording of the event. Our Investment Forums are primarily aimed at Australian financial advisers, but anyone can watch.

 

The last five years have been difficult for equity investors who follow a value-based strategy. There has been significant market dislocation as growth stocks have generally outperformed value stocks. This dislocation creates opportunities, however, which is partly the reason for some of our current optimism. And it’s why we believe that there’s opportunity to outperform from here with a portfolio that’s quite different to the market.

As contrarian investors, it often feels awkward to own the stocks in our Funds. And that’s the way it should be. If we felt comfortable holding these stocks, we wouldn’t be doing our job. As contrarians we go against the herd, against market consensus, so usually sentiment is very negative towards our holdings.

We look forward to the time when our holdings feel less awkward or more comfortable, as that’s when we can rotate out of them as the price is rising as sentiment improves, and into our next idea.

It’s easy for us all to get worked up by news headlines, but it’s also quite dangerous. It can lead to emotive responses that in turn lead to decisions that aren’t grounded in the fundamentals. We believe it’s much better to focus on the fundamentals; in other words, focus on the price you pay for a company relative to the earnings you get. All companies are worth the present value of their future cash flows.

We believe there’s a real risk that earnings for some companies are going to fall quite significantly from here. Then the multiple those companies (and the overall stock market) will trade at will be very high, unless it adjusts itself. There is one saving grace: that the price of the stock market in inflation-adjusted terms is lower than it was before the global financial crisis, so there is a little bit of a ballast there that counteracts the very high earnings.

But if you combine multiples and where we are in the earnings cycle, to us it looks like the stock market in general is a little bit expensive. If we want to deliver good returns for our clients, we must position our Funds differently to this potentially expensive stock market, a good scenario for bottom-up, fundamental investors like us.

How are we positioned?

One way we have positioned our Funds differently is by not owning healthcare companies, as they don’t seem good value to us. We also haven’t bought into the consumer discretionary space yet, nor do we own the most popular consumer staples companies.

Instead, we own a lot of materials companies, a lot of energy and some utilities companies. This is quite different to the index, particularly in materials. Unlike the wider benchmark, which is dominated by iron ore miners, our materials exposure has no iron ore miners. Instead it is predominantly gold equity exposure and other things, like the alumina miner Alumina Limited and Sims Limited, which is a scrap metal processor.

Within the top 10 active weights in the Allan Gray Australia Equity Fund portfolio there are no iron ore miners and no banks. Again, that’s very different to the benchmark S&P/ASX 300 Index.

To us, our portfolio seems very depressed in terms of price relative to the broader stock market. You can see this clearly in the table below, which shows the price/earnings multiple of the Equity Fund versus its benchmark. As you can see, the Fund trades significantly lower than the index and it is forecast for this to continue.

Source: Factset, Allan Gray, 31 May 2023. (A) = Actual; (F) = Forecast

 

It’s this that makes us most excited about our portfolio, and one of the reasons why we believe there is cause for you to be optimistic about our future returns in a relative sense.

 

If you would like further detail on two of the stocks we hold, you can check out our March 2023 Quarterly Commentary where we dive into Downer EDI Limited. Or you can watch our April 2023 webinar, when we met with Tony Lombardo, Global Chief Executive Officer and Managing Director of Lendlease.