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Uncomfortably comfortable

Uncomfortably comfortable

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Article highlights

  • There is still some attractive valuation to be found in equity markets around the world
  • There has been a relative value divergence between the US and the rest of the world, so we are finding more opportunities there
  • We’re not finding opportunities in the high yield and distressed debt market, an area which has been a feature of the portfolio in the past

Steven Romick is a Portfolio Manager at First Pacific Advisors, the managers of the Nedgroup Investments Global Flexible Fund. Steven provides an update on the contributors to performance, the composition of the portfolio and what they’re thinking looking forward.


The objective of the Fund is to achieve equity-like returns over the long term with less risk than the market, while avoiding permanent impairment of capital. We do this broadly by investing with tremendous flexibility around the globe in different asset classes. Our emphasis has always been on capital preservation.


Asset class composition

Equities are currently 74% up slightly from our position in June 2021 at 68.8%. Bonds are very low at 0.7% consisting largely of high yield bonds and distressed debt. Traditional, conservative fixed income is not historically something that we've engaged in. We prefer to assume some level of credit risk when the opportunity presents itself and avoid the interest rate risk factor. The number of equity positions is currently at 56, similar to Q1, but up from a year ago, which was largely a function of having taken some profits in some names that worked out and building into some new positions as a result. 


Asset allocation

The Fund doesn't consistently look like any index or other fund regarding sector or regional allocation. We go where we find value in debt or equity globally, and we’ll usually be quite overrepresented or underrepresented in any one sector or region. Our portfolio is very diverse globally and can be reflected two ways, both as in country of domicile as well as in revenue source. Although we have 62% of our equities located inside the United States, this is slightly overstated because of the SPAC (Special Purpose Acquisition Company) exposure in the portfolio at just less than 3%. More importantly, the revenue exposure of the companies held largely comes from outside the US, with just 40% of revenue generated from inside the US. 


Fund performance

Performance over the last 12 months has been very strong with the Fund returning 35.8% outperforming its European peer group by 16% and placing it in the 2nd percentile over the period. Over 3, 5, 7 and 10 years, the Fund is also ranked within the top decile of the Morningstar European peer group. 


Performance contribution

The top performing positions (Alphabet, Jefferies Financial Group, AIG, TE Connectivity and Glencore) added 11% to return in the trailing 12 months, while the top five detractors took away 1%. Our performance contributors and detractors reflect our diverse portfolio with our contributors including two tech stocks, two financial stocks and a global metal and mining stock. 


The gap between growth and value remains wide

The gap between growth and value remains very wide. The last time it was this wide was in the late 1990s, but the companies in the value cohort back then were positioned better than companies in the value cohort today. Today there are more disintermediated and growth challenged companies making the gap, although wide, not as reflective of opportunity in our view. Despite appearing very inexpensive, we would argue that the value cohort is not as inexpensive as it appears.


When the spread in valuation between the most highly priced companies and the average widens out, we tend to get more invested, lean into the market and increase risk exposure. The global pandemic created an opportunity to lean into the market a year ago, which we did. That gap has narrowed and still reflects that there is some relative opportunity in the market, and we continue to maintain our risk exposure because of that. However, the world is not as cheap as it was a year ago. 


High yield is anything but

What's surprising is that every time we get recessions, yields might be relatively weak and spreads pop open, but the spreads didn’t really get to be that attractive last year. Yields are an all-time low and clearly not reflective of risk. We view this largely as return-free risk. It doesn't make sense for us to be buying high yield. To get a yield on a gross basis that offers less than 5% before defaults, so it's going to net something lower than that, is not of interest to us. This is why our high yield exposure is as low as it is. 


SPAC premium has all but vanished

SPACS are a sector of the market that we found relatively attractive and created a basket in the portfolio. SPACS are blank cheque companies who raise a lot of money from investors in the hopes that their equity sponsors will find them an attractive acquisition. SPACS were trading earlier this year at a premium upwards of 25%. This premium has, however, narrowed down to zero and we’ve been able to create a basket of SPACS in our portfolio that trade below their trust value. For us to be able to get this kind of free option and a return above cash with the potential for something more is an attractive place for us to invest. That's why we have built a position of approximately 2.7% of the Fund in this type of vehicle. 


Some broad themes

We are price sensitive and will not buy a company regardless of price. We want to buy a good quality business at a good price. We have found more opportunity outside of the US. We are mindful that interest rates are at all-time lows, and this could change and wreak havoc in the market, so we are sensitive to a lack of opportunity that high yield offers because of low yields. We're sensitive to the fact that many companies and public equities are benefiting from low interest rates and how that might change. We have a lot of cash sitting in reserve for us to take advantage of opportunities in the future.