Why FPA doesn’t try to predict where inflation will go
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There will always be uncertainty when it comes to predicting the course of rates, inflation and the various economic and political knock-on effects of these movements. That’s why investments should be stress-tested to withstand uncertainty and be resilient through a range of market and economic cycles.
This is according to Brain Selmo, Co-portfolio manager of the Nedgroup Investments Global Flexible Fund, who presented at a recent Global Perspective event.
What is causing the current spike in inflation
Selmo said that there are many factors at play that have contributed to the current inflation situation. “First, it goes back to a number of financial measures that were put into place over a decade ago in order to deal with the great financial crisis which resulted in the unusual phenomena of zero and negative interest rates in a number of countries around the world. Then, more recently we saw novel monetary and fiscal programmes launched to deal with the Covid pandemic. All this created the backdrop for the situation we are seeing now.”
“So, while these things have set the scene for inflation, the pressing issue this year is definitely energy and commodity prices and their significant increases, which have also been exacerbated by the war in Ukraine and a very strong US Dollar.”
A dramatic underinvestment in energy markets and, in the last few years, responsible investing mandates have further curtailed capital that would typically have been directed to base commodities like oil and gas.
Expect the unexpected
Selmo says FPA make a point of not making predictions or point estimates, because they recognise that the world is highly uncertain. “The natural human state is uncertainty. We will never know what the future level of inflation, GDP or a stock market index will be, so we build portfolios recognising that uncertainty.”
According to Selmo, FPA always expect a recession at some point in their holding period. “With a five-year outlook, we assume that there will be some disruption along the way, so we model the portfolio to be able to withstand and even thrive in recession. Many of our positive returns come out of recession,” he said.
“In times or fear of uncertainty, we remind ourselves that the global economy is incredibly likely to be larger and more valuable 10 years from now. We want to participate in that value creation. So, we are always looking to buy high-quality franchise businesses that we think can grow on the back of long-term trends.”
A value driven approach
FPA have an absolute value approach and use that lens to make sure that the math works – starting with a reasonable yield on equity, whether that’s free cash flow or earnings – and then modelling out conversative margins and growth rates to get to an equity-like return over time, even with some level of volatility or economic weakness.
Recently FPA have bought an eclectic mix of securities ranging from busted tech companies like Uber and Netflix and some consumer facing companies like Carmax and Herbalife. “We’ve also started to purchase some discounted convertibles, where the bonds themselves are available at 20bps to 30bps below par, and there is some chance we will participate in the upside if the stock does well. We could earn a better than equity return,” said Selmo.
To find out more about the Nedgroup Investments Global Flexible Fund go here.