Global Equity Fund Quarterly Feedback – What ultra-low Interest rates mean for future returns

Andrew Headley is a Portfolio Manager at Veritas Asset Management, the managers of the Nedgroup Investments Global Equity Fund. Andrew provides an overview of the Fund’s performance and the impact that interest rates are having on markets.

Fund performance
The last 12 months have not been great for us with a return of 39.2% versus the MSCI World Index of 54.03%. We outperformed in the declines in Q1 2020 and have underperformed since. Our aim is to provide good returns over five or more years in a stable, low volatile way so, over longer-term horizons, our returns are much better. Positive relative contributors in Q1 were Alphabet, Canadian Pacific Railway, CVS Health, Moody’s Corp and Sonic Healthcare. Negative relative contributors were Charter Communications, Aena SME, Safran, Unilever and Intercontinental Exchange. None of our companies performed particularly poorly in Q1. We’re seeing a lot of sectoral rotation in the market and made a few changes to the portfolio. We bought CoStar Group, a digital retail business in the US, and bought back into Moody’s Corp as we really like the ratings agencies. We made complete sales in Philip Morris and Svenska Handelsbanken. The Fund is a concentrated portfolio of 29 holdings with heavy weighting in healthcare (30.4%), industrials (23.4%), communication services (17.1%) and information technology (10.3%). Our IT exposure is to Mastercard, Fiserve and Microsoft. The balance is in diversified financials but not banks, consumer staples and consumer discretionary. Cash is 3%. The top holdings are Alphabet, Charter Communications and Canadian Pacific Railway. Our portfolio positioning and characteristics haven’t changed much. We are long-term investors and in general hold our positions for at least five years. We have a lot of holdings in value-based healthcare, big data as well as holdings in aerospace, consumer staples, financial services and infrastructure/networks. We focus on companies with distinct growth drivers, barriers to protect future cash generation and a high level of recurring revenue.

What ultra-low interest rates mean for future returns
We’ve been in a 40-year bull bond market with interest rates peaking in the US at 16% and the 10-year US Treasury falling to almost zero. This has been the trend everywhere. Interest rates power everything in the economic universe and everything is priced based off interest rates. The original bull market from the 70’s to the 2000’s seemed fairly reasonable. It was based on increasing globalization and increasing technology, which are both deflationary. As a consequence, you would expect bond yields to decline as inflation and structural inflation declines. Policymakers are supressing interest rates by buying the bonds they issue. The Fed is buying over 70% of the bonds issued by the government. They are price agnostic or worse and will pay almost any price to get to the yield that they want, which is supressing yields. When you do this, it impacts every asset price. As you reduce your yield or as the price increases, you get an upfront benefit in the value of that asset. What it also does, however, is embed a lower return going forward. Government has essentially brought forward returns.

This could be threatened by an increase in rates or inflation. We could get inflation through a normalisation in policy where the Fed reduces the amount of treasury issuance it buys or because people start spending more and the velocity of money goes up. The growth rate in money is 25%-30%, which we haven’t seen before. As lockdowns relax it is likely that the velocity of money will increase. If the money supply and velocity of money goes up, either GDP goes up or inflation or both. It is likely that we will see inflation rise. As the Fed buys treasures and T bills, asset prices rise and interest rates go down. The S&P 500 sales to price ratio has never been higher, currently 2.8 times. The cyclically adjusted price to earnings is 34 at the moment and is the second highest we’ve seen. In 2020, on a market cap weighted basis, unprofitable technology companies over the whole year were up 92% in the US. These are highly speculative, loss-making companies that almost doubled during 2020. Other recipients of these speculative investments are Bitcoin, Dodgecoin (a Bitcoin parody) and SPACs. We are now in a period where we’re seeing the impact of interest rates and the huge amount of money and credit in the system, running into a speculative period.

We invest in high quality, low volatility companies. The S&P 500 Low Volatility Index, which represents companies we would invest in (healthcare, consumer staples, etc.) and that compound earnings over a long time, outperformed the High Beta Index in Q1 2020. Since then they recovered a bit, but are now flat. The high risk companies in the High Beta Index underperformed significantly during the Covid declines, but because of declining interest rates and speculative excess, we’ve seen these companies hugely outperform and are up around 55% from the start of 2020 whereas the low volatility index is flat. When the speculation stops, the low volatility index tends to do well and over the long term it outperforms and did so post the declines in 2000. The future return has been brought forward and perhaps even overdone and we would expect some of it to be given back over the next five years.