Global Flexible Fund Quarterly Feedback – Beginning of the end

Brian Selmo is a Portfolio Manager at First Pacific Advisors (FPA), the managers of the Nedgroup Investments Global Flexible Fund.

Brian provides an update of the portfolio’s performance over the quarter and some of the drivers of performance. He will also share insights into where the team is finding value and how they have positioned the Fund for permanent impairment of capital if there are further market downturns, while still participating in market upside to deliver on the Fund’s growth objectives through a full market cycle.

Portfolio overview
There’s been a lot of hope and success with vaccines and we’re hopeful as are markets that the pandemic will be behind us, that global economies will come out of it stronger and that there will be for attractive investment opportunities on the back of that. But, we never know if it’s the end, the beginning of the end or how the economy will perform on the back end of it. With that as context, we have a 70% position in equities, very little in bonds (1.5%) and cash is slightly lower at 27.4%. We’re considering the relative attractiveness of equities compared to other alternatives as yields are incredibly low. We want to invest in a diversified manner across many names to provide a defensive characteristic over and through market cycles and with the uncertainty that might come. We spend a lot of time thinking about where the economic centre of gravity is for our portfolio and companies. We’re very international in nature and have increased exposure to companies domiciled outside of the US in response to valuation and opportunity where we see cheaper valuations and greater discount to intrinsic value. What’s more relevant is where the revenue is generated. The portfolio is fully diversified around the world getting blanket coverage of where economic activity is today. 61.3% of the portfolio is domiciled in North America, 24.8% in Western/Northern Europe, 10.8% in Asia Pacific and 3.1% in Middle East/Africa. During Q1, we added names that were more defensive in terms of their underlying businesses, including Alteryx, Entain, JDE Peet’s, Just East Takeaway, Willis Towers Watson, Cie Financiere Richemont-reg. We reduced our position in Signature Bank and made complete sales of CIT Group, Bank of America and Puerto Rico -A 8 7/1/2035.

Fund performance
A year ago, our performance looked much worse, but that’s the nature of investing in a largely equity portfolio. There will be times when markets are unfavourable and if your underlying research is solid and the businesses are strong, you would expect to come through that and revert to normal valuation or market outlook. Today, the world has a very different outlook compared to last year. The Fund returned 8.3% for Q1 and 49.3% over the 1-year period. We tend to focus on the contributors over the trailing 12 months, which included Alphabet, Jefferies Financial Group, Broadcom Inc, AIG and TE Connectivity. A lot of our larger names have been key drivers of results over that time. Some names were exited last year entirely or recently purchased so there were no material losses over the last 12 months. We have an average 5-year holding period in the Fund. Many of the names may be in different sizes, but will be in the portfolio over a long period of time. Alphabet is our top holding and was bought over a decade ago. We continue to hold it due to the strength of the company’s underlying business. Comcast, our next biggest holding, has a strong position in the US in broadband and video and we added materially to this position during the sell-off last year. Lafarge and AIG, our third and fourth top holdings, are more cyclical in nature and traded down to some very cheap valuations allowing us to increase their size last year. Many of our top holdings benefit from strong, secular trends and exhibit the characteristics of high quality franchise businesses, such as high returns on invested capital, strong free cash flow generation and appropriate shareholder-friendly deployment of excess cash. We’re also happy to be in companies such as Group Bruxelles Lambert, with an owner operator, long-term shareholder or family in control of the capital allocation decisions. You’ll see this setup throughout our portfolio and it starts to matter when you hold businesses for a long period of time such as we do.

Interest rates
This may also be the beginning of the end of ultra-low interest rates, which could have very different impacts on financial assets. We think it’s a large risk for the developed economies. Interest rates have been very low for a long time and that’s probably become embedded in a lot of company’s capital structures as well as government funding. If something were to disrupt that, there could be some negative tag-on effects.

Not-so-high yields
There hasn’t been much opportunity in credit and spreads in high yield. The current spreads are pretty low as are absolute yields, which is why we have so little going on in credit right now.

Broad themes and outlook
We don’t know if this is the end of the pandemic or the end of the more speculative aspects of the market and the infatuation with hyper growth businesses or the end of very low interest rates. We want to continuously improve the business quality of the companies we own and what the portfolio looks like. We’re agnostic on international vs US, but it’s something that has started to show in the portfolio as a gradual shift over the last few years and this is continuing, but we are doing it on a bottoms-up, opportunistic basis.