Perpetual’s star stock picker Anthony Aboud says companies with strong balance sheets will finally be rewarded for their discipline in an environment of rising interest rates and global market upheaval.
Mr Aboud, who helps oversee Perpetual’s long-short strategy, is among the portfolio managers that will present their best stock ideas at the Sohn Hearts & Minds event in Hobart on Friday.
He is making his second appearance having tipped Corporate Travel Management as a short idea at the inaugural event in 2016, and this year his message is that corporate conservatism will prevail.
“We think that balance sheets, for the first time in a while, matter,” Mr Aboud said, as he pointed to the August earnings season as evidence of a shift toward exalting financial strength.
“Transurban and Dexus disappointed with their EPS [earnings per share] guidance because the cost of debt was higher. That is going to be a slow-moving beast because a lot of companies have hedged interest costs so as that debt rolls off it becomes a headwind.”
On the flipside, he says companies that are net cash are all of a sudden in a good position.
“McMillan Shakespeare, A2, Omni Bridgeway and oOhMedia! all announced buybacks. That’s because they can.”
Mr Aboud said that in an uncertain and complex macro environment balance sheet flexibility will give companies an edge.
“When things are cheap enough companies with cash can buy back stock and that can put you in good stead.”
Perpetual’s equity fund managers have a long history of obsessing over balance sheets. They also have a reputation as value investors. But Aboud is quick to clarify that it doesn’t mean they look at old world “cement mill” businesses.
“We see value in some of the growth stocks that have de-rated a lot and property trusts that have de-rated massively because of interest rate expectations,” says Aboud.
This year has been dominated by macro forces as rising inflation, and the response to it by central banks, drives market performance and sectors. It was also a good one for the long-short fund.
According to the Mercer survey, Perpetual’s long-short share plus fund eked out a 3.8 per cent gain over the year to September 30, 2022, compared to an 8 per cent decline in the S&P/ASX 300. Over both three and five years, the strategy Aboud oversees has delivered a 9.8 per cent annual return, compared to the market’s 2.7 per cent and 6.7 per cent returns.
Aboud said the fund succeeded by shorting non-profitable tech stocks that he described as “ridiculously overvalued” such as Peloton and Zoom, while also betting against e-commerce names on the ASX, some of which are now lower than their pre-COVID-19 levels.
The hedge fund manager said a total reversal in fortunes for the pandemic winners is not surprising as their success spurred investment from competitors.
“The biggest threat to companies is unknown competition. That usually gravitates to hot sectors, so incumbents end up in a worse situation than they were at the beginning.”
The e-commerce stocks, he said, have faced added pressure from the cost of Google Adwords as larger bricks and mortar players muscle in on their digital turf.
“So there was a squeeze on the top and the bottom line as the COVID [sales surge] was rolling off.”
But the challenge with shorting fast-growing tech stocks is getting the timing right. Aboud utilised strict stop-loss limits on trades, but then added to positions when they were working. The patience to wait for the interest rate environment to change was also required.
“We thought once interest rates got off zero, markets would start focusing on the sustainability of the business.” But the beaten-up tech sector is now where there is money to be made on the long side, he said.
“Where the opportunities are is usually where everyone’s running away from and that is long duration stocks.”
It didn’t all go to plan though in 2022. Aboud said positions in non-bank lenders haven’t worked out, and he will be more apprehensive when companies in a single industry simultaneously storm the market to float.
“It’s a bit of a red flag,” he said, citing aged care as another example.
Aboud will be presenting a long idea this time at the Sohn event, and will steer clear of making grand predictions about the future.
In a market where the macro has been such a powerful force, stockpickers need to resist the urge to become experts on everything from epidemiology to geopolitics to inflation, he said.
“Everyone gravitates to the narrative of the day and becomes an expert, but it doesn’t necessarily help you unless you take it, move forward and try and predict the future.
“That’s a long way of saying that you have to wake up every day with an open mind. If you start becoming an expert on a topic, it becomes very hard for you to shift your view.”
His view is shifting to one in which the macro indicators are deflationary. But central bank policy is still the main game for investors.
In that regard, there are two big questions that will drive markets in the near term: the first is how deep a recession has to be before the Federal Reserve enacts the so-called Fed put and comes to the market’s aid.
“The [price of the Fed put] is lower than it has historically been. But how much pain will need to occur before it’s exercised?”
The second is how responsive central banks will be if parts of the financial system break. “When interest rates rise as quickly as they do, things will go bump in the night that you don’t know about.”
This article was originally posted by The Australian Financial Review here.
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