Justin Braitling, Watermark Funds Management

A long/short strategy helps Watermark Funds Management keep a balanced book, and swing easily between positions on research and hunches. 

Alongside two other distinctive listed investment companies, Watermark Funds Management runs the Australian Leaders Fund (ALF), focused mostly on the Australian market.

Braitling spoke to InvestSMART about the biggest risk to global growth (which isn't likely the most obvious), how the ALF is keeping a balanced book, and why he thinks the market won't be getting away from us anytime soon. 

Listen to our podcast, or read the full transcript below. 

Transcript:

Laura Daquino: I'm sitting down with Justin Braitling, the founder and portfolio manager of Watermark Funds Management. Today we're specifically chatting about the Australian Leaders Fund, a listed investment company that he is director and chairman of. 

There have been several swings recently in global markets, which you did seem to be anticipating, and your portfolios, as you have said, seem to allow for that because of your hedging strategy. I'm wondering if you're seeing any weakness, any particular weakness, in the market right now and whether that's changed at all in the recent past?

Justin Braitling: Well, I think the Australian market sits aside from many of the global markets. When you look at many of our sectors, there's not a lot of earnings growth in our market. If you look at the banks, which are the largest sector in our share market, accounting for roughly a third of the market by value, there's very little growth there. You've got the impost of the Royal Commission, and so forth. So, you know, there's little growth there. 

If you look at the broader industrial sectors, like telco, utilities, infrastructure, again, there's not a lot of growth. You just have to look at Telstra as an example. The utilities are the same. 

Mining is another important sector for us, and frankly it's a difficult one to call, but again we've seen a really strong recovery cycle here. But the outlook for China is a little bit more circumspect, as that economy slows. Across our market there's not a lot of growth, and so, we don't see this market really getting away from us. We don't think the market's really going to go anywhere in the short-to-medium term. Then there are these risks in the background around the inflated values that we're dealing with here, and so we think a correction at some stage, or a bear market at some stage, will come into play. 

Laura Daquino: But you're still quite bullish on global growth, at the moment?

Justin Braitling: Global growth is as strong as it has been in this expansion cycle. That's a fact. But that also is backward looking. In investing in these risk assets, you need to look over the horizon to the next year and what lies beyond. And we are seeing incredibly strong growth today, particularly in America. 

The risk is though, and the US Federal Reserve commented on this in the minutes [March 21, 2018], that the economy is overheating – the US economy is overheating. Within 12 months you'll have unemployment at 3.5 per cent, you'll have full capacity utilisation in the manufacturing sector. The economy is overheating. And at the same time, you've got negative real interest rates, and they're running a 5 per cent fiscal deficit. This is an economy that's already fully deployed, and they're throwing stimulus at it. This economy is certainly going to overheat. They're tightening policy to slow the economy; whether they have a policy accident and they're forced to really put their foot on the brakes, that's the big question investors should be thinking about. But the economy is overheating. That is a problem for asset markets. And it just leaves asset markets exposed to a policy mistake, as they try and cool the economy. 

The global economy is growing at a reasonable rate. We've got synchronised growth, that's all positive, that's why the share markets are up. But we need to look beyond the immediate horizon and think about what the outlook looks like next year and beyond. We've got a global economy, or US economy in particular, that's overheating and needs to cool. That's not good for asset markets.

Laura Daquino: Drilling into Australia, specifically, and on that note, where are you holding short positions at the moment?

Justin Braitling: We manage a balanced book, so across the various sectors we have a balanced book of longs and shorts. We don't like to mention individual names; the companies don't like to hear that you short their securities. But just as an example, without picking on any particular sector or company, to think about it in our process, we like a bank that's called Westpac, and we're not as excited about another bank, let's call it ANZ.

In our process, we benefit to the extent Westpac does better than ANZ. A traditional manager might just own Westpac, but because we have a short on the other side, ANZ, we have this hedge position, and we benefit to the extent Westpac does better than ANZ. Irrespective of what the broader share market does. That's how the hedge works, and that's how we make money. We're picking the stocks, winners and losers. We benefit to the extent that one company does better than the other. 

We tilt one way or another. We have a balanced book of longs and shorts in these sectors. Then we'll be a little bit long or a little bit short, depending on our view of the different sectors. There are lots of good opportunities in share markets still. We're finding lots of good opportunities. But, overall, the market is definitely fully valued. The industrial shares, excluding the banks and the real estate companies, today are trading on 20x earnings, which is as expensive as they have been in 25 years. 

What's more challenging is the growth outlook. The earnings growth that's forecasted for those companies is just 5 per cent, which is the weakest growth that we've seen, outside of the financial crisis, in that 25-year period. So you're paying the highest price for the least growth. That's why, again, we don't think this market's going anywhere or going to get away from us. 

There are some sectors that look a bit more interesting than others. Banks actually don't look too bad here. They are relatively well priced. There's a lot of negativity around obviously, with the Royal Commission. They're paying attractive yields, dividend yields. Those dividends are sustainable in the short term. The banks are okay.

Resources are a bit more challenged, and then there are some individual securities in the industrial sector that don't look too bad. It's a bit of a mixed bag. 

Laura Daquino: As it always is, I'm sure. Thank you very much for meeting with me today, Justin, and sharing your views.

Justin Braitling: Pleasure. Thanks very much for your interest. Thank you.