Where fund managers are looking to buy

Summary: Where Chief Investment Officers and senior portfolio managers are looking.

Key take-out: Active fund managers are on the prowl for undervalued stocks, and they are seeing plenty in Australia and overseas.

While equity markets are destined to remain volatile in 2019, fund managers are sensing new buying opportunities.

Following on from our question “What do you see as the main challenge for markets in 2019?”, we asked the same 20 leading fund managers “Where do you see growth opportunities?”.

Most believe there is significant value in markets around the world, including in stocks on the Australian Securities Exchange that are primed for growth.

As well as providing their views on the specific regions and market sectors that are likely to deliver the best returns, both in Australia and globally, a number of senior portfolio managers talk to specific stocks they are buying in their funds and that they believe will outperform.

Below are their predictions and tips on the growth opportunities in 2019.

Jacob Mitchell, Founder and Chief Investment Officer, Antipodes Partners

For equity investors, this environment favours the status quo – a stylistic preference for ‘structural growth’ or ‘quality’ at any price. Q4 2018 saw a sharp reversal in the outperformance of expensive ‘structural growth’ or ‘quality’ at any price, with extreme policy settings in developed markets leading to severe herding in these styles. Given the divergent risks of US monetary tightening, the Fed reaction function and the global growth outlook, investors should focus more than ever on uncovering sources of idiosyncratic alpha rather than relying on momentum or passive beta.

We’re encouraged by the high level of valuation dispersion within and across markets as indicative of broad pragmatic value opportunities, both long and short. In this sense, broadly both North American and Developed European equities look expensive. Given that these regions represent ~77 per cent of the MSCI ACWI, investing in the global index is unlikely to lead to a great long-term return outcome. Comparatively, both Developed Asia (Japan, Korea and Taiwan) and EM stand out as regions with greater return potential.

David Macri, Chief Investment Officer at Australian Ethical Investment

We continue to see earnings growth opportunities in the IT and healthcare sectors, particularly in the small and micro-cap segment of the market. The recent market volatility has in some ways been a healthy correction and thrown up select opportunities in these sectors. Our stock selection process for the Australian Ethical Emerging Companies Fund tends to gravitate towards companies that have sustainable business models, a competitive or differentiated offering, and led by a strong management team capable of executing on corporate strategy.

Julian Beaumont, Investment Director, Bennelong Funds Management

In our view, a number of strong business franchises look attractively priced for their growth prospects. Many of their share prices sold off late in 2018. Companies like CSL, Aristocrat, Costa Group and Reliance Worldwide all have competitively dominant positions and all are consistently investing significantly in their longer term growth. These types of businesses will be selling more, earning more and worth more over time, regardless of what happens in the economy or markets in the interim.

Scott Kelly, Portfolio Manager, Income Portfolio, DNR Capital

Some of our strongest periods of outperformance have emerged from downturns as we use the volatility to add to positions held in quality businesses at attractive valuations. We have identified a number of high conviction ideas with significant excess returns on offer and have accumulated positions with active weights of 4 per cent or higher. These stocks include James Hardie (JHX), Lendlease (LLC) and Link Administration (LNK).

Stephen Miller, Investment Adviser, Grant Samuel Funds Management

The better investment opportunities will continue to swing away from ‘beta’ sensitive areas and more toward opportunities that reside within proven stock-picking capabilities and perhaps even more so in private assets (both equity and credit). I think Aussie bonds will outperform the US but the absolute returns on offer will be very modest.

Mark Arnold and Jason Orthman, Chief Investment Officer and Deputy CIO, Hyperion Asset Management

Our view is that long-term, sustainable earnings growth is a function of quality, solid business propositions, strong management, and a large and growing market. This means businesses with innovative and disruptive strategies (often technology-based) and, which we believe, have structural growth opportunities will perform well in the long term.

Furthermore, global companies are often of a higher quality than their Australian counterparts, reflected in their higher five-year earnings forecasts. This means investors will reap stronger returns with relatively lower levels of risk.

Nathan Bell, Senior Portfolio Manager, InvestSMART Group

Reece and Reliance Worldwide will have to perform well to justify their high price-to-earnings ratios and large US acquisitions, but both have excellent prospects over the next decade even if earnings slow in the short term. They both operate in the US and Australian plumbing industries and earn a large proportion of revenues from repairs and maintenance, which provides a base level of profit to get them through tough times. Both should also benefit as America’s millennial population, the country’s largest population cohort ever, buy homes and start families.  

Christian Obrist, Head of iShares, Australia

In the equity market, emerging market assets have cheapened — offering better compensation for risk in 2019. Country-specific risks — such as a series of EM elections and currency crises in Turkey and Argentina — look to be mostly behind us. At the factor level, value can offer balance, we believe, helping to offset declines in other styles and assets. In fixed income, rising rates have made shorter-term US bonds an attractive source of income, dependent on an investor’s funding currency.

Jay Sivapalan, Co-Head of Australian Fixed Interest, Janus Henderson

In credit markets, participation in coupon income remains an important source of excess return for investors. But the manner in which we participate is important at this more mature phase of the credit cycle. Whilst we don’t see credit markets as imminently risky, it is worthwhile continuing to be prudent when investing in corporate debt, favouring defensive sectors and being biased towards the higher credit quality spectrum.

We have had minimal exposure to the Australian ‘AAA’ rated residential mortgage backed securities for obvious reasons. But at some stage, pricing is likely to get to levels where the breakeven returns are very much in favour of investors. This is an area we’ll be watching with interest over 2019 and looking to exploit.

Aaron Binsted, Portfolio Manager, Lazard Asset Management

There isn’t a specific sector that we have identified as an exceptional opportunity. What we are seeing is individual stocks in a diverse range of sectors as being compelling value. For example, our top holdings in our Select Australian Equity Fund are Woodside (energy), QBE (insurance), Rio Tinto (miner), AMP (diversified financial) and Alumina (miner) cover a wide range of industry groups.

The market has not been as focused on fundamental valuations and some out of favour stocks are now trading at exceptional value. If you avoid the high growth expensive stocks and those stocks most exposed to the cooling domestic economy, we think there are some reasonable opportunities for investors.

Reece Birtles, Chief Investment Officer, Martin Currie Australia

Australia is at an earlier stage in the economic cycle than the US and is benefiting from the weaker Australian dollar, a growing population and strong employment and wage growth. The stimulus cycle (personal income tax cuts) should be positive for the consumer in 2019, and the cyclical sector of the market.

Nick Griffin, Head of Investments, Munro Partners

We see several attractive investment opportunities into 2019. These ‘Areas of Interest’ are parts of the market that can grow somewhat regardless of the economic cycle. These include Digital Enterprise (shift to cloud computing), Innovative Health (reducing the cost, increasing the quality of healthcare) and Digital Payments (shift from physical to digital cash, which has much further to run).

Specifically related to current tensions around US and China geopolitics, we are invested in numerous beneficiaries of the race for 5G and ‘internet of things’ superiority. This includes the so-called ‘national champions’ like Cisco, Microsoft, etc. as each side looks to boosts their domestic champions for the long road ahead.

To position the portfolio for monetary policy tightening, we are investing in companies with strong balance sheets (predominately net cash) and that have strong free cash flow yields.

Will Low, Head of Global Equities, Nikko Asset Management

The changing face of US healthcare. Away from the very public blood-letting over drug pricing, healthcare delivery is changing (slowly) in the US. We still see a number of opportunities from focusing reimbursement around delivered patient benefit and delivering healthcare where patients really want it (e.g. at home). We are playing these themes through holdings like Anthem.

The Industrial Internet of Things. The consumer Internet is arguably fairly commoditised already, but we still see considerable scope for industrial applications to play catch up. Given macroeconomic uncertainties, the need to ‘do more with less’ should underpin efficiency-related investment, even in more straitened times. Edge computing and digitalisation seem like real opportunities to us. The portfolio reflects this theme through a variety of holdings such as Keyence, Hexagon and Microsoft.

Gaming. Our team might be more Sonic the Hedgehog than RDR2, but the scale of innovation remains immense and business models in the sector are evolving to reduce cyclicality, e.g. console manufacturers investing in game development / software. This is one of the reasons why we like Sony.

George Latham, Chief Investment Officer, Pengana WHEB Sustainable Impact Fund

After a tricky 2018 for sustainable investing, we believe that the tail-winds will pick up in 2019. The transition to low carbon in power is already well underway and the growing maturity of wind power, for example, is expected to support stronger returns in 2019. The automotive sector too, while still some way behind power, is also decarbonising. In 2019 we will see this transition accelerate as the variety and performance of battery electric vehicles improves.

Paul Moore, Chief Investment Officer and Portfolio Manager, PM Capital

It’s quite exciting from a stock picker’s point of view because there’s so many opportunities. In every sector you look at now there’s stocks down 20, 30, 40, 50 per cent. If companies can grow their earnings from here, or beat earnings estimates, with these kinds of valuations stock prices are going to rise. Commodities and energy are interesting – some of the copper producers are down 50 per cent, so too the oil service providers. Generally, 80 per cent of the stocks in the market have now had their bear market and 20 per cent haven’t. If you’re thinking about the next three to five years, you want to be in the 80 per cent that’s had their bear market.

Dr Bob Baur, Chief Global Economist, Principal Global Investors

The best growth opportunities next year could be in the US and India. Both countries have enacted structural changes that are long-term positive: US tax reform; in India, formalising the underground economy, equilibrating sales taxes across state lines, and recognising non-performing loans. Domestic consumer companies in developed countries may do well as US wage growth is accelerating nicely and gains are picking up the pace in greater Europe.

Beverley Morris, Director, Rates & Inflation, QIC Global Liquid Strategies

While volatility sounds scary to some, we see it as an opportunity. As an active fixed interest manager, we are driven by fundamental valuations and actively positioning fixed interest portfolios based on a deep understanding of macro, micro and technical factors driving markets. As markets react in a short-term manner to data announcements, political tensions and other transitory factors, it creates an opportunity for us to add value to our portfolios. In an environment of tighter financial conditions and slowing growth, moving up the capital structure into higher quality credits and employing more defensive interest rate, yield curve, inflation and FX strategies will be critical.

Peter Wilmshurst, Portfolio Manager, Templeton Global Growth Fund

We see value opportunities outside the US, as the valuation gap between US and rest of the world narrows down. Europe, for instance, has not seen as robust growth as the US, giving European companies an easier hurdle to clear in 2019. Meanwhile, the Japanese market, which has seen decent earnings growth, could benefit from any signs of a more durable pickup in inflation. Additionally, we expect companies with low debt and strong cash generation to do well as economic and earnings growth moderates

Jun Bei Liu, portfolio manager, Tribeca Investment Partners

We are seeing plenty of growth opportunities in the current market, most of which generate earnings from offshore, particularly from the US and emerging Asian markets, underpinned by strong economic activities. Some of the innovative sectors domestically are also experiencing enormous growth, such as the technology sector with earnings drivers independent of economic activities. Interestingly, in the current risk-off environment, our gaming sector couldn’t catch a bid. Both Aristocrat and Tabcorp are growing at double digit rates while earnings multiples are below their respective long-term trend.

Jonathan Baird, Investment Specialist, Western Asset Management

Our base case is that the risks hanging over markets will not materialise into a more systemic issue and we hold the view that the global economy will remain sound. While we expect global growth to moderate, central bank policy should help continue the expansion phase both globally and in Australia. Australian portfolios are employing much of their risk budget in corporate credit which offers the best risk/reward characteristics domestically, although this remains somewhat defensive with the overweight focussed at the shorter end of the yield curve to manage credit spread risk. Globally, we continue to believe that select emerging markets (EM) exposure represents a significant valuation opportunity. Higher US rates and the USD weighed heavily on EM currency and bond returns throughout 2018. However, in our view, valuations and fundamentals will eventually carry the day.