Given: (1) a spike in the AUD to 80c vs the USD (2) an increase in the interest in our international fund and (3) that our tactical asset allocation portfolios remain heavily overweight international, I thought it worth expanding on our international equities portfolio and its exposures.
It’s a tough time to be making investment decisions. Everywhere we look markets are expensive, returns look low and risks are building. So, for the most part putting together our international portfolio it has been about finding novel ways to get the exposure that we want.
Based on growth and relative valuations, we are country agnostic at this point, if the USD keeps falling we will be looking to pick up more US stocks – that is the market where the growth remains the highest.
While “technically” we are underweight the US, this is illusionary. I’m going to do some work over the next few weeks to illustrate this. Basically, we are finding stocks listed in the US to be relatively expensive and so we have been looking to other markets to find stocks that are exposed to the US at a cheaper price.
For example Unilever is a UK listed stock but Unilever’s actual sales exposure to the UK is only a little over 5% – its biggest markets are actually the US and China.
We have been hunting for value in non-Euro European markets in particular.
The UK is one of the cheapest markets, burdened by Brexit fears, but we are also finding a number of quality multinationals in markets like Finland or Denmark that look better value than similar stocks listed in the US. We are mainly looking for multinationals rather than domestic stocks.
Some of the names include Unilever (household products), Imperial Brands (tobacco), Kone (Finland listed elevator manufacturer), Roche (Switzerland listed healthcare company) and Vestas Wind (Denmark listed but mainly US sales of wind turbines and parts). Most of these stocks have significant US sales, and trade at lower multiples than equivalent stocks in the US.
Defensives are expensive. REITs, Utilities, Telcos and Infrastructure are the usual places to look for defensive exposure but (just as the central banks intend) lower risk investors continue to “shuffle up the risk spectrum” and they have bid the price of traditional defensive sectors to levels that make investment difficult.
So, again we have positioned the portfolio to benefit in a different way. We are looking for a mix of the more stable industrial, consumer staples and healthcare stocks to get a similar defensive exposure without having to pay the nosebleed prices in the traditional defensive portfolios.
Our biggest call is underweight energy. In particular oil producers. We have blogged a lot about the oil price, (see this post in particular https://www.macrobusiness.com.au/2017/03/when-will-electric-cars-disrupt-oil/) but the thumbnail sketch of the sector is that:
- the short term is not positive for the sector with oversupply and OPEC needing to cut production to try to prop up the oil price.
- the long term is not positive with increasing electrification of cars and falling battery prices limiting the upside
- the mid-term might be good, if an undersupply emerges and before electric cars put a dent in oil demand and assuming US shale costs don’t keep falling
Meanwhile oil stocks are pricing $60-$70 oil prices in perpetuity – a 20-40% increase on current prices. The mid-term is going to have to be spectacular to justify current share prices, let alone getting any share price growth.
Having said that, it is a big risk to our portfolio being underweight energy. If there are geo-political ructions, particularly in the Middle East, we would probably underperform.
We are underweight financials – mainly as we can’t find US financials that are cheap enough to justify purchasing. We have been trawling the European banks for value.
We have a reasonable tech / IT exposure. Apple isn’t too expensive (although there are growth concerns) and Google we can just squeeze into our model as very high quality but expensive. There are a number of smaller tech stocks that we own, in particular a range of semiconductor stocks where we like the growth outlook.
As a reminder, we like to look at stocks on a Quality / Value Matrix – trying to buy stocks below the green line and sell stocks above the red line:
From a value and quality perspective, something usually has to give – you can’t find great growth companies with stable earnings that are cheap on every metric.
For the Value axis, we use a broad range of factors including:
- Cashflow: Free cashflow, Operating Cashflow
- Earnings: Range of earnings measures, pre and post abnormals, EV/EBIT, P/E
- Balance Sheet: Asset backing, replacement value
- Returns: Dividends, sustainable dividends, buy backs, capital returns
At the moment our international portfolio is expensive on a Book value vs Market value basis but much cheaper on Free Cashflow yield and Earnings Yield relative to the index. You can’t have it all so we are focusing on the cheaper companies on an earnings or cashflow basis rather than based on book values or dividends.
Source: Factset, Nucleus Wealth
From a dividend perspective we are earning a higher yield, but at the moment this is more of an outcome than part of the process – there is a global hunt for yield which is pushing a range of traditionally high yield stocks into expensive territory.
For the Quality axis, we use a broad range of factors including:
- Economic Moat: High margins, high returns, high proportion of earnings converted to cashflow
- Economic Trajectory: High marginal returns, above average EPS growth, sustainability of economic moat
- Stability: Earnings, cashflow, dividends, share price
- Financial: Appropriate gearing, interest cover
Currently we are finding that lower volatility stocks are expensive. While we prefer stocks with low volatility, we are not going to buy them at any price and so our portfolio currently has a beta very slightly higher than the market – usually it is lower than the market.
Damien Klassen is Chief Investment Officer at the Macrobusiness Fund, which is powered by Nucleus Wealth.
The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.