If you run different sets of metrics over the prospects for Australian companies then the best bets will vary enormously.
T Rowe Price, which follows a quality growth style and philosophy with a focus on the potential for Australian companies to expand abroad, mentions reinforced concrete product manufacturer James Hardie, medical product manufacturer ResMed and supply chain logistics firm Brambles as three of its current favourites.
Boutique fund manager Montgomery Investment Management, which has a core growth belief, cites medical device manufacturer Sirtex, financial services company Challenger and biotech firm CSL as among its current favourites.
While Vince Pezullo, portfolio manager at Perpetual, who follows a value based strategy, has gone overweight on shopping centre manager Westfield, medical glove and condom manufacturer Ansell and metals and electronics recycling firm Sims Metal in 2014.
Here are their three approaches.
The Boutique MANAGER – Montgomery Investment Management
Of the three approaches to the index, the manager that veers off benchmark the most is Montgomery Investment Management. Its founder Roger Montgomery says his aim is to build a portfolio of outstanding businesses regardless of the index constituents or capital weightings.
This approach has led to only 26 companies in the Montgomery Fund and 21 in the Montgomery Private Fund. Notably some of these are small cap such as Icentia and InfoMedia.
“We believe that true blue chips come in all different sizes,” he says. “What these businesses also have is bright prospects for intrinsic growth for their product and they tend to have identifiable competitive advantages.” He adds that the most valuable of these advantages is the ability to raise prices even when there is excess capacity.
A key part of his process is to evaluate the long term changes in the valuations of these businesses, the strength of their balance sheets and those with high rates of return on incremental equity.
Along with this approach, Montgomery is happy to sit in cash if value cannot be found at current prices. He reasons investors are paying his firm for knowing when it is the appropriate time to be in stocks and not in cash. Prior to the market correction in September, the Montgomery Private Fund had almost 40pc in cash and the Montgomery Fund 27pc in cash.
The approach is based on protecting its investor capital. “Our clients are regular people who do not care about the capturing of the last 1-2 per cent of a market’s rise,” he says. “What they do care about is that you do not lose them 20 per cent. They do not care about is that we have outperformed the market by 3 per cent when it has gone down 15pc.”
The GROWTH MANAGER – T Rowe Price
T Rowe Price has a quite different approach to the market. It reasons that with Australia having a population of only 23 million, its best performing companies will seek sales overseas for growth and that its investment experts on the ground in these markets, by virtue of its global network of investment offices, is a huge advantage in being able to determine how successful these Australian companies will be. It also reasons that the multitude of domestic based equity managers lack access to these insights.
Randal Jenneke, head of Australian equities at T Rowe Price, believes the more a company moves away from the domestic market the harder it becomes to assess the strength of its competitors. “It is very hard to tap into what is happening in the US or Europe if you are sitting in Sydney or Melbourne,” he says.
Beyond such a bias, its approach is to seek companies with strong and attractive returns on capital and growing businesses. In choosing these it first rates all of the stocks in its universe with a proprietary quality ranking.
Unlike, Montgomery Investment Management and Perpetual below, it does not keep large amounts of cash in its portfolio and only had 2 per cent at the market’s peak in August. Jenneke reasons that even in the middle of 2014 valuations were not stretched on companies it had picked for growth. The main movement by the fund was to “rotate” capital out of stocks that have done well for them and reinvested that back into the stocks whose prices were hit hardest in September and which met T Rowe Price’s quality filter for growth.
The VALUE MANAGER – Perpetual Investments
In the value driven approach taken by Perpetual Investments, the recent high valuations in the market has led the Industrial Share Fund (ISF), the Australian share fund, the Concentrated Equity Fund and the SMA fund up to the brink of their 10 per cent cash limits from July to September. The cash limits were built up after selling stocks that portfolio manager Vincent Pezzullo thought profit could be gained – the Industrial Share Fund has been taking profits in this way for the last 12 months.
The fund’s value approach forces it to be patient at times of high valuation and the recent falls in October were its first big chance to buy stocks in 18 months. “When people are selling stocks aggressively, it is a good opportunity to buy quality companies at attractive prices. The markets are starting to take a lot of the premium out of the market which is starting to make it much more interesting.”
One way the value approach works for Perpetual is in its determinant of currency changes on companies’ foreign earnings.
“We have had a reasonably large overweight position to US dollar and offshore earners for the last six months,” Pezullo said in October. “Up until about April-May the PE spread between US dollar earners/ foreign offshore earners and domestic earners was the smallest in probably 2-3 years, so we had a large US dollar exposure through Westfield, Ansell, Sims Metal. That looked relatively cheap then, but now they are at a 40 per cent premium to domestic.”
Current views on the market
Randal Jenneke believes the outlook for the quality companies in the ASX is positive. “The Aussie market is on 14 times earnings, so it’s not hard to make an argument that Australian equities is the best value asset class in the current environment”.
Going forward he sees good scope for profit growth at Australian companies after several years of cutting costs and improving productivity to combat the impact of strong currency on export competitiveness.
“When we get to a slightly more healthy growth environment, the first thing you will see is their margins expand and strong profit growth,” he says.
Even for more domestically focused businesses T Rowe Price is positive in select areas such as businesses exposed to the housing market and financial services, where bad and doubtful debts are expected to stay at low levels.
Roger Montgomery takes a more jaundiced view of the market. He notes that the ASX 300 has about an 80 pc weighting to the top 50 companies within it. “The vast proportion of that top 50 are mediocre performing business they have not added value for a decade or more,” he notes.
