August 2020 – Mid Monthly Update
Not the affliction also known as halitosis but a reflection on the how the S&P 500 has rapidly become the S&P 5 as the most popularly quoted US equity index (sorry DJII) has increasingly been driven by the top 5 stocks. Take the Nasdaq 100 index too. Often used to reflect the tech sector’s influence, Microsoft, Apple and Amazon represent 35% of the Nasdaq 100 index. These top five, the above three plus Facebook and Alphabet (Google), also represent 22% of the S&P 500 in market capitalisation terms and 18% of that index’s earnings. This leads me to a key point – valuations.
Many fund managers evaluate companies using tools such as the price/earnings ratio, so popular it gets referred to as p/e where ‘p’ is the price and ‘e’ is earnings. Price is fairly easy, it’s the price you pay (not necessarily the value you get though) and in public markets, price is easy to find on a stock exchange. The key variable is earnings, a figure which analysts and other market pundits invariably get wrong. Last week was a salutary lesson in earnings forecasts as most of the big five mentioned above reported calendar second quarter earnings and guess what? As a group, they beat estimates. So, their stock prices rose. Now predicting quarterly earnings is a dangerous game, much better to invest in companies that have solid business with low debt, low fixed costs, healthy returns on capital employed and most likely, will be highly cashflow generative over a longer period of time. These are what we like to call growers and when attached to key long-term themes are likely to deliver good performance. We don’t measure the overall p/e of our equity holdings but it is a fair assumption that the p/e ratio of Growth and the equity allocation of Dynamic would exceed the p/e ratio of any relevant index – for good reason.
As total return investors, we avoid the pursuit of income. For us, the purpose of equity investing is to find companies within key themes, that can generate free cashflow based on revenue growth from a low fixed cost base. They will, over time, most likely regularly beat analysts’ quarterly earnings forecasts. Their share prices will reflect that success.
Even if the big five referred to above represent an increasing amount of US and Global equity market indices, it has no bearing on how we at T. Bailey Asset Management (TBAM) invest your clients’ wealth. We thank those of you who have been complimentary of our performance this year, but it hasn’t come from riding the coattails of the big five. Our look-through exposure to them is minimal. Performance has come from a focus on the broader digital economy which should continue to prosper in a post-pandemic world. The managers that TBAM invests with are index agnostic, conviction investors who, like us, are seeking to invest in growing companies rather than those grinding out an existence. A focus on key long-term growth themes that are drivers of performance.
We have changed little so far in August. Recognising the impressive performance of risk assets since March, we have let cash build up a little. Consequently, there is some firepower should there be a pull-back but without being too aggressive in that tactical allocation as cash is an unrewarding asset over time.
As of August 1st, the Dynamic’s ‘A’ share class and the adviser charging ‘X’ share class AMCs have been reduced to 0.45%. At TBAM, we appreciate the cost pressures of providing a complete solution to your clients. The OCF on the Dynamic Fund is now down to 1.07% which we believe is a competitive offering for a multi-manager, multi-asset solution.