PSG Global Flexible Feeder - Mar 17
At PSG Asset Management, we construct our portfolios using a bottom-up approach
We do not attempt to forecast political or economic events, because even if we could do this accurately, we wouldn’t have conviction about the ultimate impact of these events on the market.
Acquiring quality assets at the right price
Over the past 18 months we have written extensively about the divergence in valuations we have observed between cyclical and defensive companies.
In many cases, valuations of companies whose earnings are (perceived to be) more cyclical or uncertain than their defensive counterparts, have been trading at relative multi-decade lows, providing us with excellent investment opportunities. At the same time, those companies that had performed well over the last few years, or whose earnings streams are of a more defensive nature, had been significantly overvalued.
With US bond yields inflecting during mid-2016, coupled with an expected increase in global growth and inflation, we have witnessed a significant recovery in the share prices of companies that had previously underperformed, such as the portfolio’s global bank holdings or more cyclical industrial companies.
Some of the best investments are made in times of distress
To provide some context, JP Morgan, one of the world’s largest and oldest banks with a corporate history dating back to 1799 has been a long-term, high-conviction holding in the portfolio. As recently as 2012, after the ‘London whale’ incident, the company’s share price was $31 and it was trading at a price to earnings (P/E) ratio of 6.5 times and a price to tangible book ratio of 0.94. Fast forward to March 2017 and after recovering by 63% from its 12-month low, its share price traded at $94, at a P/E ratio of 15 times and a price to tangible book ratio of 1.8. The fact that the share price of JP Morgan trebled from a point of deep pessimism in a space of five years, illustrates that some of the best investments are made in times of distress. A similar tale can be told about the portfolio’s other global bank holdings and industrial counters such as Union Pacific, Colfax and Glencore which appreciated significantly ahead of the market over the past year.
Investing with a margin of safety
You are by now aware of our 3M investment philosophy, with the third M referring to a margin of safety. A rising share price in isolation is not necessarily an indicator of a reduced margin of safety. Our emphasis is always on the price we pay compared to the intrinsic value of the underlying security. We have, however, taken the opportunity to increase our allocation to cash. Market sentiment, especially in the US, continues to be one of greed. This has resulted in a reduced margin of safety in several holdings. We need to stress that all the stocks we mention above continue to trade well below intrinsic value despite recent share price moves.
Increased cash allocation The portfolio’s cash holding increased to 30% at the end of March 2017. This is an increase from 24% in cash at the end of 2016 and 8% during the February 2016 lows, where the portfolio had 92% of its assets invested in equities. We are willing to hold cash because it effectively expands our opportunity set from risk assets at today’s prices to the prices that will become available for risk assets in the future.
Cyclical companies continue to offer value
We continue to hold the view that many high quality, defensive companies are trading at valuations that put investors' capital at risk or, at best, offer poor prospects of positive returns. Several more cyclically-exposed companies continue to offer good value. But, in most cases, their margin of safety and prospective returns are lower than they were 12 months ago.
Global opportunities exist
Long-term investors with PSG Asset Management know that we tend to find our best investment opportunities in times when fear or uncertainty permeate the marketplace. While global investors have been welcoming the increase in global growth recently, we think it is coupled with an elevated level of complacency given the geopolitical backdrop. In our view, the best hunting grounds for opportunities driven by fear and uncertainty currently exist in the UK - where Brexit-related fears have depressed the valuations of several domestically-focused companies – and among selected emerging market companies, Japanese industrials and in agricultural commodity-producing companies.
We are high-conviction managers and while well-diversified, we tend to have relatively concentrated portfolios. Fortunately, we are still able to find excellent opportunities and Brookfield Asset Management currently leads the charge as the portfolio’s largest position. This company, which dates to 1899 and where management has around $7 billion of personal exposure, remains an outstanding, unique investment opportunity that we expect to compound at well-above-average market rates for many years to come.
While both the short and medium term will likely be characterised by uncertainty, we continue to stick to our 3M process and only invest in opportunities that we believe are likely to deliver attractive risk-adjusted returns.
The PSG Global Flexible Feeder Fund is a Rand denominated Feeder Fund, feeding solely into the PSG Global Flexible Sub-Fund, denominated in US Dollars and a sub-fund of PSG International Funds SICAV plc. The fund aims to achieve superior medium to long-term capital growth through exposure to selected sectors of the global equity market and/or bond market and/or money market, and exposure will vary in accordance with changing markets and economic trends.