In an uncertain environment: Earning visibility is key
27. January 2023
- Retail funds
- Institutional investors
Jordan Cvetanovski, CIO and Portfolio Manager at Pella Funds Management, analyses the current market environment with a special focus on inflation and rates. Who will win? The Federal Reserve or the markets? What impacts are high inflation and rising rates having on the UI I – Pella Global Securities Sustainable fund (ISIN LU2564817075 (AK EUR RD)) that was launched in January, and why has Jordan Cvetanovski positioned his fund towards more stability?
The market and the Fed are in a tug of war. Both are currently pricing the yields of Treasuries and a peak Fed Funds rate differently. The realised outcome for inflation and interest rates in 2023 could have a profound impact on equity markets. If market expectations are proven correct, and provided there is no Black Swan event, it is fair to expect sanguine equity markets in 2023. If the Fed’s expectations are proven correct, there are likely to be some major market shifts and headwinds. Our current expectation aligns more closely with the Fed than the market.
Current consensus expectations have been based largely on the CPI figures from October and November 2022, which were decelerating and lower than expected. This prompted a view that inflation is under control and the Fed will not need to increase interest rates much further. We do not dispute the fact that inflation may have peaked and is subsiding. Where we differ from the market is on how much we expect inflation to decelerate over 2023.
We emphasise the importance of investing in companies that have a relatively high certainty of earnings, provide a clear growth pathway and are trading at attractive valuations relative to those earnings.
Company earnings are increasingly under pressure
This does not mean we need to take a defensive stance, instead we emphasise the importance of investing in companies that have a relatively high certainty of earnings, provide a clear growth pathway and are trading at attractive valuations relative to those earnings. This entails investing in established businesses with proven, structural, and consistent earnings. We believe this is the cornerstone for delivering on our objective of growing our client’s wealth by beating the fund’s benchmark - MSCI ACWI (Euro, net).
For this reason, we have several stock level requirements in our UI I – Pella Global Securities Sustainable fund: all the companies in our portfolio are growing in revenue; we target companies with favourable secular growth and the valuation is measured relative to growth and risk. This leads to a portfolio volatility lower than the benchmark and to outperformance. The strategy seeks to capture the best quality growth opportunities without overpaying.
Avoid unnecessary risks
To avoid unnecessary risks in this higher-for-longer interest rate environment, we have also de-emphasised younger, disruptive companies that might have grown their top-line rapidly but have not demonstrated consistent earnings, and we are highly selective on cyclical companies with large exposure to a slowing consumer. In addition, we have a comprehensive list of excluded activities, such as fossil fuels, weapons, tobacco, pornography, animal cruelty and other harmful activities.
Focus on stability
Our emphasis on earnings visibility and certainty is observable in the portfolio positioning and individual holdings. Approximately 80 percent of the portfolio is invested in the Core segment, which is the highest weighting since strategy’s (developed in 2004) inception and compares with a maximum weighting of 80 percent for that segment. Meanwhile, the Cyclical segment comprises 10 percent of the portfolio, while Innovation is less than 1 percent of the portfolio, which is an all-time low. The Innovation segment has a maximum exposure of 20 percent.
Investing in companies with the above characteristics and skewing the portfolio towards the Core segment given the current market environment provides us with confidence in the stability of the fund. Most importantly, as we only ever invest in growing cashflow-generative businesses, this also increases our visibility for achieving our capital growth expectations. In an economic environment where corporate earnings are likely to face notable headwinds, stability will be the key to the fund delivering on its financial goals of beating its benchmark, with lower volatility than its benchmark and with superior sustainability to the benchmark.
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