Investing for a US Market Correction

Bronze Rated Old Mutual manager Ian Heslop thinks the US market rally is slowing, and has positioned his portfolio to prepare for a shift in the source of market returns

Emma Wall 8 August, 2014 | 10:04AM


Emma Wall: Hello, and welcome to the Morningstar Series, 'Why Should I Invest with You'. I'm Emma Wall and here with me today is Ian Heslop, manager of the Old Mutual North American Equity Fund. Hello, Ian.

Ian Heslop: Hello, Emma.

Wall: So first off, congratulations, because your fund won Best Fund Manager in its section at the Morningstar Awards.

Heslop: Thank you very much.

Wall: It's been a fantastic performance over the last couple of years, but I believe now you are looking to take some risk off the table. Is this because you think there is going to be a correction?

Heslop: I think, with the way we run the money, it's very much more to do with the market environment, how the market is reacting to macro news. We know that the U.S. market rerated quite significantly last year. So 10% earnings growth led to 30% growth in price. So rerating is probably not on the table this year. So we are expecting and requiring to see some measure of earnings growth this year, and we would expect to see sort of high single, low double digit earnings growth this year.

So the expectation is still there and that’s not unreasonable. Good employment growth. GDP in the first quarter was difficult, but GDP in the second quarter kind of caught up, which we were expecting. And we have one or two kind of slight niggles, slight worries. Basically: the housing market, and also the worries about the long bond yield and how that long bond yield will reprice as the emergency economic policy is taken out of the U.S. economy.

Wall: I think we're all quite familiar with what's going on in the headlines with that huge weather event that did knock GDP significantly. How does that impact the stock market and how you run the fund? Because there is all well and good all this economic macro stuff going on, but what does it mean for investors?

Heslop: That’s really interesting thing, because what we try and do is recognise that macro is just one impact. Macro is important, but really what you really need to understand is what is the market doing, because that has a very large impact on the types of stocks that investors will buy and sell.

So not only do we do a lot of work on the underlying companies, we try and understand supply and demand at the share level, because we don't buy companies - we are not in private equity. But really the big thing is to try and understand how the market looks, what is the market really telling us about the types of stocks that investors will buy and sell.

The types of things that we look at, is volatility low or high. We know it's very low at the moment. Is there dispersion in returns, are markets moving up or down or kind of sideways and risk appetite, investor risk appetite very important. I'd point to the idea that macro does tell you some things, but doesn’t tell you everything. Volatility is very important one there.

Volatility is very low. So low volatility realised and the implied volatility is also showing very low levels relative to, you know, 30 years, very, very low. But what we're seeing in the market is quite significant rotation. There is lots and lots going on underneath the surface of the market, which tells us a lot about investors are uncertain. There is not this complacency that people often talk about within markets. Although markets are moving up. These are very uncertain times, I believe.

Wall: I think that’s quite an interesting example to use because you would think considering how significantly the market has rallied but investor confidence would be high. But you're right, there's still a lot of uncertainty there. So where does that create opportunities then – those sort of inputs?

Heslop: Well, I think the major thing that we really try to do with this portfolio is to understand that it is very important not to concentrate your style positions in the portfolio. So we look to build a portfolio that's very diversified, not just at the stock level but also at a theme level. So the types of stocks that we buy and sell are very broad, different types. So not only will we include things that we believe are cheap relative to fundamentals, but we also look for good quality stocks.

We look for stocks that are showing good earnings growth. We are looking for stocks that are showing good price momentum. So they have moved up in certain periods. But we try to adjust that, amend it based on the environment.

The classic example of that is low volatility, because what you find in low volatility environments is the stocks that have performed well will continue to perform well. So, a low volatility environment is very good for trending type stocks. It's less good for other types of stock selection components we use.

We look very hard at kind of how management teams are making decisions and actually the market looks less at that in benign, quiet markets. But when volatility rises, trends tend to break down and management quality tends to be much more interesting for investors.

Wall: So then if that's where the opportunities are, where are you taking risk off? In what sectors are you trimming the position?

Heslop: Well, actually what we found is, for instance, the consumer discretionary sector, where we've been overweight for a considerable period of time, we're now bringing that down on to underweight. We're overweight in healthcare. We've gone overweight in utilities for the first time in a long time, where we tended to be underweight.

So you could class these kind of sectoral exposures that we have in the portfolio as somewhat more defensive than they used to be. But the more important thing I think is that actually within sectors what we're tending to do is bring off the kind of very highly exposed stocks, remove those types of stocks from the sectors.

So stocks that will tend to perform well in good markets, we're just blending in some kind of more safety first stocks into the portfolio. So not necessarily aggressively moving towards kind of a risk-off stance, but just blending to have a quite an equal portion of both the stocks that will perform well in good markets but also stocks that will perform well if the markets become more choppy.

Wall: So hedging your bets for this interim period.

Heslop: Very much, yeah.

Wall: Ian, thank you very much.

Heslop: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Old Mutual North American Equity Acc11.20 GBP0.63

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Emma Wall

Emma Wall  is Web Editor for