Prepare for a Stock Market Downturn Warns JO Hambro

JO Hambro's Ben Leyland explains how quantitative easing has made quality stocks expensive - and warns investors should prepare for a correction in the next 3 years

Emma Wall 17 August, 2016 | 10:36AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Ben Leyland, Manager of the JO Hambro Global Opportunities Fund.

Hello, Ben.

Ben Leyland: Hello.

Wall: So, global by name but by nature a real bias towards developed markets at the moment. Why is that?

Leyland: The main reason is that's where the valuation opportunities are. We scour the world for the best value available with a quality threshold to make sure we're investing in things that we can have long-term conviction in and we simply invest the capital of the fund where the best value is and that happens to be particularly in Pan-Europe at the moment.

The other thing I'd emphasize is that we have a lot of emerging market facing companies within the multinationals that we own. So, we've never seen geographic listing as particularly relevant to the economic case that we're making for a stock.

Wall: That sounds like you're a very bottom-up then as a fund manager. Do you think about a macro overlay? Are there particular themes going on in the world where you think that's a great opportunities or that's something I really need to avoid?

Leyland: I would say we would use macroeconomic weakness to our advantage by buying great franchises when they're going through a period of difficulty. We're much more likely to do that than we are to chase some cyclicals in a strong phase of the cycle. So, the macro view currently would be we're in a prolonged period of weakness which we're using to pick up certain cyclical companies like U.S. Railroads, for example, which are going through a period of negative volumes.

Wall: Because of course some of the areas that you are invested in, in the U.K., in Japan, and indeed, in Europe, the macro backdrop is a lot of stimulus in those areas. Has that helped the fund so far make rallies or will it indeed help further?

Leyland: My view is this stimulus has helped asset prices rise rather than economies recover. I would say we have benefited to a degree from that because the stocks that have benefited most are the quality areas of the market which we like to buy with recurring revenues, bond-like cash flows and a degree of yield. That's creating problems for us now because the valuations of such assets are becoming stretched and we're getting uncomfortable with those valuations. And so we're having to look at slightly less-advantaged sectors and companies.

Wall: And these are the stocks which some people call bond proxies, aren't they? They are high quality, income-paying stocks that have, as you say, had such demand because bond yields have been so incredibly low that actually the price of these stocks have been pushed up considerably?

Leyland: Yeah, the distinction we're trying to draw is between bond proxies and compounders. Both are types of companies which generate cash in a reliable way, but bond proxies pay most of that cash back to shareholders as a yield whereas compounders have the opportunity to reinvest in high-return activities to create more value.

And my view would be at some stage in the next three years we will have a market-wide de-rating, when and how I have no idea, but you need to be invested in companies which have created value and grown under the bonnet so that your capital return, your total return is acceptable.

Wall: Are there particular sectors which lend themselves more to these new opportunities?

Leyland: I'm not sure I would emphasize any particular sector. Clearly, I think the bond proxies are concentrated in certain sectors, the staples, healthcare and to a degree, a lesser extent, the utilities and telco sectors would all be the more defensive, more reliable cash-generative sectors of the market.

When we're looking for growth opportunities in compounders, we can find them in any sector, be that's industrials, there are certain energy companies which are investing heavily for growth, there are certain software companies which are doing the same. So, we try to be as broad-minded as possible when it comes to the industries that we're looking at.

Wall: So, prepare for a correction but focus on quality?

Leyland: Broadly, yes.

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

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar