Active fund managers are feeling the heat. Funds are flowing towards low-cost index huggers, and away from more expensive active alpha generators. There are a number of factors driving this funds management trend. One of the starkest is shared with individual investors – the difficulty in finding good “value” shares in markets near post-GFC or all-time highs.
Value investing is a style many investors favour. It’s intuitively appealing. Buy shares when they’re undervalued, and wait for the broad market to agree and adjust the share price higher. In a rising market this can be a very powerful way of generating outperformance as truly undervalued shares can rise faster than the market.
However markets globally and locally are nearer highs than lows. The dynamic of a rising tide is much less powerful at elevated levels. Additionally as the market rises investors tend to broaden portfolios, meaning undervalued stocks are harder and harder to find. Markets may continue to rise, but the risk of pullbacks is clearly increased.
This illustrates a key investment challenge. There is no single investment style that outperforms throughout the market cycle. Value investing, growth targeting, momentum approaches – they all have their time. This is a product of market logic. If there was a consistently superior style all investors would use it, and by definition it could not outperform.
The reality is that investors rarely change their style, even in light of the information above. This lack of flexibility is usually the product of conviction and previous positive experience. Taking a behavioural approach to the issue means examining possibilities for value investors at elevated market levels.
Fallen angels versus fading stars
Stock meltdowns are a regular feature of share markets. Whether caused by internal or external factors investors need to know if this is a temporary phenomenon or a sign of a company in terminal decline. In other words, will the shares bounce or keep on sliding?
A fallen angel is going through temporary tough times. A fading star is on the way out. Obviously value investors seek the former and shun the latter. But how can investors tell if a beaten up stock is a buy or avoid? Not even the brightest minds can say with certainty which is which until one of two things occurs – the stock recovers or fades to zero.
Investors need to examine the situation and decide for themselves. Here are two examples, and my view on which category the populate:
Bellamy’s Australia (BAL) is trading around $5.00. Its all-time high in December 2015 was $16.50 at the peak of the China pure foods frenzy. A slide of that magnitude means it’s either a fallen angel or a fading star. Unfortunately, there are multiple factors driving the share price capitulation.
Mistakes in inventory management. Tightening regulation in China. An alliance with Bega Cheese that exacerbates BAL’s inability to export to China. And behind all this a board and executive that appear to be at war. Any one of these factors is a concern. The constellation of problems combined with self-imposed handicaps in solving them leads me to conclude that BAL is a fading star. While the business may recover one day, there are many bridges for BAL to negotiate, and risks are higher.
The situation at Platinum Asset Management looks different. A former market darling, its share price is down from$9.50. The trend away from active funds management drove Funds Under Mangement lower, and with it profitability. However the most recent half year result in February showed an 18% Earnings Per Share increase and a 2% lift in FUM. The March FUM report confirmed what looks like a turnaround in mandate losses, with another increase.
Additionally, PTM has around $360 million in cash on hand, and a buyback program of up to 10% of the stock. While the dividend payout ratio above 90% would limit any buyback implementation it is a powerful stabilising tool should the share price fall further.
The technical picture (above) adds to the idea that PTM is a fallen angel. Note the repeated bounces off $4.85. Many chartists describe this as “basing behaviour”. The catalyst for a move higher is harder to predict, but buying close to the support level seems a lower risk approach. the rfall through this level is concerning - although the potential for the buyback to kick in may mean this is a short lived situation.
By definition value investing requires going against conventional wisdom, often buying when the majority are selling. Investors who bought bank shares in the late 2011 European inspired sell off were rewarded handsomely. Similarly, investors who looked through the China related resource jitters in Q1 2016 did very well. Differentiating between fallen angels and fading stars is an important investment skill. In investing, knowledge is power.