Themes not events
While shifts in sterling and developments in technology can be useful to investors, Adrian Frost argues macro forecasting should be avoided.
In recent months, poor corporate earnings and the Brexit vote have raised fears that dividend cuts may be in store across global equity markets. Yet share prices remain buoyant. In the UK, the FTSE 100 is more than 500 points (almost 10%) above where it closed on the afternoon of the referendum. Even the more domestically oriented FTSE 250 has risen more than 2.5% since voting closed three months ago.
Moreover, while some sectors may face dividend pressure, Adrian Frost of Artemis Investment Management believes the Brexit vote’s impact on sterling may be providing some insulation for those companies listed in the UK.
“There are certain sectors where there is a well-debated and decently recognised risk of a dividend cut,” says Frost. “Some companies may be subject to a share price hit on the back of bad news, but sterling has made them slightly more secure, given the mix of cash flows in the portfolio – and I am reasonably confident of our ability to maintain and grow dividends.”
The referendum result proved most pundits wrong, even the major pollsters and bookmakers. Predicting the movements of sterling could likewise be classed a fool’s errand. But if such macro events cannot be predicted, investors can at least prepare for them – and thereby cushion their impact.
“Whilst it is unrealistic to think we can simply take macro risk out of the portfolio altogether, we have a preference for finding stocks where the micro considerations are likely to have a greater influence on their future,” says Frost.
Nevertheless, while guessing at macro events is not part of the investment strategy, identifying macro themes undoubtedly is. Among these, Frost believes that technology has particular power to transform all sorts of sectors through a process of ‘creative destruction’ – a term coined in the 1940s to describe the churn of new technologies and processes forcing out old ones, within the capitalist system.
“Firstly, having a perspective on technology is helpful in showing you what not to invest in – it’s about having a clear view of where the potholes are,” says Frost. “The market often gets technology wrong but if tech shifts a company’s position even only slightly, that can be enough to make a material difference to the share price. Retail is the obvious sector at risk here and, while the pressures are well-known, the implications have not been well-explored. It’s easy to jump at a short-term opportunity when the share price is cheap. Conversely, five to ten years ago you might have thought there’d be no bookshops by now, but actually sales of physical books are rising again.”
Yet Frost’s focus is not simply on recent developments like GoPro’s new drone or Uber pilot-testing its driverless taxis on residents of Pittsburgh. Instead, he looks for the impact of technology far beyond the major names.
“There are plenty of decent, well-invested individual companies with a strong market position where the application of technology can – at the margin – help customer service, price competition and more besides,” says Frost. “Next year, phone manufacturers will put e-sims into mobiles, and then you can change your network provider more easily,” says Frost. “That will be significant and you have to think it through in advance. You need to try to read the book to the end, even though you’re actually living in the early chapters.”
Like technology, the pharmaceutical sector holds out the promise of radical research breakthroughs that transform a company’s profitability. Yet the sector also shares technology’s unpredictability – it is almost impossible to forecast such breakthroughs. For Frost, whose portfolio includes a significant holding in GlaxoSmithKline, this makes a pharmaceutical company with diversified research and development (R&D) programmes more appealing.
“Glaxo has become more like a Unilever now, and so it is very balanced,” says Frost. “A single R&D failure wouldn’t be material to its share price.”
For other holdings in the portfolio, Frost is more focused on headwinds than on opportunities, notably in the energy sector, where the risk of oil prices remaining subdued for an extended period presents a particular challenge.
“We have not moved the proportion of the fund invested in oil overall but we have bought some BP at the expense of Shell, shifting away from what had been an equal weighting,” says Frost. “We met with BP recently and we are more comfortable that the company is managing its affairs for a harsh oil-price environment. Shell is also doing so, but its plans work much better with a higher oil price.”
The largest stock holdings in Frost’s portfolio are also among the least familiar. RELX, Informa and Wolters Kluwer are similar in providing specific services to business clients, often based around the intelligent gathering and dissemination of industry data.
“Their skill is in amassing data and recasting it into tools that people can use,” says Frost. “Each of us has a particular service that we look to – take a Bloomberg away from a fund manager and they’ll miss it. For another business, it will be legal services they need. Those tools can be very important.”
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The opinions expressed are those of Adrian Frost of Artemis Investment Management and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any strategy. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.
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