It’s Tracey’s birthday soon, one after a big one that wasn’t that big because of lockdowns. So I thought, nice hotel in the country, nice meal and maybe a bottle of English fizz. Thinking of the wine miles.
I found a hotel about 40 minutes away, fancy fittings, Michelin-starred restaurant, ticking the boxes ... but the smallest room for bed and breakfast was over £800. Now the room was nice, but this is Wiltshire County not Wiltshire Boulevard. Obviously I want to spoil my wife so I’m willing to push the boat out – but a nice little punt, not the HMY Britannia. This price went beyond good value into Veblen good territory. I know what you are thinking: he’s an old softy and went ahead anyway. Wrong. I am Welsh remember. I found another hotel, better accommodation and same restaurant rating, all significantly cheaper. Still expensive, but better relative value.
Value is such a subjective measure. Yet we hear ‘growth’ and ‘value’ talked about all the time as if they are statistically meaningful. I continue to struggle with this concept.
As equity markets have risen pretty consistently since spring 2020, valuations of COVID-19 friendly stocks are starting to look lively. In fact, we have had to come up with a new ratings system: ‘lively’, ‘spicy’ and ‘eye-watering’. Two US software and computing hardware holdings in our Rathbone Multi-Asset Portfolio funds, simulations company Ansys and computer chip optimiser Cadence Design Systems, have forecast 2021 price-earnings (PE) multiples of around 50. They have definitely gone from ‘quite expensive’ to ‘spicy’, whizzing right past the ‘lively’ category. And if you think it’s just the US, think again. ASML, another of our computer-chip positions, is also on 50 times 2021 earnings.
The software smorgasbord
At least in America there are many technology names for investors to consider. In Europe the pickings are slimmer, and we worry ASML may be over-owned among European active managers, hence we have been aggressively taking profits.
Now if you subscribe to the belief that high-PE stocks will sell off substantially if interest rates rise, and if you hold these sorts of companies in your portfolio, then you’re probably sitting very nervously. We are holding them and we are extremely nervous. We’ve been slowly but steadily reducing our exposure to technology over the past 12 months, yet the problem is this is where the growth lives – and everyone knows it.
Other factors contribute to this problem. The raft of funds launched focusing on environmental, social and governance (ESG) factors has increased the demand for tech companies. Today's IT giants tend to be asset-lite and therefore relatively carbon-lite, helping them get through negative-only screens. And then there are innovation funds, aiming a laser beam at the technology sector. We are very nervous about owning companies alongside hyped-up active funds and ETFs where often the definitions of eligible securities are sketchy.
Innovation funds, I mean, really? All the companies we invest in are trying to innovate, that’s how you gain market share, improve profitability and stay relevant. Adapt or die, to paraphrase Charles Darwin! We own bleach manufacturer Clorox for example. It has one of the biggest-selling kitchen bin liners because it patented and introduced double skins to avoid tears and therefore mess on the kitchen floor. I bet Clorox is not in an innovation fund ETF!
Stick with quality, but keep cash ready
So the conundrum: we know the best-quality companies are expensive right now. I’m not going to try to defend this. No new paradigm chat. However, they could remain expensive and increase in price with greater sales and smarter cost cutting for another couple of years or more. I don’t want to sell these sorts of companies to replace them with lower-quality or low-growth names. We are long-term investors. We aren’t buying highly indebted or unprofitable businesses valued on a price-to-sales basis. That tends to end badly when sentiment shifts.
To try and prepare for the beginning of the (very long) end of volume 11 monetary easing, we’re holding lots of cash so that we can add to our preferred companies on any ‘tantrums’, and potentially other asset classes such as high yield bonds.
When real yields are as low as they are, cash seems the only safe option, followed by put option protection on your stocks. In our case, we have made use of both. But put options are based on the broad index, not purely high-valuation names. Also, the VIX volatility index has been relatively high recently, increasing the premium you pay for this sort of portfolio insurance. Because of these reasons, we’ve been adding only to cash in recent months.
We also own a basket of short-duration sovereign bonds issued by several different governments. Again, these should provide some insurance and, most importantly, liquidity if we get an equity market shock. In summary, our strategy is high(ish) growth and high liquidity. It’s not the time to go all in.
I hope Tracey doesn’t notice that I seem to have mapped her birthday strategy on my investment strategy … avoid ‘eye-watering’ prices and settle on ‘spicy'. Going any cheaper could lead to trouble.
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