By: Mikhail Motala, Fund Manager at PSG Asset Management
To say that the period since the Global Financial Crisis (GFC) has been anomalous would be an understatement. And yet, the low inflation and low interest rate environment associated with this period has become viewed as the ‘new normal’. However, as inflation persists at higher levels than in the past, market participants are increasingly asking themselves whether the environment is changing in some fundamental way – and what it could mean for their portfolios.
The short answer, in our view at least, is that the environment has undergone a fundamental shift, with inflation likely to be higher for longer. And we believe this is likely to have a fundamental impact on portfolios and how they perform.
In the post-GFC period, artificially low interest rates boosted the performance (and attractiveness) of so-called long-duration assets: assets that offer the promise of long-term growth, but with limited cashflows in the short term. These typically have a longer payback period. When inflation and interest rates trend higher, however, capital becomes scarcer, and money must work harder to earn a viable return. Therefore, investors are also keener to earn returns from their investments sooner rather than later.
The problem is that although the post-GFC environment was an artificial one, it persisted for a long time – and, so, it reinforced the belief that certain investments would reward investors, perhaps indefinitely. As such, it encouraged crowding into areas of the market that worked in the past. During this time, indices became ever more concentrated, while the premium for investing in ‘desirable’ areas of the market soared. These included mega-cap technology stocks and, more recently, AI.
The painful unwinding process
However, imbalances cannot persist forever, and we believe the COVID-19 pandemic marked an inflection point that set in motion the painful unwinding process.
We believe that the assets that are likely to fare well in the future will be very different to those that outperformed during the anomalous post-GFC period. The areas that are well-suited to the environment that lies ahead are likely to be found outside the expensive and overly concentrated large capitalisation shares that dominate global indices.
Instead, investors may have to pay attention to areas that have been unpopular and unloved over the past decade or more, where assets are trading at very attractive valuations, and where the market is less crowded. We believe this is crucial to positioning their portfolios for the environment we see ahead. These areas include industries that have seen underinvestment, and where supply constraints are prevalent.
Such industries typically have long lead times and investment cycles, and thus, early movers are likely to benefit handsomely, and potentially for a long time. Specifically, we have included Glencore plc, Shell plc and Afrimat Ltd in our portfolios – all of which have delivered excess returns, but from which we expect substantially more outperformance.
Find the opportunities that exist
The challenge for investors, however, will be that these opportunities reside outside the large-cap and well-known names that have come to dominate portfolios over the past few years. While we believe the environment that lies ahead offers many opportunities for excellent investment returns in the long run, those relying on benchmark-focused investing (including passive investing) or replicating the investment successes of the past, are likely to miss out on excellent opportunities. By contrast, we believe bottom-up stock pickers are uniquely positioned to find the opportunities that exist in the market, and to construct portfolios that are both robust and diversified enough to navigate the challenges we believe lie ahead.