An overweight position to financials and energy stocks as well as a top 10 position in supermarket giant Tesco are the contrarian positions Invesco Perpetual’s Stephen Anness is hoping will help him beat the market.
The FE Alpha Manager, runs the £234m Invesco Perpetual Global Opportunities fund alongside deputy manage Andrew Hall.
The pair manage the fund on a high conviction, unconstrained basis, meaning they can move into underloved areas of the market that many may avoid.
As such, the fund can behave very differently to its peers. Since taking over the fund in 2013 it has returned 126.95 per cent, a top quartile performance in the IA Global sector, although it has been one of the most volatile.
Performance of fund vs sector since manager start
Source: FE Analytics
Below, the manager highlights some of the more contrarian investments he has made in the portfolio over the last 18 months.
Energy
The first contrarian bet is in the energy sector, which Anness said investors appear to have completely forgotten over the last few years following the oil price slump in 2014 and a small recovery in the first half of 2016.
“I think energy is an interesting contrarian place to be at the moment as there is generally a high level of apathy towards the sector from the buy side,” he said.
In the Invesco Perpetual Global Opportunities fund, the manager has a 14.2 per cent allocation to the sector.
“People in the industry for 20 years can’t remember a period where investors have been less focused on energy,” he explained. “They are not even disappointed or upset or angry at the sector they just don’t care about it.”
As such, the manager said there are some interesting valuations in the sector as well as structural positives, particularly on the demand side, which many investors see as a headwind.
“I think there has been a huge belief in the market that North American shale will continue to grow at one million barrels a day for the next five years,” he noted.
“It does definitely feel that there has been a lot of high grading of acreage, high grading of crews, high grading of rig equipment which has meant that the shale players have demonstrated huge efficiency gains over the last two years in the downturn of oil prices.”
However, the mistake the market is assuming is that these cost efficiencies are structural rather than cyclical, something Anness disagrees with.
“I think the market has extrapolated that efficiency gain as structural whereas I think a lot of it was cyclical and we are about to see a return to tightness in the oil field services market,” he explained.
“So, labour and some sort of equipment costs are beginning to pick up and I think that will dampen the rate at which the North American shale plays can grow output."
As such he said the expected supply side implications of an increase in US shale output is being “overplayed” by the market, especially as it only accounts for 10 per cent of the sector currently.
Also restricting supply is the huge reduction in capital expenditure from many of the big oil and national oil companies in recent, Anness highlighted.
While this will take some time to filter through to the oil price thanks to the long cycle of the industry, it should do so by 2019 or 2020, he added.
Meanwhile on the demand side, Anness said investors have overblown the impending disruption from electric vehicles, a topic FE Trustnet will cover in more detail in an upcoming article.
While the manager does not forecast the oil price, he said that over the long run it tends to move towards marginal costs, which he currently estimates at around $60.
“But even at a low oil price we think they can be good quality investments and the oil price doesn’t really need to go anywhere,” he noted.
Financials
While the financials sector is becoming more of a mainstream investment, Anness said it remains a contrarian play, representing a 30.53 per cent weighting in the fund.
“Financials have been quite a contrarian position in the portfolio for probably two or three years and we had a view particularly that the US financials,” the manager said.
Indeed, two of the funds top 10 holdings are Citigroup and JP Morgan while just outside the top 10 is fellow financial First Republic.
“They healed themselves fairly quickly after the crisis in terms of dealing with balance sheet issues and raising capital,” he noted.
As such, due to the high levels of capital being created, Anness felt that they would be able to return more of their capital going forward.
The US financials sector has been a good place to be invested over the last five years, outperforming the wider S&P 500 index by 30 percentage points during the period.
Performance of indices over 5yrs
Source: FE Analytics
“Fortunately, what we have seen in the recent past is that the latest Fed tests are allowing the banks to return more capital so Citigroup and JP Morgan are both in the top quintile of cash returns to shareholders in the US market,” Anness added.
“We felt that those businesses were healing themselves well and that has definitely been a contrarian position but is possibly a bit less so now. I think there is more investor positivity towards that sector.”
However, some remain wary of the sector, with the strong run of recent years suggesting that stocks are looking fair value and more in-line with the rest of the US market.
“They have performed well and their valuations have improved from what were very, very low levels, but we would still argue that relative to the profitability and capital they are generating and returning we still think in aggregate the valuations look attractive,” the manager said.
“As ever it is quite stock specific, there are some small- and mid-cap regional banks that we do think are quite highly rated and that we are not invested in and some of the larger ones we think are still very interesting.”
Tesco
Another contrarian call by the manager in recent years has been its position in supermarket giant Tesco, which is the seventh largest holding in the fund.
The company has come under pressure in recent years with the rise of discounters such Aldi and Lidl, while a lack of price inflation has hit the company’s top and bottom lines.
Indeed, the share price has fallen by 59.24 per cent between 2011 and 2016, as the below chart shows.
Performance of stock over 6yrs
Source: FE Analytics
“There are some obvious industry challenges around supply growth and the rise of the discounters and things but, in many ways, it was Tesco’s behaviour under previous management when they allowed the UK margin to build up in the business probably to a level which provided oxygen for the discounters to grow their market share,” Anness said.
The share price has levelled out over the past year however and the manager said he believes the new management team headed by chief executive Dave Lewis is bringing the company back on track.
“I think Tesco has done the right thing for the business and for the consumers by helping to reduce prices and reducing complexity and I think it providing a better service and pricing to its consumers which is ultimately what will get it back to being a much better business,” he added.
“We have seen in the last six-to-nine months a definite improvement in the operating performance of the business and they released recent numbers which I thought were very robust and the business is performing well.”