Central bank monetary policy has chased valuations to “crazy” levels with too few value opportunities in the market, according to Pyrford International’s Tony Cousins.
Cousins, who manages the £2.5bn Pyrford Global Total Return fund and is chief executive of the asset manager, said he has been “hiding in the cave” and waiting for buying opportunities to reappear.
“Our current views are pretty negative and all we can do as fund managers is be price takers and recognise value,” he said.
The biggest risk to investors is the reversal of quantitative easing and ultra-loose monetary policy implemented by central banks globally since 2008, he said.
“I think it will happen, the Fed has clearly signalled that, and in time I think every bank will be following suit – though not the Bank of Japan which is trapped – and that withdrawal of liquidity is what would give us the greatest level of concern,” the manager said.
“I don’t know when this will reprice but all we can say is that whenever markets have exhibited this level of overvaluation they have always been very vulnerable.”
However, investors don’t need to wait for all the problems to be put right, he said, adding that investors just need to wait for assets to look cheap.
For example, the three best buying opportunities over the last 50 years occurred in 1974, 1981 and 2009, Cousins explained, when news was universally bleak yet there was significant value.
The manager has four key ways to create alpha four clients – asset allocation, active equity selection, duration management and currency exposure.
Over the longer term he said equities are the riskiest asset class but will be the best performing asset and will pay off for investors.
However, throughout history there have been many five-year periods when investing in equities has been “dreadful”, according to Cousins, and all have been driven by a starting point of high valuations.
Indeed, the manager said he entered the financial crisis with a very low weighting to equities on valuation grounds.
Performance of index over 10yrs
Source: FE Analytics
Since 2008, central banks have printed more than $14trn over the last nine years and printed $2trn in the last 12 months alone, driving equities to “fairly outrageous levels”, potentially even more so than before the global financial crisis, he added.
As such, the fund has just 30 per cent of the fund weighted to equities – one of the lowest levels in its history.
The most obvious example is in the US, where the S&P 500 has returned 200.68 per cent over the last decade, a period which includes the financial crisis, as the chart above shows.
The current US cyclically-adjusted price ratio, sometimes called the Shiller P/E, has only been exceeded on two separate occasions in 1929 and 1999 and we have now far exceeded the level of valuation before the financial crisis in 2008.
“On this, and on many other measures, equities are an extremely expensive asset class and that is why we don’t own a lot of them,” Cousins said.
As part of its equity portfolio, the team use an active stockpicking approach and are happy to take punchy bets compared to the market, he added.
“We don’t need to own anything. The biggest risk control is the willingness to have zero in any asset class, sector or name regardless of how big a weighting it may be in the benchmark if it offers excessive amount of risks.”
The fund went through the entire decade of the 1990s with a zero weighting in Japan and hasn’t owned a UK bank for more than a decade.
Turning to fixed income, the manager said while central bank monetary policy has made equities unattractive on valuation grounds, bonds offer even lower returns.
In this area his focus has been on duration, which is the measure of price sensitivity of a bond to any given change in yield.
“Today if you bought a 30-year gilt you would be buying a modified duration of about 25. What that means is if yields were to rise by just one percentage point then you will lose 25 per cent of your money which is obviously a fairly catastrophic result,” Cousins said.
This has not always been the case during previous periods of extreme valuations, with government bonds offering an attractive 5 per cent yield during the global financial crisis.
“History tells you that was an absolute bargain so that is why we moved the portfolio to a very high level of duration – the highest achievable at that time – and that worked well for us and was one of the key reasons we were able to produce a positive rate of return in 2008,” he noted.
The manager said: “Right now this $14trn in new money has been indiscriminate in chasing yields down everywhere and this is absolute unprecedented in my experience.
“Going back in history there were always pockets of value that you could go to because this level of printed money has never been done before. In 2000, you could find other value in old economy stocks. In 2008, it was in high quality government bonds.
“People have got complacent and dulled to think that this is normal monetary policy but I’m sorry no it isn’t. They have chased valuations to crazy levels and our advice would be to put it into something that does not destroy capital.”
Overall, the manager noted that he has moved the portfolio to help protect client capital with 70 per cent in very short-duration, high-quality government bonds.
“These don’t yield very much but it is positive as we won’t buy bonds that are giving negative yields. They will not make you a lot of money but they won’t lose it either and it is now so long ago since people saw big drawdowns in markets that they have forgotten about it,” Cousins said.
“If you look at market history these things do happen when you get these valuations levels and the portfolio we have invested in now is not going to deliver the RPI +5% target we set but importantly it is not going to deliver RPI -20% and that is the risk when you are dealing with such excessive valuation.”
One of the main drivers of performance over the past two years however has been through the fund’s currency calls.
“We are a value manager and the only metric we have found that works with respect to currency is purchasing power parity. We calculate this in house and buy a huge amount of data and do regression analysis to work out the value of a currency and we do this for every currency pare that we can be exposed to,” he said.
“This works because it is a measure of export competitiveness and if your currency is too overvalued for too-long a period of time then your exports will be priced out of the market and your trade account will suffer.”
Through this metric, he said, the Pyrford investment team identified that in the lead up to the EU referendum last year that sterling was overvauled.
Performance of sterling vs dollar over 2yrs
Source: FE Analytics
“We went into the Brexit vote with a significant portion of the fund exposed to unhedged overseas currency. We had 38 per cent at that time,” Cousins said.
“I woke up the following day as surprised as anyone else but what this analysis did show was that sterling was expensive and needed to fall whether we voted for Brexit or not.
“When the facts changed we changed our point of view and went from 38 per cent in three successive stages taking away exposure to the US, Canadian and Australian dollar and have reduced that today to around 10 per cent of the fund because sterling is a cheap currency.”