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FE Alpha Manager Cutler’s favourite sectors for uncorrelated returns

15 February 2018

Orbis Investment Management’s Alec Cutler explains where he is finding value opportunities and the areas that are too expensive.

By Rob Langston,

News editor, FE Trustnet

Banks, energy companies and the healthcare sector offer the potential for “attractive returns without undue risks”, according to Orbis Investment Management’s Alec Cutler.

Cutler, who manages the five FE Crown-rated Orbis Global Balanced fund, said he continues to underweight markets where there is little value, such as US stocks and government bonds.

The FE Alpha Manager said both the US dollar and US stock market look expensive compared to other regions, preferring Asia ex-Japan instead, which represents 14 per cent of the portfolio.

“More than half of this concentration is represented by just five technology-related companies: e-commerce operator JD.com, Samsung Electronics, internet company NetEase, Taiwan Semiconductor Manufacturing and social media juggernaut Tencent,” he said.

“We believe each of these companies offers above-average growth and cash generation potential, with minimal balance sheet risk.”

The manager said there were few reasons to hold government bonds as yields had dropped and interest rate risk had lengthened.

We have completely avoided government bonds for some time – long before the sharp sell-off in recent weeks,” said Cutler. “While sovereign bond yields have fallen over the past few decades, their duration has lengthened.”

He explained: “In 1990, an investor in global government bonds would have expected a 4.7 per cent loss for every 1 per cent rise in yields.

“Today that expected loss would be 7.9 per cent. The index yields 1.6 per cent. To that, we say ‘no thanks’.”

Instead, the manager is focused on areas of the market where greater value could be found, such as the energy sector.

 
Source: Bloomberg

Cutler noted that while oil prices have rebounded from unprecedented low levels in recent years, oil producers were continuing to trade at a discount.

“Energy shares also continue to look attractively valued versus the wider market, despite recovering oil prices,” he said. “While oil prices are now about 15 per cent above their levels of early 2015, energy producers have still not recovered – even when including dividends.”


 

While rising oil prices would benefit exploration and production holdings such as Apache, said Cutler, it was less important for its largest holdings integrated energy giants BP and Royal Dutch Shell.

These companies are less reliant on oil prices given that they span the full value chain, Cutler said, which includes drilling, transporting and refining.

“This makes BP and Shell more attractive to us, because it improves their cash generation throughout the cycle,” he said. “Lately their strength has started to show.”

Both companies have cut costs and become more disciplined about new investments, the manager said. The two energy giants have also reported growing free cash flows enough to cover dividends and capital expenditure and share buybacks.

“While the trajectory of improvements is not certain – industry costs could rise again and a glut of liquefied natural gas could hurt both companies’ profitability – we believe these risks are well-reflected in the companies’ valuations,” he said.

Performance of indices over 3yrs

 

Source: FE Analytics

Another attractive sector for the manager is banking, which has adapted to a tougher market environment, according to Cutler.

“Since the financial crisis, regulators have strangled banks with red tape, while compelling them to hold more capital,” he said. “Both efforts put pressure on banks’ profitability, yet they have been remarkably resilient.”

Cutler added: “As regulators start to unwind emergency measures from the financial crisis, well-positioned companies should be able to increase their shareholder returns and as central banks unwind quantitative easing policies, banks should again be able to earn decent margins on their loans.”

Elsewhere, the healthcare sector has also thrown up some interesting value-driven opportunities for the manager.

Cutler said the fund’s largest holding biopharmaceutical company AbbVie, produces one of the world’s best-selling drugs Humira, which is used to treat rheumatoid arthritis and other autoimmune diseases.


 

“Patents on Humira are expiring and bears expect this to challenge the product’s competitive position,” he said. “But late this year, AbbVie reached a settlement with rival Amgen – which we also hold – that will delay serious US competition for Humira until 2023.”

The manager added: “AbbVie’s shares have performed well since the Amgen announcement, as investors have become less sceptical of the company’s quality.

“As we look at the company, however, we still believe its valuation does not fully reflect the long-term value of its development pipeline.”

Another holding for the fund is Bristol-Myers Squibb, which manufactures cancer-fighting Opidivo, which boosts the body’s immune system.

“This immunology approach is promising and works well in combination with other drugs,” he said. “Those combinations must be tried and approved by the Food and Drug Administration before use and prior to our purchase, Bristol shot itself in the foot with a botched trial.”

However, Cutler said the company had moved forward with a redesigned trial, which would stand a better change of securing new approvals.

“We continue to believe that selected shares in Asia, energy, banks and healthcare offer potential for attractive returns without undue risks,” the FE Alpha Manager said. “With indices for equities and bonds looking richly valued, uncorrelated assets that are resistant to central bank printing presses look attractive.”

 

The Orbis Global Balanced fund aims to balance income generation, capital appreciation and limit the risk of loss. It has a composite benchmark made up of 60 per cent MSCI World and 40 per cent JP Morgan Global Government Bond index.

Over three years the fund has delivered a total return of 45.90 per cent, compared with a gain of 19.94 percent for the average IA Mixed Investment 40-85% Shares fund.

Performance of fund vs sector over 3yrs

  

Source: FE Analytics

Like all Orbis funds it has ongoing charges of 0 per cent, however it carries a performance fee of 50 per cent for outperformance of the benchmark. Last year the fund levied a performance fee of 3.68 per cent.

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