Ask A Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part 1 of our interview, Perennial portfolio management director Stephen Bruce tells how value managers like him are loving the world right now.
Investment style
The Motley Fool: What's your fund's philosophy?
Stephen Bruce: I'm the portfolio manager of the Perennial Value Australian Shares Trust. And that fund is an Australian equities fund. It's a value style ESG-aware broad cap fund.
We've been around for over 20 years. We run a moderate value style investment process. We're not an ESG fund per se, but we do have a high level of ESG sub-integration through our research and portfolio construction — and we're broad cap focused.
We've got a team of effectively 19 people looking at Australian equities across large cap, mid cap, small caps and micro caps. So we're pretty well equipped to go wherever the alpha opportunities are.
MF: To give our readers an idea, what are your two biggest holdings?
SB: Two biggest holdings at the moment are Westpac Banking Corp (ASX: WBC) and Healius Ltd (ASX: HLS).
In the case of Westpac, we're pretty positive on the banks. The banks had a tough 5 years pre-COVID with the Royal Commission.
But if we look forward, a lot of the things that were headwinds for the banks are now starting to turn into tailwinds. Credit growths are starting to pick up. They're well provisioned, the bad debts outcomes are going to be far better than expected. There's a good opportunity with costs. The capital positions are really strong, so dividends will be good. And there's the potential for capital returns to top that up a bit. The valuations are pretty reasonable compared to the overall market.
So we're keen on banks, and clearly Westpac has been beleaguered, having some issues probably more recently than the other banks — but it'll work through those. And the valuation is looking pretty attractive.
The second-biggest holding is Healius. Now Healius, being a healthcare stock, brings a degree of defensiveness to the portfolio — because overall our portfolio is quite cyclically skewed and they're participating in the value recovery pretty well.
But we do like to have some defensives in there. And I think with Healius, as healthcare stocks go, it's on a pretty reasonable valuation. It gives you some good protection in the sense that, being a pathology company, it does benefit from COVID. So COVID hangs around a bit longer, there's some upside there. But importantly, internally there's a turnaround story within the business [and] the balance sheets — they're geared.
It's also in a sector where there's been a reasonable degree of corporate activity going on, particularly at the smaller end. And [private company] Healthscope plus our Healius may be able to participate in that, in some way or other down the track.
MF: Running a value-orientated portfolio, I gather your team has enjoyed themselves the last 6 months or so?
SB: Yeah, well it's really the last 12 months, or in fact ever since the market bottomed [in March 2020].
When we look at things following the typical pattern during periods of economic expansion, where growth's broadening out, the opportunity set of stocks that will provide earnings growth is much broader. Your more cyclical stocks and sectors, which is typically where value investors find themselves hunting, they participate really well in those sort of recoveries.
Probably also when we think about the market, we think there's been a fairly significant change as policies moved from being focused around monetary easing to turning on the fiscal taps as well. A bit like monetary policy, once started in [quantitative easing] it's pretty hard to turn it off.
Now the governments have gone down this fiscal path and it seems to be working, seems to be making people happy. It's pretty popular. It'll be hard to wind it back immediately. There's probably some positives to it being targeted and you can start to address some of the important social issues.
We think monetary policy, to the extent it's gone, asset price inflation [and] all of those problems are starting to appear. So maybe it's time for something a bit new, but yeah, but who knows, if we go down that path, then what are we going to see? Better growth, increasing inclination for rates ticking up, which is all kinds of good stuff for value, really.
Buying and selling
MF: What do you look at closely when considering buying a stock?
SB: Naturally, being a value manager, the first thing we look at is the valuation — what you're paying. But then, of course, just as important to the equation, is what you're getting.
At its simplest level, we're looking for companies who have sustainable businesses, which are actually going to be able to grow their earnings over time, that aren't just going backwards for some structural reason. Also, importantly, are able to generally generate an adequate return on their investor capital, which is what you need to do to be a sustainable business over time.
We have a conservative attitude to debt. So a strong balance sheet is an important starting point. And then the other usual thing of looking for companies with good management.
MF: Is the price-to-earnings (PE) ratio itself important to you or is it more about the rate of change of PE?
SB: A PE ratio is just a single input into something and obviously you'd like it to be lower, but it's in no way the be-all and end-all. You're balancing off what the PE is today versus what a reasonable expectation is for… the PE in the future.
But the differentiating feature that, say ourselves and probably every other value manager would have, is our willingness to believe about the future. We're less likely to ascribe a value to companies that are promising enormous earnings growth and asking you to accept an astronomical PE now.
It is always a trade-off, what you pay versus what you get. And if there's one thing that you learn very quickly is just buying the cheapest thing is usually not a very good investment strategy.
MF: What triggers you to sell a share?
SB: Sometimes things go wrong with a stock and you realise that it has issues that you weren't counting on, so you'll sell.
But hopefully, more often you're selling because you bought something, it's performed well, and the share price's run ahead of its fundamentals. You made good money and it's no longer offering attractive value.
Knowing when to sell is just as important as knowing when to buy.
Having a fairly disciplined sell process is really important because we're all human and we all have a tendency to fall in love with stocks. You can be sort of swept up and lose sight of the fundamentals and hang on for things too long.
So typically we'll have a valuation on a stock in a relative sense. And if that's stopped, runs through a point where it's no longer stacking up quantitatively as good value, that'll trigger us to start exiting the position. In a measured way — we don't have to sell things on day one. You start to wind the position back and lock in profits and hopefully have opportunities to reinvest them into better value opportunities.
MF: In addition to that, do you also have a standard horizon in mind?
SB: When we're looking at stocks, the valuation basis we're looking at is typically the next 2 to 3 years. So when you see a stock has got to a valuation based on the forecast in that period where it's no longer comparing relative or attractive relative to the rest of the market, that'll be the trigger to move on.
Tomorrow in part 2 of our interview, Bruce tells how, even as a value manager, he's made money from growth stocks.
