Ask A Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In this edition, Perennial Value Management portfolio management director Stephen Bruce explains how growth has overlapped with value in the past 2 years and his fund's 2 biggest bets at the moment.
Investment style
The Motley Fool: How would you describe your fund to a potential client?
Stephen Bruce: We're a broad-cap ESG-aware, value-oriented Australian equities fund. We've got a long track record. We've been around for over 20 years, with a moderate value-style process.
The important thing is that we've got a real broad-cap focus. So we want to be able to find the opportunities wherever they are across the market cap spectrum. I think one of the reasons that we think we've got a good opportunity to do that is that we're part of a very big equity business with 21 investment staff who cover everything from large caps, small caps, micro caps — and even down into the unlisted space, which is kind of helpful too in the sense that it gives you a good feel for what's coming to [Initial Public Offering] IPO, et cetera.
MF: The last month or so has been poor for growth stocks with inflation and interest rate fears. Do you feel like next year will be a positive one for value stocks?
SB: I think in the same way the last 12 months has been pretty good for value and, in fact, since the day the market turned back in March 2020, it's been good.
That really, in our view, comes down to this change of emphasis in the way the economy's being managed — from an exclusive focus on monetary policy towards the acceptance that fiscal policy is important as well.
That's led to this kind of a broadening of growth across the market. And if that continues, which on balance we expect it will — I'll say why in a second — then we would think that you're going to start to see this sort of kick up in interest rate, inflation being a bit more normal, lower than it is now but higher than it has been.
And in that environment where you could find growth across quite a number of parts of the market and money isn't quite as free as it used to be, the more valuey parts of the market tend to do better.
Some of the really expensive parts of the market might start to feel a bit of valuation pressure coming onto them. We've seen a bit of that just recently.
Biggest convictions
MF: What are your two biggest holdings?
SB: Healius Ltd (ASX: HLS), which was one of our biggest holdings last time we spoke, is actually our biggest holding at the moment.
The investment case with that one hasn't really changed in the sense that it's got this really strong leverage to COVID testing. Being the second biggest pathology operator in Australia and doing about 20% of all pathology tests, it's had an enormous first quarter.
Just as we're sort of expecting it to fade, with the latest variant of COVID entering the scene, those testing rates have started to go back up again. So that's the headline near-term driver but, in the background, it's a business which is being, we believe, significantly improved from an operating point of view — we should see that once COVID's washed through over time, the business that's left will be in much better shape and generating much better margins.
It's also in a sector where there's a lot of corporate activity. One of the really interesting things is infrastructure investors, which are a growing part of the market as more and more money is looking for assets with supposedly stable returns, it's been expanding what is considered "infrastructure". Many healthcare businesses are now starting to fall under the broader umbrella of infrastructure.
And if you think about something like pathology, where it grows at about 5% per annum, it's largely government-funded, it's pretty economically insensitive, that's potentially an attractive space and we're starting to see offshore non-traditional investors starting to look at that space.
MF: What's your other big one?
SB: Interestingly our other second-biggest overweight is actually BHP Group Ltd (ASX: BHP). We have been underweight off miners for probably the last 6 months or so, but just with the extent that the share prices have come back and how far the iron oil price has fallen — it's done the round trip from $100 to $200 and back again — even if you assume that iron ore stays at $100, BHP's probably trading on 10 times cash flow and it'll pay you a 10% dividend yield, which to us looks like really good value.
But our expectation is that as we go into the new year, Chinese steel production will start to pick up again as the property market starts to accelerate. Because now, as we all know, the Chinese government has been clamping down on the property market which accounts for 40% of steel consumption in China.
But now they've sort of seemed to have achieved a fair bit of what they've been wanting to do — rein in the big private developers, cool the market a bit — we're starting to see the early signs of them easing up there.
It's obviously such an important part [of the economy] and the comments that have come out of the most recent party meetings around their areas of focus all kind of indicate that housing, a recovery in housing and including construction of say, social housing, are going to be important.
That augurs pretty well. So if the iron ore price, which already seems to [have] started to head back up — it's $114 or so now — if that continues, then we see a lot of upside in all of the big miners. But BHP is quite good in the sense that at the moment it's got pretty good operational performance. It's got an ungeared balance sheet. It's divested. Its fossil fuel exposure though is cleaning itself up and attracts some extra interest from that perspective as well.
