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 three of this edition, we're rejoined by Andrew Martin, principal of Alphinity Investment Management. The Alphinity Concentrated Australian Share Fund has delivered an annual return of 7.6% after fees over the past five years.
The Motley Fool: With higher interest rates crimping share price gains, ASX dividend shares are gaining more retail investor attention. Do dividends play a role in determining your investment decisions?
Andrew Martin: We care about dividends in terms of what it means from a valuation perspective. We care about franking credits and take those into account.
But we ultimately see the dividend yield as an outcome rather than something that drives our investment decisions.
There are points of the cycle where dividends mean more. But in a period where interest rates are rising, it puts more pressure on dividend yield types of stocks on average because the alternative in cash looks more attractive relative to yields. And cash has less risk obviously. So suddenly, you have competing assets that you can go into rather than buying a stock and getting yield on that.
That's not to say you can't find good dividend stocks in this environment.
I mentioned banks, for example [in part two of our interview]. Banks are reasonably decent value, they're getting upgrades, and the yields are looking pretty decent. Unlike potentially other yield type stocks, banks are actually benefiting from rising rates rather than getting hit by the rising rates.
MF: If interest rates do continue to ratchet higher, perhaps reaching 4% or more in 2023, do you think this could significantly impact the banks via rising bad debts and lower levels of new loans?
AM: Yes, that's one thing we have to keep our eyes on.
But I would say the banks are entering any kind of potential downturn in probably as good a position as they ever have. They all got prepared for a massive recession in 2020 that never happened. So they still have excess provisions, they still have very strong capital positions, and credit quality is pristine.
That's largely off what happened in the pandemic. Everyone got handed free money and got ahead on their repayments. And interest rates went to nothing, so people built up savings buffers.
That's not to say the banks won't have losses in a downturn. They absolutely will. But at this stage, it appears very manageable.
MF: Are there parts of the market you believe will outperform over the next 12 months?
AM: We think the whole market is probably due a large proper earnings downgrade, frankly. And if you're getting earnings downgrades hitting the whole market, there are parts of the market that can hold their earnings, that are much more defensive. That's the part of the market that's likely to do well.
So, we're talking about the Telstra Group Ltd (ASX: TLS) companies of the world. Those staple type companies.
MF: And are there areas you're more likely to steer clear of?
AM: Yes, on the flip side, you probably want to avoid sectors that are particularly impacted by slow income growth.
When you think about it, all central banks are trying to do is engineer a slowdown. As economies are slowing you want to avoid companies that get hit by falling economic growth.
Therefore, avoiding companies like consumer discretionary types of business, like some cyclical things that benefit from economic growth, and then some companies that are exposed to China as well. You want to be watching that pretty closely. Of course, if China decides to change tack and stimulate massively and open up, then we may need to change our view on that.
MF: If the market closed tomorrow for five years, which ASX share would you want to be sure to hold in your portfolio?
AM: Macquarie Group Ltd (ASX: MQG) is the bottom of the drawer stock. The last few months, it's been hit by the market volatility, and it's been a bit beaten up. And I think that volatility will probably continue for the next six months or so.
But over the next five years, the opportunity sitting in front of it is just so large. There's the traditional infrastructure business they're in, which is still pumping along.
Then there's the whole green energy transition business they've been building for the last six or seven years. That's really coming into its own. They're world-leading in that area now, just as everyone is starting to focus on it. The global market in that space is growing at a huge rate. So the opportunity set is huge for them. It comes down to how they execute, frankly.
Over the next six months, as market volatility continues, they could jump around a bit. But the quality of the business, quality of the management, and the opportunity set in front of them is huge.
MF: What do see as the biggest threat for ASX investors in the year ahead?
AM: We all know that there's an economic downturn coming. The biggest risk is that will be bigger than the market expects.
I think the market is being a little complacent around earnings. We're only at the tipping point of where earnings are starting to come off. Interest rates take up to 12 to 18 months to flow through to the real economy. We're only six months in. So I think, as we head into next year, you're going to start seeing the real earnings impact out of that.
That's the biggest risk.
MF: And what's the biggest opportunity for ASX investors?
AM: The biggest opportunity is that things get cheaper. I'm not sure we're all the way to the bottom yet. But a lot of the market is already negatively positioned. It lends itself to at some point if there is a change in direction – whether that's from the Fed, or economies are holding up, or inflation is rolling over – it could well give you that bounce.
We may not be at the bottom, but we're not at the top either. So I'd say, start to look out for some bargains around, particularly as we head into next year, as that real interest rate bites in terms of earnings and the economy.
That may be the opportunity to find some really interesting stocks at good prices.
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If you missed part one of our interview with Andrew Martin, click here. For part two, click here.
(You can find out more about Alphinity's Australian, Global, and Sustainable funds here.)
