Equity Portfolios: Diversifying Into “Less Cyclical” Cyclicals
Pramit Ghose
Pramit Ghose

Many investment managers currently emphasise how they are investing in only the very highest quality companies that have strong competitive advantages, such as high barriers to entry, industry leadership and pricing power with suppliers and customers. These companies have performed relatively well throughout the Coronavirus crisis. We still hold many of these companies in our Cantor Global Equity Income and Global Compounders equity portfolios, they remain truly excellent companies.

However, as we move further into the easing of lockdowns and the reopening of economies, we think some have become “overcrowded” (too popular with investors and funds) and expensive. Many of these companies trade at record high valuation levels, companies such as Amazon, Netflix, Facebook and Microsoft. Of course, you feel comfortable if you or your fund manager hold them, but a lot of the next few years’ expected growth for these companies seems well baked into their share prices today in our view.

There is a clear disparity in performance between high quality growth companies and “value” companies (higher volatility, more cyclical businesses), which has been extenuated in recent months during the Coronavirus crisis.

Investors in general do not want to invest in underperformers; there is a comfort to being in on the outperformers and to following the momentum.  However perhaps these excellent growth companies have now become over-owned and too expensive. Are they now “yesterday’s winners”? A recent Bank of America Merrill Lynch global investor survey shows that, unsurprisingly, “technology and growth stocks” is the most “crowded” area for institutional investors by a large margin.

In terms of equity market experience, we are reminded of mid-2009. Markets then had already bottomed in March and gone up about 15% by April/May of that year as the world emerged from the 2008 Financial Crash. During this time, we invested in “less cyclical” cyclicals (companies less exposed to economic trends) to benefit from the potential next leg up in equity markets. These companies were in cyclical sectors but had strong balance sheets, strong cashflow and upside earnings growth potential if economies recovered, but they also seemed overlooked and less “crowded” by investors.

In recent weeks, encouraged by the success of the lockdown easings in Europe, we became more comfortable with the idea of investing again in “less cyclical” cyclicals. As well as looking for comfort on the companies’ financials, we looked for strong track records, attractive valuations based on conservative 2021 earnings forecasts, “uncrowdedness”, and share prices that were well below where they were before the coronavirus crisis hit financial markets. The financial criteria we require from these companies remain stringent in terms of cashflow generation, balance sheet strength, revenue growth and dividend cover.

• CRH – the global building materials company that should benefit from increased infrastructure spending as governments seek to stimulate economies.
• Cap Gemini – the European IT consulting company, also moving into “edge computing” via a recent acquisition.
• Moncler – luxury Italian ski clothing brand

All these stocks are certainly more cyclical and volatile than the major tech and other growth stocks that many fund managers are overweight in currently. However, these new holdings are part of a diversified equity portfolio, are “out of favour”, and have downside protection in our view given their valuations and financial strength.

Pramit Ghose is Global Strategist with Cantor Fitzgerald Ireland.

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Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up.