294. Why the big tech names can continue to outperform in 2024

14 December 2023 (pre-recorded 11 December 2023)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[NTRODUCTION]

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. This week we cover everything from the strong performance of technology and the appeal of government bonds to packing companies and the defence sector.

Chris Salih (CS): I am Chris Salih, and today we’re joined by Simon Nichols, manager of the Elite Rated BNY Mellon Multi-Asset Balanced fund. Simon, thank you very much for joining us today.

Simon Nichols (SN): Morning, Chris. Thanks thanks for having me on the podcast.

CS: No problem at all.

[INTERVIEW]

CS: This is one of the newer funds rated on FundCalibre so, for a number of listeners, this is the first interaction they’ve ever had with you. Let’s start with a very generic introduction to the fund for those listeners in terms of what it aims to achieve, how it operates during challenging periods. And, just give us some examples of what you’re looking to do in there.

SN: Okay. So, it’s an actively-managed, global, multi-asset portfolio which really means that the fund holds a mixture of equities, bonds and cash. It’s quite flexible – actually very flexible: we can hold equities and bonds in any geographic region of the world or indeed any economic sector of the world. We are in the 40% – 85% [Shares] IA sector which means that we have to hold between 40% and 85% of the fund in equities. But, in practice, over the time that I’ve managed the portfolio, it’s tended to be towards the higher end of that, so maybe 65% to 80% of the fund in equities.

We like to keep things relatively simple, so we directly invest our portfolio in a relatively concentrated list of individual equities, so maybe 50 to 60, and we’ve got round about 60 in the portfolio at the moment.

What we’re trying to achieve is capital growth and income over a five-year period, so long-term, and we take a relatively long-term view with the investments that we’re making. We have a relatively low turnover in terms of what we’re doing in the portfolio. Probably important to say that this is a relative fund, and so, we do have a good portion of the portfolio investing in equities. But we do balance that, as I said, with bonds and cash which can help the performance in, as you say, more challenging times.

CS: Let’s maybe pick on a few parts of that then. So, firstly just for clarity, you have a huge resource behind you to help you in the building of this fund. Maybe just talk to us a little bit about that possibly.

SN: Okay. So yes, I’m the lead manager on this portfolio, but we have our mixed assets and charity desk [too] so we have a number of other portfolio managers managing similar types of mandates. But probably more importantly, we benefit from Newton’s multi-dimensional research platform which means we have a number of equity research analysts which produce work just for us. So their work is proprietary and they’re looking to recommend stocks for inclusion in the portfolio along a thematic basis and maybe we’ll talk a little bit more about themes later.

We also benefit from having our own in-house fixed interest team where we can talk about what’s happening in bond markets, and so they’re really helpful when we’re looking at the fixed interest part of the portfolio.

But also, we’ve got resourcing in the quantitative space out in San Francisco and we have a number of our research analysts based out in the US as well. So, a relatively broad team with lots of inputs coming from lots of different directions. So yeah, really interesting and useful.

CS: Okay. Well, you mentioned all those inputs. Let’s focus back on the fund itself specifically. Obviously you have mentioned those thematics, there’s no point in avoiding it. Let’s go straight into them now, the number of long-term thematics in the portfolio – maybe just explain which ones they are, and then maybe talk to us [with] a couple of examples perhaps in a bit more detail of how you utilise those thematics to the benefit of investors.

SN: Yeah, sure. So themes really, they’re just about identifying long-term trends in markets. And so they can identify areas of opportunity where the fund can invest behind, or, just as importantly, they can identify areas of risk where we would look to make sure that the fund is avoiding exposure to those areas. And so, it’s about looking at different countries, markets, sectors and we are really trying to identify what’s changing. And this can be at any level.

So, for example, our tectonic shifts theme looks at de-globalisation, ageing populations, emerging market spending patterns, for example. So, very, very big picture. While some of our micro-themes such as the ‘smart everything’ theme may look at things like silicon everywhere; so how semiconductor chips are becoming smaller, they’re becoming faster, they’re becoming more cost effective, and this is really changing the way that computing is working, how the world is interacting with each other, how things are digitalising around the world. So, that is more of a micro-theme in looking at how individual corporates may be disrupted.

Maybe another one is our natural capital theme. And one of the sub-themes here looks at electrification. This really looks at how industries, particularly in the industrial sector, may be being disrupted by changes in the way things are powered from an environmental point of view. And really what we are looking for here is to identify those companies that are best positioned to take advantage of future demand trends whilst trying to avoid those companies that are in areas that may be disrupted by things such as new technology.

CS: Okay. You mentioned, again, obviously you have that flexibility to invest across the entire market, so much choice within that sphere. So, let’s talk on a few points within that. Firstly, if I’m right, you have a bit of a focus towards the larger-cap styles in the market. Maybe just talk us through that. And then also, even though it’s not a specific mandate of the portfolio, you tend to like companies to pay a dividend. Just explain, maybe you could wrap that together and give us a bit of insight into that please.

SN: Yeah, so the fund does have exposure to larger companies in the market. And really, we’re looking for companies maybe in the technology space, in the industrial space, that have got the ability to invest behind these longer-term themes that we’re thinking about. But what we’re not doing is trying to invest behind those companies that have got … well, we’re not style-biased, should I say. So, we’re not looking particularly for growth companies or for value companies.

We do like companies that have strong capital allocation and if management teams have got fantastic growth opportunities to invest behind at high returns on capital, that’s great. We would encourage them to go and invest the capital that a company is generating behind those opportunities. Whereas because, as you say, we’re in some of the more larger companies, paying a dividend is a relatively good discipline for management, [so] the cost of equity isn’t free, there is a cost of capital and therefore we do like companies that pay an element of their cashflow out to us as shareholders. But you know, not at the expense of maintaining the relevance of the company and investing for future growth opportunities. So, it is a balance that we’re looking to achieve.

CS: Okay. You mentioned styles there, so obviously growth and value, the different styles of investing, you will look at value companies provided these companies are not in structural decline. For the listeners who perhaps don’t know, could you maybe just give us a bit more into that in terms of maybe an example of one that is and one that isn’t or just a bit of a guidance on what that looks like, please.

SN: Okay. So yeah, as I said, the fund does invest behind some of these more longer-term thematic growth drivers. Technology industrials are the examples we’ve used, but we also hold companies that perhaps have lower growth outlooks and, as you mentioned, with higher dividend yields. And so, when we are thinking about where we’re going to achieve a return from these investments – perhaps more of our return will be coming from the dividend yield and the return of capital than it would from the growth opportunities – but what’s very important when we’re looking at companies with lower growth outlooks is that their products remain relevant to the future. And so, maybe an example of this might be in the packaging sector. And so, we will invest behind packaging manufacturers. You know, most of my delivery is still come in cardboard boxes. And so we think that those products are future-facing.

Maybe another example would be in the defence industry. So, we have some companies that are exposed to defence budgets, so a little bit less correlated to economic growth plans, more correlated to government budgets. They have in the past been seen as low-growth companies with high dividend yields. Now clearly over the past 12 to 18 months, they’ve done relatively well given all the geopolitical tensions that we’ve seen. But those will be a couple of examples of the companies that you may book it in the kind of more value area; low PEs, relatively low growth, high dividend yields, but you know, with products that we believe have got relevance into the future.

CS: Okay. We’ve gone a fair bit in without really going into too much detail on bonds yet, but we can’t avoid them forever. So, I’m going to start by asking you, because obviously 12 months ago people were writing obituaries about the 60/40 portfolio and the like, this year’s been maybe a slightly different story, but essentially do you think bonds and equities will move in lockstep going forward? Do you have a view on that? Do you feel that it’s not as simple as one scenario or another?

SN: Yeah, I mean, it is never one scenario or another. You know, I think that you are right, 60/40 portfolios have moved in lockstep over recent years. There are clearly factors which may drive bond returns to move in the same direction as equity returns over some periods, but there are also other factors which may drive them in the opposite direction. And so I guess it depends on what the market is most focused on and wants to emphasise at any particular point in time. So maybe, you know, thinking about how these drivers work, so, I don’t want to get too technical, but the risk-free rate is effectively the building block for the valuation of any financial asset. And this really is determined by the rate that is available on US treasuries as these are often used as a proxy by investors for the risk-free rate.

Now, if we look back over the last number of years, these rates have been held artificially low really due to the quantitative easing and monetary policy that has been in place by central banks around the world. And these central banks were buying bonds for reasons other than the investment return that they offered. And so, I think in an environment where policy action is driving the key buyer or seller in the bond market, then maybe you’re in a situation where bond and equity returns maybe move together with each other because you’re changing effectively the cost of capital.

I think now in my view, we’re in an era where the risk-free rate is more determined by market participants other than central banks and policy makers, so real world market participants. We’ve seen, as you’ve said, over the last couple of years, that bond markets have had to adjust to the lack of return-insensitive buyers, central banks in the market, and we’ve seen yield move higher,  particularly real yields becoming positive once again. And so, I think bonds can now play a more diversifying role in a multi-asset portfolio than perhaps they have been able to over the last few years. And clearly where that moves, it will depend on your view on inflation, it will depend on your view on a hard or soft landing for the economic outlook. But I think in this kind of environment then bonds and equities might potentially move in different directions to each other going forward.

CS: And just for clarity for our listeners, so you mentioned it there in terms of the risk-free rate and that it has moved higher: are the attractions ie. the yields on offer in other parts of the bond market, (because you can go there if you want to, beyond government bonds) have they tempted you out into the corporate bond world and beyond, or are you a bit more cautious than perhaps some of the others on the market seem to be?

SN: So, in our portfolio we do have a relatively high weighting to equities and so I said earlier that the weighting has probably moved between 65% and 80% – we’re at low 70% at the moment. And so, what we’re wanting to do is make sure that the bonds that we hold in the portfolio very much play a defensive role and so that they work when risk isn’t in favour by the markets. And so our fixed interest holdings at the moment are predominantly in government markets. I think if you were moving into corporate and high yield markets, the spreads are relatively narrow still. So, whilst the absolute yields look reasonably attractive because of the move higher in government bond yields, the amount of additional return you are getting for taking on corporate risk doesn’t really look too out of line with historical norms. And so, we’d rather take the risk at the moment in our equities where we’re achieving hopefully a higher level of growth and having our fixed interest as a defensive play in the portfolio.

CS: Well, let’s move back to equities then. Because obviously a lot of the headlines this year have been about those ‘Magnificent Seven’ companies and the influence of AI and how that could bolster them even further. Do you feel big tech can keep performing and driving the market or, you know, the idea that small and basically everything else, particularly small, every other stock as well as that is an afterthought almost in 2023 beyond those companies. Do you feel that’s the case? Do you think small cap can make a comeback and there’ll be a bit more of broadness across the market in terms of performance?

SN: Yeah, I mean, I guess you’re right, you’re kind of returning to the Magnificent Seven where the large technological stocks in the US market have really driven most of the returns this year from US equity markets. I do actually think that big tech can continue to perform reasonably well. I don’t tend to look at things in terms of larger caps versus small caps. You know, I’m a great believer in, it’s the earnings growth and the cashflow growth that a company can produce that really matters in the long term. And …

CS: So just those seven companies alone, you feel they can keep performing just purely because of those metrics you just mentioned there?

SN: Yeah, so I mean, let’s look at one. So, if we think about Nvidia, which is obviously really at the vanguard of artificial intelligence, so they are designing the computer chips that are making artificial intelligence programs possible. The stock is up, I don’t know, maybe more than 250% this year. But when we look at the earnings, if we were to look at the start of this year and look at the earnings that the market was expecting in 2025, those earnings expectations have actually moved more than the share price. And so Nvidia is on a lower P/E rating now (depending on where the share price is when the podcast goes out) but it’s on a lower rating now than it was at the start of the year. And so, that appreciation we’ve seen in the share price has really been driven by a significant change in the future earnings outlook of that company.

Now, that’s not the case for the whole of the Magnificent Seven. Some have achieved the growth we’ve seen in the share price due to an element of re-rating as well. But I think that’s because those companies are very well positioned to take advantage of the new technological wave that we’re seeing. And so artificial intelligence may improve their products that they may well be able to charge a little bit more for in the future. And so their future earnings outlook has improved a little bit. So yeah I accept that those companies have really driven the market. And it has been an element of re-rating this year, but over the long term, those companies that have got the best earnings growth, the best cashflow growth, whether they are small or large, are likely to perform particularly well.

CS: Okay. And then just finally and briefly from my end, just perhaps because of the broadness of where you invest, maybe just give us an outlook on how you see the market at the moment. Because a lot of people are saying, you know, ranging from the ‘stock-pocalypse’ to there’s lots of pockets of opportunity: where do you sit on that scale? Do you feel the market’s fully valued from the equity perspective? Do you feel there are opportunities? Conversely, maybe just give us a minute or two insight on that please.

SN: Sure. Obviously we’re always looking for opportunities. As I said, we’re investing on a longer term timeframe rather than what’s going to happen in the next quarter. Having said that, our equity weighting is towards the lower end of where we’ve been historically, so maybe low seventies at the moment. Our cash weightings are a little bit higher than we’ve seen over the recent past. But then we’re achieving a reasonable return on cash now, given where base rates are. I think we are in this period where we’re seeing another shift in the interest rate regime. And so, all investors are wondering whether interest rates have peaked and how fast they will come down and whether the interest rates that have been put in the past will operate with a lag and therefore will reduce economic growth, maybe causing a slight recession or maybe just slowing down activity in the market to allow inflation to come down more in-line with what central banks are thinking.

So, there is quite a lot of uncertainty at the moment. We have been through a very, very steep interest rate rising period over the last 12 to 18 months, so we are marginally cautious in terms of is some of that yet to feed through into corporate earnings, which is why we’re a little bit lower in our equity weight. But we definitely see areas of opportunity over the longer term with some of the fantastic growth opportunities that our thematics are pointing us towards.

CS: Simon, thank you very much for joining us today, and thank you for introducing yourself to the listeners.

SN: No problem. Thanks for having me.

SW: The BNY Mellon Multi-Asset Balanced fund aims to achieve a balance between income and capital growth by investing in equities and bonds using themes to target the forces driving global change in markets. To learn more about the BNY Mellon Multi-Asset Balanced fund please visit fundcalibre.com. And don’t forget to subscribe to the Investing on to go podcast, available wherever you get your podcasts.