Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
You can’t teach an old manager new tricks: Hyperion
Active manages have failed to heed changing times – and changing markets. But while Hyperion doesn’t do “concept stocks”, it’s got its eyes on plenty of disruptors.
The great elephant in the room for active managers has been their inability to outperform the index long-term. Around 93.4 per cent of international equity managers and 86.3 per cent of Australian equity managers were outperformed by the index over a 15-year period, according to Hyperion Asset Management (which has consistently beaten the benchmark – banish thoughts of stones and glass houses).
“Both professional and retail investors succumb to a lot of biases, including recency bias. And that’s a large aspect of what drives markets, which is effectively overweighting recent news flow or extrapolating current data points into perpetuity,” Jason Orthman, Hyperion lead portfolio manager and deputy chief investment officer, told media on Tuesday (November 23). “Life, business, and investing don’t work like that; it’s hard to resist.”
“A lot of the lead portfolio managers grew up as analysts in the late 90s and early 2000s, and it’s a very different environment – you had a growth bubble there, average companies did well. The world wasn’t digitised. The last 13 years have been really competitive and digitised and it’s been this slow grind. Its hard for a lot of players to adjust to that.”
Doubtless there are exceptions to that view. There might have been a growth bubble, but that bubble burst spectacularly on several occasions, and average companies doing well is hardly a phenomenon limited to the dawn of the century, as even the most disinterested market observer will tell you.
But the rise and rise of passive investing has been another hurdle. It’s the “easy, lazy” option, and one that Hyperion believes active managers have allowed to influence their own portfolio construction, with lacklustre results.
“We’re seeing more and more funds returning to that strategy of having a broad selection of stocks and going overweight or underweight in each position vs the index or effectively having a benchmark enhanced or smart passive strategy,” Orthman said.
And the strong returns that passive investors have taken for granted are also going the way of the dodo. That’s because the benchmark is full of oil and gas companies and other businesses geared to current consumption trends – traditional automakers, for example – that face “permanent demand destruction.”
“The indices are full of businesses that are really old world; second industrial revolution type technologies that underpin these businesses, and we think they face a world of massive disruption and that disruption is really going to come from modern technologies,” Orthman said.
“The businesses that have these modern technologies are still a minority of the overall benchmarks. In a world that’s facing radical innovation and disruption, it’s going to be less financially rewarding to track the index over the next ten years.”
Value investing will be another casualty – mainly of economic headwinds, high interest rates, and technological disruption. “Innovation and the ability to take market share” will be the key attributes of successful companies in a world of low economic growth.
Spotify is one of Hyperion’s favourites. It “won the music streaming race” and is the most relevant to Gen Z, with nearly 400 million active users. Hyperion believes it’s harder to identify a market winner in video streaming, which is substantially more fragmented. Amazon has a lot more growth ahead of it too, with the shift to e-commerce and the cloud. Other holdings in its Australian Growth Fund include Afterpay, Macquarie, and Dominos – which was recently downgraded by a number of analysts and is the subject of significant short interest.
Hyperion doesn’t do “concept stocks”, but is something of a contrarian on Tesla – even a cheerleader for it. The share price looked cheap when they bought it, and still looks cheap compared to the earnings they forecast for the next ten years. The proposition here has little to do with electric vehicles and more to do with the technology and culture that surrounds them. It’s the same proposition trotted out by Cathie Wood to justify a valuation that nobody else seems able to grasp.
“The recent share price outperformance is based on excellent business economics that continue to improve over time,” Orthman said. “The evidence suggests that Tesla is a rare investment opportunity due to its ability to rapidly innovate, create new products that are highly disruptive across a variety of industries, and all of those industries have very large addressable markets.”
But as Howard Marks noted in another of this week’s stories, investors shouldn’t take anything for granted; “tech” stocks with sky-high valuations least of all. Perhaps Hyperion are themselves guilty of “extrapolating current data points into perpetuity” – after all, you’re only a disruptor until you get disrupted.
