InvestmentsAug 19 2014

‘Bubbles’ fit to burst, gloomy First State warns

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First State is hiking cash levels across its Worldwide and global emerging markets funds as the managers’ outlook turns bearish.

In a note to investors, the emerging markets team, headed by Jonathan Asante, said it was “gloomy” about market prospects, adding that this “has led to cash levels deliberately higher than usual”.

The managers behind the Worldwide funds, Mr Asante and Stuart Paul, have also been “maintaining a high cash holding” on the back of a poor outlook for returns.

The team warned investors that “grounds for optimism about the returns we can make over the next three years are not great”.

Mr Asante, who manages the Worldwide Leaders fund and co-manages the Worldwide Equity fund with Mr Paul, has raised the cash level on both funds significantly this year.

The cash weighting in the Worldwide Leaders fund now stands at 17.6 per cent, according to the fund’s factsheet at the end of June, having stood at 10 per cent at the end of March.

The cash position on the Worldwide Equity fund has risen from 5 per cent at the end of April to 8.4 per cent at the end of June, while the First State Global Emerging Markets and Global Emerging Markets Leaders funds have seen a similar rise.

In a note, the Worldwide investment team said it had raised its cash weightings in the face of “unsustainably high valuations across stock markets”, which it said had been engineered by “reckless governments” and loose monetary policy. “More worryingly, manufactured bubbles in fixed income and real estate pose grave economic risks from which it is hard to envisage an orderly escape,” First State added.

In the face of these risks, the First State team said it had raised its cash level in “a serious attempt to preserve as much capital as possible in order to invest when markets are offering better opportunities”.

It claimed that many of the companies that it looks to invest in “look fully priced”.

The First State team tends to invest in businesses with strong, stable historic growth patterns that are able to generate sustainable profit growth for long-term shareholders through the market cycle.

These tend to be concentrated in the consumer staples sector, by far the highest sector weighting in most First State Stewart funds, and include the likes of Unilever and Nestlé.

However, such companies have been substantially bought up by investors since the financial crisis and many are trading at high valuations compared with their history.

The First State emerging markets team said it was looking to hang on to its consumer holdings “where valuations permit” but admitted that many of the stocks were “priced to make acceptable, but not especially high returns in the coming years”.

Both the emerging market funds and the Worldwide Leaders fund have very good long-term track records.

However, performance has not been as strong in the past year as some investors turned away from expensive quality growth stocks.

Unilever’s allure

‘Quality’ is a tough term to nail down when describing stocks. For First State, one indicator is the ability to make money over time “by either keeping or raising the share of profit that the company can sustainably extract from the economy”.

Using this description, its managers tend to be drawn to multinational consumer goods firms with lots of branding power.

Unilever is a prime example. The firm has substantially outperformed the FTSE All-Share index in the past decade as its strong cash generation and expansion into emerging markets has attracted investors.

But since May 2013 the stock has suffered from the slump in sentiment towards emerging markets, with investors querying its high valuation.

Bloomberg data shows that the stock has a forecast price to earnings ratio for this year of more than 20x – high expectations for a steady growth-style company.

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