Investors should re-assess the risk/reward of “buy-and-hold” funds run by the likes of Lindsell Train, Fundsmith and Baillie Gifford, according to Artemis’s Simon Edelsten as he looks to take his Silver-rated fund into even more defensive territory.
Edelsten runs his Artemis Global Select fund with a quality-growth bias but a valuation discipline that he says many of his peers, which are ever-more popular with retail investors, do not. And that is likely to see them run into problems as the economic cycle continues to roll on and, eventually, reverse. Valuation investing is at its simplest, the discipline of selling stocks when they become too expensive.
Edelsten’s approach has led him to sell almost all of his exposure to FAANG stocks – the only one he still owns is Alphabet (GOOGL) – in the past 18 months, as he re-thinks his exposure to many of the more in-demand quality growth names around.
“A load of people of experience, whether it’s Lindsell Train, Fundsmith, ourselves, Baillie Gifford, had a look at the market after 2008/09 and said, ‘there’s a load of quality growth stocks which are really cheap’, so we all bought them,” Edelsten tells Morningstar.co.uk.
“For the people who are buy and hold forever, of course, they’re buy and hold forever, so these stocks have now become quite lumpy parts of the portfolio and the portfolios to my mind don’t look balanced.
“The average multiple of cash flow that you’re now paying when you get into any of those funds is miles higher than it was five years ago, let alone 10 years ago.
“If you’ve got a fund with 8% of the portfolio in Amazon (AMZN) on a [price/earnings ratio] of 123 times, that can go down pretty fast if anything ever goes wrong.”
As a comparison, Edelsten’s Artemis fund’s price/cash flow is just under 8 times, compared with the Gold-rated Fundsmith Equity’s 18 times and Silver-rated Lindsell Train Global Equity’s 15 times, Morningstar data show. On a price/earnings comparison, Artemis stands at 15.5 times compared with 21 and 22 times for Fundsmith and Lindsell respectively.
Defensive Qualities
Edelsten, who also runs the Silver-rated Mid Wynd International (MWY), believes we’re now moving into a period where his style will “really come into its own”. “It’s not just about making money when the money’s there to be made,” he explains. “It’s about not giving that money up when wobbles come about.”
The fund’s healthcare exposure didn’t quite live up to its supposed defensive qualities last year, hurting performance in the latter part. However, Edelsten says his decision to sell his FAANG names and a third of his big healthcare stocks limited the downside somewhat.
“Our valuation discipline really matters in terms of trading through these cycles whilst sticking with the holdings for the long run,” he continues.
On positioning moving forward, the manager adds: “We have taken, and we will carry on taking, the unit trust into more defensive territory.
“What that basically means is that we’re going through the fund, looking at the stocks which every knows and loves and questioning whether we really want to stick with them.
“Our view now is that you review all of those winners one-by-one, you make a decision about whether the market has now priced them beyond what they’re worth and you really go back and concentrate on valuation.”
Valuation Investing Unfashionable
Many of his competitors focus on investing in strong business capable of weathering any storms and avoiding those that look like they could go bust. Keeping an eye on valuation allows Edelsten to miss those whose share price just do not perform, as well as those that go out of business altogether.
“Buying and selling shares on the basis of valuation seems suddenly to have become unfashionable,” he says. “I think what the public pays us fees to do is to keep an eye on valuation because the public can’t do that terribly well.
“In my experience the bulk of the job is you have to sell things when they’re expensive. If you don’t, you may not have a permanent loss of capital, but you can still find yourself watching Vodafone (VOD) go down from 475p to 130p over 20 years and I don’t call that particularly good investing.
“Inside quality, our approach would be quality and growth but only at the right price. I think other people seem to have got stuck on quality at whatever price, and I think that’s quite dangerous.”
Edelsten may be tempted to cash in on those growth stocks he picked up 10 years ago that have matured, but he also has an eye on what to replace them with. “As ever, there are always new growth stories around,” he says.
“As long as you look around the world far enough and as long as you’re fairly nimble and keeping your eye on enough themes, there are new themes coming along.”
Buying Back In
Two of those themes he’s been looking into in recent times are automation and healthcare. The former is biased towards Japanese robotics makers, some of which he used to replace Amazon and Facebook (FB) through 2017 and 2018.
Having bought them in 2017, he traded out last year when they had run up too far, too quickly. However, having lost around half their value in the market shake-out late last year, he found an opportunity to buy back in at a low valuation.
That’s paid off thus far, with those stocks having recouped all their 2018 losses as investors become more confident the US and China will avoid an all-out trade war and agree a deal imminently. Should that happen, and Edelsten expects it to, there’s “a whole load of pent-up orders out there are about to explode through to the Japanese robot manufacturers”.
Indeed, the companies themselves are confident the future looks rosy. Fanuc, for example, recently announced a capacity expansion to make more of their smaller robots, which largely go into automotive vehicles.
“So, at the bottom of the cycle Fanuc are strong enough to say that they’re going to increase their capex because the long-term prospects are so good.”
Daifuku (6383), which specialises in warehouse automation, is one he likes, with its joint venture with Uniqlo, one of the world’s largest retailers, being a key affirmation of its capabilities.
Will the US Embrace Universal Healthcare?
On the healthcare side, most of the stocks have been under pressure as the Democrats begin their push for the 2020 Presidential election. The health insurers in particular, says Edelsten, have been hit on rumours that Bernie Sanders will look to implement an equivalent of the NHS across the Atlantic.
But Edelsten says he’s “prepared to put money on America not having an NHS”. Indeed, he thinks Wall Street will soon begin to price in the re-election of Donald Trump, which should lead to a rally in those stocks.
Edelsten has big exposure to health insurers, but has also been buying some of the drugs makers involved in the new cancer immunology area.
These drugs allow the human body to continue killing cancerous cells even once one’s immune system has not strong enough by stopping the cells that inhibit the immune systems of, for example, the elderly.
While previously he’d held off investing in drug companies because of a reliance on health budgets increasing due to rising drug costs, the price of care for these new cancer treatments is much lower because there are few, if any, side effects.
The big winner from this area is Merck (MRK), whose Keytruda drug is widely seen as the best around having taken over from one of rival Bristol Myers’ (BMY) offerings.
Showing the confusing way the stock market works, Edelsten explains: “On the one hand, the evidence that Keytruda is a proper wonder-drug has gone through the roof; and on the other hand, the Merck share price has sunk gently down under the weight of Bernie Sanders.
“We thought that was a nice opportunity to buy,” he adds. The fund also bought Swiss firm Roche (RO).
“As I say, there are always new stories out there. The nice thing about investing in something like immunology now is that you’re at the beginning of a multi-year growth story. You’re not at a very mature stage of understanding how much of the world Amazon’s going to supply.”
