Kate Howitt: investing lessons and avoiding the PIPO trade
Firstlinks’ Graham Hand interviewed Fidelity’s Kate Howitt. Kate Howitt is Portfolio Manager for the Fidelity Australian Opportunities Fund which she has managed since its inception in 2012. She was included in CNBC’s list of the world’s top 20 female portfolio managers across equities and bonds and named in Citywire’s top 30 female fund managers, ranking 11th out of 1,762 female active managers. She was with Fidelity when it opened its Australian office in 2004.
GH: Do you feel the economic stimulus packages in Australia have done enough to carry the market through to whenever a vaccine arrives?
KH: We have the benefit of good economic management in the past, which means we went into this with a clean sovereign balance sheet and a close-to-balanced budget. It gave us more room to maneuver than a lot of other countries. The Government has grasped the enormity of the challenge and thrown dogma out the window quickly with some effective policy responses. Globally, we’ve seen enormous liquidity injections and strong fiscal measures and now pump priming, but it wouldn’t be surprising to see some wobbly patches as we move from one stimulus level to another, and not all jobs and businesses will survive.
GH: And allowing companies to continue trading while they are insolvent has delayed an inevitable wave of company liquidations which will hit the news in coming months.
KH: Absolutely, a reality check. And one of the challenges is to avoid creating a class of zombie companies. There needs to a constant creative destruction or winnowing out of weaker companies to leave sunshine for stronger companies to thrive.
GH: Your Australian Opportunities Fund invests across the market including small to mid-cap stocks. Do you feel the stock market has missed a sector or companies that you've identified?
KH: We’ve seen many COVID winners and losers. Some companies have benefited from people working from home but we're seeing a line of sight back to normalisation. We think there's upside in homebuilding in Australia, such as Bluescope (ASX:BLS) with Colorbond, but also a recovery of industrial activity in the US, particularly the auto sector. In smaller companies, we like the Australian biotech Starpharma (ASX:SPL). It has a range of therapeutic molecules, mostly targeted at the oncology space, but they've got an antiviral that shows great promise with regulatory approval already in major markets. Until a vaccine is thoroughly worked through and even beyond that, there will be gaps and a desire for a simple, low intervention nasal spray as a convenient therapeutic. And when you look at the market value of Starpharma relative to other companies around the world that have COVID-19 therapeutics, it's not being priced in at all.
GH: Where are you in the ‘value versus growth’ debate?
KH: Well, broadly, there are two ways to make money with stocks. One is to find stocks that are cheap now relative to the value today, and the other is to own stocks that are long-term winners. They may be fairly valued today but they will continue to grow through time.
Both are valid ways to make money but the latter that has really outperformed this year. Software companies and online retailers started expensive and then got much more expensive. That can be characterised as ‘value versus growth’ and growth has delivered for many years now. It’s one of the big questions for markets: when will it make sense to buy those cheap companies with attractive valuations when such investing has not paid off for a while?
GH: So that leads to whether you see specific stocks and sectors the market is too optimistic about.
KH: There's a huge amount of optimism baked into the Buy Now Pay Later space and into the retailers and they've been clear beneficiaries of the lockdown. But it's hard to untangle how much of that is a structural shift caused by COVID versus how much is a short-term boost. When conditions normalise, will they lose some of those gains? There’s not much margin of safety in those valuations.
GH: Where stocks run on their own price rise success and they lose connection with the fundamentals.
KH: Yes. The fascinating phenomenon is the shift in market participants. A couple of decades ago, markets were comprised of institutions and mum and dad investors. Both were working on price versus value. So whether a professional or not, investors would buy a stock based on a view of what it was worth, and its value over some time horizon. And that was pretty foundational.
But now the majority of investments are index flows or ETF flows trading on some other proxy of outperformance. They are agnostic on valuation, they don't even ask the question on what is fair value of a stock. They just ask the question, what’s its weight in the index. Or does it fit into my ETF parameters or does it tick some other quantitative box like momentum.
Markets used to work on the wisdom of crowds, which was a lot of non-correlated guesses of how many lollies are in the lolly jar. The old saying was that in the short term, the market is a voting machine but in the long term, it's a weighing machine. Now, there's a lot voting activity and not nearly as much weighing.
GH: That’s a great point, that we don’t simply have a cyclical change but a new structure in the way the market works. Can anything break this pattern?
KH: It's one of the drivers of this extended bifurcation between growth and value. The things that do well draw even more buying support so inefficiencies and anomalies persist for longer than they would have in the past.
GH: What have been your best performers in 2020 and why do you remain keen on them?
KH: Our Top Three contributors over the past 12 months were Evolution Mining (ASX:EVN), Mineral Resources (ASX:MIN) and CSL (ASX:CSL). Evolution is our top pick in the gold space, based on both its own merits and the gold price. They've made a recent acquisition in Canada which shows a lot of potential on a medium- to long-term view. Management are good capital allocators in a sector where it's easy to destroy value by buying other gold companies when the gold price is high.
Mineral Resources has performed well, particularly with its exposure to the iron ore price. It also has lithium assets which the market has been attributing no value to. And CSL is a large stock but still capable of delivering strong growth although there might be some hiccups over the next 12 months from plasma collection.
In all three cases, quality management is a key part of investment thesis. We are believers in the Warren Buffett view on backing the horse not the jockey, so we are looking for companies that have strong competitive advantages. But where we can also get a good jockey, we like that a lot too.
GH: And at the other extreme, what is your biggest portfolio disappointment?
KH: Treasury Wine Estates (TWE). We had done well out of it for a while, but it's had a big tumble on the back of management changes and analyst views on its export markets. We like the business for the strength of its brands, notably Penfolds, and the management team has been reorienting the business towards cellaring for longer to make more luxury wines. The cost is keeping the inventory on the books for a couple of years, but we like that re investment. It will come through in earnings in future years.
GH: We have all read about the ‘Robinhood’ retail investors, particularly in the US, but do you see the same influences in the Australian market?
KH: We always had a strong retail component but it was mostly centered on fully franked dividend stocks, which made a lot of sense. But there is now a lot of trading in a new cohort of stocks, such as Afterpay (ASX:APT), Zip (ASX:Z1P) and Mesoblast (ASX:MSB). In the US in the 1960s, retail was about 40% of stock trading flows but it had fallen to 10% by 2010 and now it’s back to about 20%.
One part of me says this is great, this is capitalism in action, the benefits of Wall Street being made more available to Main Street. But then part of me thinks that this is just people who are unable to engage in sports betting and going to the casinos and having a flutter, and they are bringing that mentality into the stock market. This type of activity does tend to be a hallmark of a late cycle. So I'm unsure whether to applaud this as grassroots capitalism or take it as a sign of a speculative top.
GH: And when you read social media posts on TikTok and Reddit and even Twitter, there’s a lot of chat about how easy it is to make money in stocks. You’ve spoken before about TINA and YOLO. What will it take to shake these new participants from the market?
KH: So let's break down those acronyms. TINA is 'There Is No Alternative'. It’s more an institutional phenomenon, that since the GFC and increasingly in 2020, monetary policy has made the largest securitised asset class in the world, ie the bond market, less attractive. Bonds now offer high volatility and low returns. So where else does money go but the next largest securitised asset class, stocks? I call these investors ‘bond market refugees’. Their natural home is bonds but they can’t stay there anymore. They can’t move quickly back because if you’ve called the top of the bond market, it’s the end of a 30+ year cycle. It's not something that plays out in a month or two. It may give strong support for equity markets globally for years. They are not buying stocks because they’re cheap but because of the relatively-better prospects than bonds.
Contrast that with YOLO, which is 'You Only Live Once', which is a tag some retail punters put on their trades. If you're a YOLO day trader, you're not buying stocks because you've done your DCF valuation. You’re buying because it's a thrill, to have something to do in an otherwise really boring lockdown.
So TINA has legs and can go on for longer whereas YOLO probably runs out either when people either exhaust their stimulus money or sports betting ramps back up or people go out and do more interesting things. I think it will fizzle out in a nearer term.
GH: What advice do you offer to less experienced investors?
KH: There's the predictable answer that they should find a quality active manager, as we have hundreds of analysts whose job it is to understand stocks and work really hard on a client's behalf. But for those people who enjoy investing for themselves, it's good to go through the mental exercise of asking if markets fell 30% from here, would I be a forced seller? If so, sell some now and put some cash on the sidelines. It's much better when markets fall to scoop up bargains rather than sitting there feeling terrible because you’re a seller at knockdown prices. Position yourself to take advantage of volatility rather than being hurt by volatility. It's a foundational part of managing a portfolio.
GH: And we've all seen investors who sell after the market falls and buy after the market rises and end up with the worst result of buying high and selling low.
KH: Yes, my head trader at Fidelity constantly warns against the PIPO trade, which is ‘Panic In, Panic Out’. People have evolved to PIPO and it’s hard to resist and make well-reasoned investment decisions.