Fund managers have been wrong-footed by the exceptionally high correlation across stocks in the US market over the past year but are hanging on to their stockpicking style, according to the latest sector review published by Standard & Poor’s Fund Services.
“High correlation was not predicted by fund managers a year ago,” says Simon Dorricott, lead analyst at S&P Fund Services. “At that time, most fund managers expected company fundamentals to return to favour and that stockpicking would become an important future driver of returns. As it has turned out, the market has shown little differentiation in ratings to reflect the quality or sustainability of future growth.”
There have been only small pockets where this has not been true. IT stocks related to the “hot” theme of cloud computing, and small-/mid-cap IT names where some valuations appear to include a bid premium following recent M&A activity.
Portfolio managers are now less certain of when the market will start to fully reflect fundamentals, rather than the macro-driven risk-on/risk-off moves that have been seen.
What they do all agree on is that the current situation cannot continue indefinitely and some, including Old Mutual, Melchior and MFS, have pointed to a short-term improvement over the past couple of months.
In the face of these market conditions, fund managers are generally sticking to their established stockpicking approaches. However, some have put more emphasis on large-cap quality growth names that offer international exposure and sustainable growth, for example the S&P AA rated BlackRock Global Funds US Basic Value Fund managed by Kevin Rendino and Kurt Schansinger.
Others have focused more on stocks where they have identified very significant growth potential in the expectation that these differentiated returns will eventually be recognised and fully rewarded by market participants. Examples here would include Jeffrey Lindsay and Edward Dowd of the S&P AA rated BlackRock Global Funds US Growth Fund, Jeff Morris on the S&P A rated Standard Life Investment Funds – American Equity Unconstrained Fund, and Bill Stewart and Mark Phelps on the S&P AA rated WP Stewart Holdings Fund.
Fund managers are generally positive on the outlook for the US equity market. Favourable levels of corporate profitability and valuation, with operating earnings estimates for the S&P 500 at near 2006 highs and a relatively low market rating by P/E ratio, indicate potential upside, they point out. Free cashflow levels are high and capex relatively depressed, while debt levels are low (relative to assets) compared to history.
Managers also agree that high levels of cash held by corporate America should also feed through to investors in the form of dividends or buy-backs, but will also result in increased capex and M&A activity.
