26th July 2024
A few weeks ago, Ben Mackie wrote an excellent Crescendo highlighting a triumvirate of headwinds our funds have faced in recent years: relatively low exposure to US equities compared to peers; relatively high exposure to small caps over large caps; and a bias to value-oriented funds over growth. This positioning has been a natural outcome of our valuation focused, bottom-up investment process – frustratingly US, large cap, and growth have all been outperforming. Thankfully, as Ben explained we have been able to add lots of alpha through good fund selection to offset these relative headwinds, with Vanbrugh, Distribution and Global Opportunities all performing admirably well in absolute as well as relative terms over all time horizons.
Despite the good performance, it has felt like a very frustrating period watching as global markets have become increasingly extreme and concentrated in a small number of very large companies which have been big beneficiaries of passive investment flow and easy narratives. During this time, we have often wondered (dreamt!!) what would happen should this period of dominance end, and the headwinds we have faced turn into tailwinds?
A couple of weeks later, we need to dream no more.
On the 11th July, a routine data release of the US CPI number for June sparked a historically extreme 5-day rotation in equity markets. So, what happened? The US CPI number came in at 3.0% year-over-year, compared to 3.1% expected by market participants. On the surface, hardly a major shock – after all forecasters are always wrong and being 0.1% out is just a minor rounding error. But the market thought different. A week later, the Magnificent Seven had become the Seven Deadly Sins, with the group (Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla) shedding -8% of their combined market cap. In contrast, the Russell 2000 index of US smaller companies rallied over +4%.
I listened to a very timely update early this week with Richard de Lisle, fund manager of De Lisle America, which focuses on investing in good quality US small caps on compelling valuations (and has a very impressive long term track record). He highlighted that the extreme nature of the market moves has only been matched on three previous occasions – in January 1974 (at the start of a 9-year run of small caps outperforming large caps and value outperforming growth), October 1987 (short and sharp technical recovery post the ‘87 crash), and March 2020 at the start of the covid recovery.
Despite the extreme short-term moves, the case for a longer period of outperformance for small caps compared to large caps is gathering force in the US. Moderating inflation, interest rate cuts to come, protectionist and America first Trump is well ahead in betting markets and his number two JD Vance a keen industrialist, combined with still extreme valuation dispersion with small caps compellingly valued versus large caps, but also attractively valued in absolute terms.
These extreme moves have not been isolated to just US markets, and we have seen value as a style come to the fore in other regional equity markets in recent weeks. For example, look no further than last week’s Crescendo where Daniel touched on recent UK small cap moves (here).
Aware that a swallow doesn’t make a summer and always cognisant of our own behavioural biases, we never get too excited when the wind is at our backs in the same way that we never get too despondent when the wind has been blowing in our faces. We just stick to what we do best – identifying attractively valued assets overseen by great managers. Perhaps the past couple of weeks are just an extreme blip. As we have demonstrated in recent years, we don’t need a tailwind to our positioning to generate strong absolute or relative returns for clients. But we would certainly welcome a prolonged breeze in our favour!! For what it’s worth, it is noticeable the impact enjoying a tailwind can have on our fund performance. In the very short period since the US CPI number (11th July – 24th July), all three funds are in the top decile of their peers and have generated positive returns vs negative returns from their sectors. All three are also top quartile this year with strong absolute returns. As mentioned earlier, this strong short term performance builds on excellent longer-term performance – after all fees. We’re really proud of this track record, but never complacent. We must always consider our newest investor.
Dan Cartridge – Fund Manager
For professional advisers only. This article is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. FPC24200.
