The market has become very quick to re-rate growth companies upwards and over-punish others, according to Lazard’s Bertrand Cliquet, who said this has propelled turnover in his fund to a higher level than usual.
Citywire A-rated Cliquet, who runs the Lazard Global Equity Franchise fund, invests in high-quality businesses with a keen focus on forecastable earnings.
Over the last two years the market has become more expensive but the key feature emerging is the discrepancy between winners and losers, he told Citywire Selector.
‘When any growth stock had a tailwind it kept re-rating and on the other hand any company that had a blip in the road has been so heavily punished that a lot people just gave up. It used to be the case that a negative earnings surprise would have a 5%, maybe 7%, impact on the share price, now it's 25% or 30%.’
If a company has had multiple negative surprise, many investors have given up on them, Cliquet said, which is a good opening for his investment team.
‘That's a blessing for us, we have some exceptional companies and because they are living and breathing creatures they have challenges and the market has been completely uncompromising on this, de-rated them to the point we feel it's exceptional value.’
Finding truly cheap companies
As much as markets are overall more expensive over the last two years, the upside from the portfolio is greater because those cheap stocks are really cheap, Cliquet said.
This has been reflected in the portfolio’s turnover, which used to sit at 30% two years ago. That increased to 70% in 2018 and even further to 80% this year, he said.
‘When we invest in companies we are ready to give them time to come to fruition but if the share price adjusts quickly to our intrinsic values we sell.’
Starbucks was a case in point last year, as the stock suffered a big de-rating over the summer of 2018 before rising sharply.
‘We’ve got to be disciplined when the price catches up with us,’ Cliquet said when explaining why he sold the stock so quickly after introducing it to the fund. The process is based on an ‘obsession’ for valuation.
In this context, the fund’s one year tracking error is reasonably high but has increased substantially since the start of the year. The manager explained to fulfil the pledge to have cheap stocks in the portfolio, it has meant going more and more off the beaten track.
Investors are becoming more and more nervous around the valuation of highly priced quality businesses, and those fears are becoming justified, according to the Lazard manager.
He said: ‘There's not a lot more that can go right for them. Investors are starting to be extremely aware and nervous. Quality growth has been a trend for seven years so it has been a long re-rating.’
Making the most of stretched valuations
Investors have been navigating a stretched valuation environment for a while now, he added, as margins are at historically high levels, which makes Cliquet uncomfortable.
‘Where you ascribe a conservative scenario and if the stock is inexpensive on that basis then you're much more likely to be exposed to a nice asymmetry tilted to the upside.
‘The issue we have currently is plenty of stocks are in blue-sky territory and that is like tightrope walking; it can work but it's precarious and what you get is the opposite of what you want.
'Your asymmetry is really tilted to the downside. If you bake-in a blue-sky scenario you are bound to be disappointed at some point.’
The core focus lies in forecastable earnings when assessing high quality businesses for Cliquet and his team.
‘There will be plenty of really good businesses that won't do the job for us because we don't feel equipped to have a strong view on how much money they are going to make in three or five years.’
Over three years to the end of October 2019, the Lazard Global Equity Franchise fund has returned 35.5% in US dollar terms. This compares to the Citywire-assigned benchmark, the FTSE World TR USD fund's performance of 40.98% over the same period of time.