Chief investment officers at Australia's superannuation funds admit that valuations can look a bit stretched in some of their equity portfolios. But they are not about to back away from active equity investments, despite potentially negative external factors.
They believe that, with ample liquidity and a benign monetary environment, as long as earnings remain positive, equity markets are only going one way.
"I think, for the first time in probably decades, equity sectors matter more than ever," Michael Wyrsch, chief investment officer at Vision Super, told AsianInvestor.
Unisuper's CIO John Pearce makes it clear he does not think there is a tech bubble, on the basis that earnings growth will continue against a backdrop of zero rates. "We are looking at an extension of another five years at least, maybe another decade of financial repression. That means we are discounting earnings at close to zero rates."
Michael Block, Australian Catholic Super's CIO said global equities appear to be "priced for perfection. Equity markets are high by any historical measure.
"Just how high? Long-run averages like cyclically adjusted price-to-earnings ratio [CAPE], include two world wars and a great depression, so mean reversion to the 100-year average may be a bit too much to expect."
Looking at current index valuations on a simple mean reversion basis over five years, it appears that the Dow Jones, Nikkei 225, Shanghai Comp and Kospi are all fully valued. The ASX 200 and FTSE 100 seem undervalued, and the DAX is fairly valued. The Nasdaq is the outlier, with tech stocks going way beyond historic measures such as CAPE.
Nonetheless, Pearce remains bullish even about the tech sector, which is experiencing conditions not seen since the tech bubble of 2000. Otavio Costa, a portfolio manager at Crescat Capital in the US, posted a chart on LinkedIn this week showing that, as he put it, "the software industry index to S&P 500 ratio is now 65% above (2000) tech bubble insanity levels".
Pearce admits than in Unisuper's more specialised portfolios such as their Global Environmental Fund, "yes, valuations are a little stretched. We've got PEs (price-to-earnings ratios) of around 45, so that's about 20 more than the S&P average. It's hard to see value there."
But he argues the market isn't going to fall away from under these stocks, especially those positioned for improvements in environmental issues.
FAITH IN ACTIVE
Asset owners say they have the utmost faith in the ability of active funds, especially those taking a growth stance, to continue to deliver returns. Whether they can identify pockets of value is another thing, but it hardly matters when growth stocks are doing so well.
As Wyrsch points out, "our manager exposed to these tech stocks [Baillie Gifford] outperformed our value manager [Harris Associates] by 56% in the last financial year."
The "incredible performance" of the big tech companies, including electric car manufacturer Tesla, is grabbing the headlines, but outside of that, Wyrsch said, "some of the healthcare company valuations look pretty reasonable."
Block places most faith in active within less well-researched sectors, where managers have a good chance of adding value, such as Australian and emerging market equities.
"This strategy has worked over 10 years and also most recently with some bumps along the way. Remembering that passive has no chance of protecting you in a downturn."
"Active management, in our view, is the same as it ever was," added Wyrsch. "If you have skill and luck on your side, you can do well and, as in the last ten years, a manager's approach will be impacted a lot by underlying thematics."
The other factor at play for super fund CIOs is seeing that other asset classes are offering very little to compete with equity market returns.
"It is hard to see decent returns coming out of bonds," said Wyrsch.
"We believe there is a decent probability that governments will end up deflating away the massive debt built up. That will mean negative real yields and currency debasement. So where do you invest?"
Pearce said that within the defensive part of the Unisuper portfolios "we look to take on a bit more credit risk and have recently topped up our holdings in US high yield."
THE COVID OVERHANG
The unique circumstances of 2020 create the possibility that a global recession in 2021 and beyond could puncture the relative buoyancy of markets.
That is a major concern for Australian Catholic's Block, who has a lower-than- usual allocation to equities as a result.
"My interpretation is that optimism about vaccines, lockdowns and the recession ending quickly has caused some equity buoyancy. Low-interest rates have helped too.
"I remain cautious because Covid is a major social, health and economic problem, and maybe markets are a tad optimistic."
Wyrsch reckons the post-Covid environment will throw up a lot of opportunities from the innovations resulting from it.
"There are a lot of comments out there about the ability to work from home, but in some ways, the most important aspect has been the realisation by senior management that much of their workforces can work from home productively."
The pandemic has also revealed a lot of the weaknesses and flaws in the private sector, he said.
"The vast majority of outbreaks of Covid in the aged care sector and from hotel quarantine in Australia has been where the private sector has been involved. We expected a bigger role for the public sector coming out of this crisis and more redundancy in supply chains and onshore capabilities."