The Business Herald’s markets and banking reporter.

Capital Markets: The positive side of volatility

There are benefits if you are taking a long-term approach, fund managers tell Christopher Adams.
Shane Solly (left) and Paul Glass. Photo / Dean Purcell
Shane Solly (left) and Paul Glass. Photo / Dean Purcell

New Zealand fund managers are embracing the volatility that has been creeping back into equity markets after several years of stellar gains.

At the open on Monday May , the NZX 50 gross index had declined 3 per cent from its record close of 5911.4 on March 16.

"There's not a lot of underlying value support so the equity market is starting to get more volatile again," said Paul Glass, principal of Devon Funds Management.

Russ Koesterich, chief investment strategist at US asset management giant BlackRock, said last month that while volatility remained below the long-term average, it was on the rise in stocks and bonds.

"This is due to somewhat mundane issues, including slower economic growth, disappointing earnings and anticipation of an eventual rate hike by the [US] Federal Reserve," said Koesterich in a blog post on BlackRock's website.

Jitters spread through markets last week following a global bond rout and Federal Reserve chair Janet Yellen's comments that high stock prices posed a danger to financial stability.

Rather than being a headwind, Glass said increased volatility provided opportunities.

"As active stock selectors we view that increase in volatility as quite positive," he said. "Investors need to be very careful to pick companies that they believe will give attractive returns, rather than simply buying the market as a whole."

Richard Stubbs, of Auckland-based fund manager Castle Point, said his firm had been targeting mispriced Australian stocks, linked to that country's mineral sector, which had been sold-off as a result of plunging commodity prices.

"There are some extremely out-of-favour and what we would consider extremely cheap companies that you can find in Australia," he said. "We think there is genuine, bottom-of-the-cycle fear and capitulation going on in a lot of those companies."

Stubbs said company failures were inevitable at the bottom of a commodity cycle. "But there often are some exceptionally good companies, with not a lot of debt, that will survive the cycle and that will end up being priced substantially higher than they are today."

Stubbs said Castle Point had invested in several mining services companies, including drilling provider Swick Mining Services and Boom Logistics, which operates Australia's largest crane fleet.

"We think there are some really exciting opportunities in that [mining services] area," he said. "These companies don't have a very positive earnings outlook over the next 12 months, but if you are prepared to take a long-term approach and hold these companies then they are all priced at substantially lower prices than their long-term intrinsic value."

Salt Funds Management managing director Paul Harrison described the local market as "reasonably fully-valued".

But daily and weekly volatility in stock prices was providing buying and selling opportunities.

"There are opportunities for us because we actively trade price ranges of stocks," said Harrison, whose firm took up a $690 million active New Zealand equities mandate with AMP Capital on May 1.

Glass said a key concern for Devon was that corporate profitability was failing to keep up with rising share prices.

The best investment opportunities are in globally facing companies.
Shane Solly

After a six-year bull run, the local market is now trading at about 19.8 times earnings, well above its long-term average, according to Craigs Investment Partners. "A number of stocks look quite stretched on valuation grounds," Glass said.

Rickey Ward, New Zealand equity manager at JBWere, said the lofty valuations of many shares made for a challenging environment for stock picking.

"When you look across the market it's hard to find a lot of stand-outs in the blue chip sector - you really are buying income [through dividends]," Ward said. "If want to get some capital return, you really are starting to dive down into the companies which are less researched, more mid-cap and small-cap, and lack liquidity."

Harbour Asset Management analyst and portfolio manager Shane Solly said "bond proxy" stocks, such as Mighty River Power and Meridian Energy, had become particularly expensive.

"Over the last year investors globally chased defensive stocks - including New Zealand gentailers - to improve their investment income yield as interest rates fell dramatically on global quantitative easing and lower inflation," Solly said.

That demand drove the share prices of Mighty River, Meridian and Genesis Energy to record levels in early 2015.

Investors need to be very careful to pick companies that they believe will give attractive returns.
Paul Glass

Solly said recent soft operating conditions had highlighted that NZX-listed electricity firms were not "riskless investments".

"In combination with higher long term interest rates we continue to see the New Zealand gentailer sector as being over-priced," he said. "Overall, we think the best investment opportunities are in globally facing companies, with strong revenue growth, good balance sheets and an ability to improve dividends, engage in [share] buy backs and make good acquisitions."

Harrison said the poor performance of a number of recent sharemarket listings meant fund managers were becoming increasingly wary of initial public offerings, but appetite remained for quality, sensibly priced offers.

It has been relatively quiet on the IPO front this year, with only one small float - transport and logistics firm Fliway Group - having taken place.

The final price of the Fliway offer was set at $1.20 per share, the bottom of a $1.20 to $1.40 indicative range presented to fund managers and brokers.

Ward said the final pricing of that offer was "a recent example of how people are viewing these things".

"Investors are becoming more price conscious," he said. "They have to be priced right given the recent performance of some [IPOs] hasn't been that great."

Glass said the window remained "very much open" for good quality IPOs.

"There is still an enormous amount of demand for them," he said. "But the market is certainly going to be quite cautious when it comes to lower-quality or mispriced IPOs."

Glass said it was a little disappointing that only one IPO had taken place this year, given the market was trading at record highs and most fund managers were looking for new investment opportunities.

The 16 new listings of 2014 included 12 main board IPOs, which raised capital, and four compliance listings on the NZAX junior market that did not raise any cash.

Potential floats in the coming months include Carter Holt Harvey, currently owned by Graeme Hart's Rank Group, financial risk insurer CBL Insurance.

- NZ Herald

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