Stock market volatility is usually held up being an investing bugaboo, however it should not be feared since it creates possibilities to generate some pretty healthy returns.
But investors will need to pick their spots given the valuation run-up recently and the chance of significant equity market pullbacks as rates of interest rise.
Andrew Hamlin and Vivian Lo, portfolio managers at Aston Hill Asset Management, for instance, are keeping away from high multiple stocks, since history shows this group experiences the largest losses during a rising rate environment.
The pair, who concentrate on dividend-paying stocks for the $330-million Aston Hill Growth & Income Fund, also have a couple of other basic rules.
The first isn\’t to second-guess a rising market because you’ll miss out on returns, but will have a process in position to take risk from the table. Another is to keep a healthy cash cushion and be disciplined about putting that money to work when stocks become cheaper.
“Within this environment, investors should own equities and, on any pullback, they must be adding to their positions,” Hamlin said, noting that the fund continues to be very much long risk both in their equity and bond exposure despite the fact that cash levels are elevated.
The fund’s only bond exposure is within high yield due to the managers’ concerns about rising interest rates and because high yield has a much shorter duration than investment grade.
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One of the fund’s biggest equity weightings at roughly eight percent is the consumer discretionary sector. The portfolio managers have hedged a number of this exposure with a short position of roughly one per cent in the Consumer Discretionary SPDR ETF (XLY/NYSE). They also use put and call choices to protect against broad market selloffs or weakness in sectors they’re overweight.
“Its valuation levels across nearly every sector – except energy and materials – happen to be elevated,” Lo said, highlighting the significant multiple expansion in consumer staples and consumer discretionary names particularly.
Hamlin and Lo became bullish around the consumer discretionary space last year as oil prices started falling, because lower gasoline prices should result in more disposable income, and wages started increasing as major employers such as Wal-Mart Stores Inc. and Target Corp. increased their minimum pay rates.
In Canada, they only own Gildan Activewear Inc. (GIL/TSX) and Alimentation Couche-Tard Inc. (ATD.B/TSX), that they believe have outsized growth opportunities compared to most peers.
“As we see money flow back into the energy space, the consumer sectors will be a source of funds, so we wanted to avoid that, especially with elevated multiples,” Lo said.
Another theme the managers are keying in on is technology. Hamlin expects?U.S. GDP growth will begin accelerating within the second quarter, with cyclical sectors such as technology at the forefront.
The managers particularly like large-cap enterprise technology and semiconductor companies.
“Investors can observe the semi space very much as an industrial – and definitely a cyclical sector,” Hamlin said, highlighting holdings such as NXP Semiconductors NV (NXPI/Nasdaq) and Avago Technologies Ltd. (AVGO/Nasdaq).
Unlike other cyclical stocks, semis aren\’t actually impacted by sharp declines in energy prices or big currency swings, and demand has a tendency to grow at 2x GDP growth.
“This is a perfect environment to have some semiconductor exposure due to increasing demand for mobile data and devices, big growth in automotive connectivity and active safety, and cloud computing and knowledge centres,” Hamlin said.
A short-term trading theme the managers like is in steel, since the changing dynamics from the North American industry, like the U.S. dollar’s recent pullback, will reduce the pace of cheaper Chinese imports.
“Small price hikes are beginning to be announced and therefore are sticking,” Hamlin said. “Inventories in North America are also coming down, which means lead times to obtain new steel are getting pushed out, which should become higher utilization rates.”
The managers’ exposure includes names for example Steel Dynamics Inc. (STLD/Nasdaq) and Nucor Corp. (NUE/NYSE).
Lo also highlighted the attractive long-term trends within the health-care space, because of aging populations and associated rising costs.
“Governments are trying to reduce costs everywhere they are able to, which provides more opportunities for the private sector,” she said, noting that Obamacare boosted the number of insured Americans by $ 30 million.
One of the fund’s larger weightings is specialty pharma company Actavis PLC (ACT/NYSE), which recently bolstered its portfolio by purchasing Allergan Inc. and should now generate about US$9 billion of free income in 2016
“Nobody drug could make or break the company’s profitability,” Lo said.