ETFs vulnerable to pullback in ‘disruptive technology’ stocks, says Bell

August 2017
The Australian
David Rogers

Published on page 25

ETFs vulnerable to pullback in ‘disruptive technology’ stocks, says Bell

August 2017

Ned Bell says Bell Asset Management aims "to build up our artillery of ideas in quality companies"

Ned Bell has a warning for investors piling into the “disruptive technology” behemoths that keep pushing the US sharemarket to fresh record highs after an eight-year bull market.

Excessive ownership by exchange traded funds and other “momentum” investors makes the tech giants like Facebook, Apple, Alphabet, Amazon, Netflix vulnerable to a sharp pullback.

Speaking exclusively to The Australian, the Bell Asset Management CIO said his $1.4 billion international fund had recently taken profit on some of its core holdings including Apple, Mastercard and Check Point Software after their share prices rose between 36 per cent and 59 per cent in the past 12 months.

At the same time, his team has bolstered its list of small-to-mid-cap prospects for a rotation of funds in anticipation of a rebalancing of leadership in the US sharemarket. “We bought more shares in Apple 15 months ago when it was out of favour and its valuation was compelling,” Bell explains.

“Sentiment has completely turned on its head now and Apple can’t do anything wrong according to the market. That’s exactly the time to be taking profits.

“We have been taking profits in investments that have worked well and rotating that money into small and mid-cap investments. They haven’t rallied nearly as hard, but that means getting out and talking to management and that’s what our research trips are about.”

While valuations have certainly picked up, particularly in the US sharemarket, Bell doesn’t think the global benchmark MSCI World index is overly stretched on a forward PE ratio of 16.8 times. “There is still value to be found and that’s a really important point to make,” he says.

Aggregate valuations have been skewed by the big tech stocks, with Apple, Facebook, Amazon and Microsoft collectively accounting for almost a quarter of the overall return of the benchmark MSCI World index year-to-date basis. To some degree that’s been driven by this huge growth of passive investing and ETFs. Facebook and Amazon alone are now held in more than 200 ETFs.

“Part of what’s creating the distortion of the overall valuation of the sharemarket is passive investing itself,” Bell says. “There are a huge number of these ‘disruption ETFs’ being launched constantly, and they are all buying the same stocks.”

Bell Asset Management first bought Apple in November 2004 at $US4.50 a share, and Google (now Alphabet) in October 2008 at $US155 a share.

“All of a sudden these stocks are very well owned by ETFs and growth managers so it has given us great opportunities to take profits,” Bell says.

“They are still very good companies, but we don’t like the way they are owned now. Momentum is increasingly becoming a bigger driver of these large-cap tech stocks than quality or valuation.”

While there’s no doubt that Amazon for example has done brilliantly, Bell is concerned that ETFs and growth managers now own 47 per cent of that stock collectively.

“The minute you have some speed wobbles in the market, you could see pretty decent pullbacks in Amazon and other mega-cap tech names that are widely owned by ETFs,” he says. In his view, the “momentum trade” in a small number of major US companies is now giving investors a great  opportunity to take profits and switch to smaller, high-quality companies. Bell and his team recently met with 170 companies in eight cities in the US and Britain.

“Really the primary objective was to build up our artillery of ideas in quality companies,” he says.

“We need to wait for valuation opportunities and then pounce when the markets get a little jittery.”

The trip focused on small and mid-sized companies in global markets, which, as far as BAM is concerned, are those companies with a market capitalisation in the $1 billion-$28bn range.

It represents a sizeable basket of companies in which the quality-focused manager has an edge.

“That’s been a great hitting zone for us that’s accounted for a bit over 30 per cent of our outperformance,” Bell says. About 40 per cent of the portfolio is now in small and mid-caps.

“There are a lot of companies in that space that are not being loved as much as some of the mega-caps, so that was a really key focus of the trip and we came back with a lot of terrific ideas. Stocks like WD40, which is very profitable, with a 20 per cent return on capital.” Broad Ridge Financial and United Health are also on BAM’s list of stocks to -acquire on dips.

Bell Asset Management has consistently beaten its benchmark MSCI World index since inception in 2004.

In the past five years it has generated a total return of 19.2 per cent per annum, at a time when quality as a style has basically just tracked the index, as a wave of liquidity stemming from unprecedented central bank stimulus has pumped up the market.



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