Current context
Global equity markets largely shrugged off the fears that contributed to the sell-off towards the end of 2018. Despite continued uncertainties around the health of the global economy, trade relations between the US and China, and Britain’s exit from the European Union, markets recovered sharply in the first quarter of 2019. The MSCI World Index delivered a total return of 12.6% and the MSCI Emerging Markets Index returned 9.9%.

In fixed income, the US market experienced its first yield curve inversion since before the financial crisis: in late March, the US 10-year government bond yielded less than the 3-month US Treasury. The 10-year government bond yield was 2.4% as at quarter end, compared to a recent high of 3.2% in November 2018. German and Japanese 10-year government bond yields traded in negative territory over the quarter.

Our perspective
As we have noted for some time, there is pervasive fear in certain parts of investment markets. This is in complete contrast to other areas that are well owned and in which investors are inclined to be complacent. While the December sell-off turned out to be an excellent buying opportunity, global markets continue to be characterised by wide valuation divergences across geographies and sectors. Graph 1 shows the price/earnings ratio of the cheapest quintile (20%) of stocks in the US market compared to the most expensive, indicating a valuation gap as extreme as it was in the late 1990s.

Many higher-quality, defensive companies continue to trade at valuations that require sustained favourable economic conditions and growth rates. We are finding far more opportunities in those parts of the markets where investors are fearful. In fact, our bottom-up analysis is indicating valuations usually seen in deep bear markets. For longer-term investors who can ride out the storm, the return profile from carefully selected securities at such low valuation levels is promising.

Portfolio positioning
As we seek to identify quality companies on sale, we often buy what we believe to be good companies that are out of favour. But it is impossible to predict when the market will start to recognise mispriced quality, and we are often early in our positioning, which we believe has been the case with several of our holdings. While the fund has largely recovered its December drawdown, it has underperformed our expectations over the past year. Although this is disappointing, investors may remember similar conditions at the end of 2015 and in early 2016. We experienced short-term pain then, but that was part of the reason the fund was subsequently able to outperform. Similarly, a cheap portfolio valuation, wide discounts to intrinsic values and compelling bottom-up investment opportunities inform our conviction in the fund’s current positioning.

Price moves over the last 12 months have widened our opportunity set, with some high-quality businesses going on sale. We have deployed cash into these sell-offs and the fund’s equity exposure (including property) increased to 82.4% as at end March, compared to a record-low exposure of 61.98% in January 2018. Over the quarter, we initiated new positions in UK-listed life insurer and financial services firm Prudential plc, oil and gas major Royal Dutch Shell, brewing giant Anheuser-Busch InBev, and Japanese-listed beer and soft drinks company Asahi Holdings.