Schroders’ global value team has an explicit mandate to invest in the cheapest parts of the global equity market so it may seem counterintuitive that the team has doubled its US exposure in the past two years. The US is arguably the most expensive region in the world and has been one of the best performing markets.
America’s rally has, however, been concentrated in a handful of headline-grabbing stocks and below the surface are some “genuinely cheap businesses,” said Simon Adler, who co-manages the £818m Schroder Global Recovery fund.
“US markets have been dominated by a small handful of companies and the companies we’ve been buying have performed horribly. Horrendous performance. And we've been buying shares on very, very attractive valuations. We bought a number of US businesses that are deeply out of favour,” he said.
Adler and his colleagues have invested in several US companies on single digit Shiller price-to-earnings (P/E) ratios. The Shiller P/E ratio consists of the share price divided by the average of 10 years of earnings, adjusted for inflation. It is designed to smooth out short-term earnings volatility.
Even so, the fund’s US exposure is still fairly low at 30%, compared to 71% for the MSCI World index.
This year, Adler has invested in the US department stores Best Buy and Macy’s, La-Z-Boy reclining chairs, computer retailer HP and healthcare stocks Pfizer and Bristol-Myers Squibb. Last year, he bought shares in recruitment firms Adecco and Manpower, as well as Sally Beauty.
“Whilst the US looks very expensive at aggregated market levels, beneath the surface there are a lot of companies that have been really difficult performers and have done terribly, that we've been able to buy into at exceptionally attractive valuations. We think on our five-year average holding period we can make great returns for our clients,” he said.
These stocks have fallen out of favour for a variety of reasons. “The healthcare companies we're in have got some really popular drugs that are losing exclusivity and the stock market can be very short term about that,” Adler explained.
With Best Buy and Macy’s: “Store-based retail is clearly not as popular now when everyone buys things online. Those businesses have got quite difficult outlooks but that is more than compensated for by the share price. So it's not that we're deluded and think that everyone's going to shop in department stores for the rest of their lives, but we think the stock market has dramatically exaggerated the decline of those stores.”
Adler hopes that the American companies in which he has recently invested will go through a similar renaissance to his Japanese portfolio.
“Two or three years ago, we bought a bunch of Japanese companies that were deeply out of favour and they have come dramatically into favour. We were buying them at some of the cheapest valuations we've ever seen” he said.
“We bought Nippon TV at an extraordinarily attractive valuation, it was almost unbelievable. Now it's doubled since then, but that’s because it was coming from such a low base. It doesn't mean it's necessarily expensive today.”
In addition to Schroder Global Recovery, Adler also co-manages Schroder Global Equity Income and Schroder Global Sustainable Value Equity. All these funds have between 10% and 15% in Japan.
The Japanese companies he owns were cheap because they had “enormous cash balances and enormous cross holdings in other companies that they'd held for many years and the perceived wisdom was that would never be returned to shareholders”.
However, the Japanese government and the Tokyo Stock Exchange have enacted reforms to improve corporate governance and increase shareholder returns, and their efforts are starting to bear fruit.
“The businesses that were moribund for decades and everyone had given up on are now flavour of the month,” Adler concluded.