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Positioning for real world risks – Marcel Bradshaw

Inflation is not the only risk that investors face in the current environment. But what should you be aware of, and how can you help mitigate these risks?

The conflict in Ukraine has accelerated shifts in investment markets that had already begun. This has included higher inflation, shortages in energy and commodities, a retreat from globalisation, and rising geopolitical risk.

The obvious initial impact for investors has come from the sharp rise in inflation that has hit 30 to 40-year highs across the UK, US and Europe. This upward move has punished global government bonds as well as the richly priced growth stocks that have done so well in recent years.

Ultra-low interest rates and stubbornly low inflation have been huge tailwinds for these growth stocks. And while there are fantastic companies that do warrant a premium, in many cases the share prices of these companies have become untethered from fundamentals.

The recent inflation shock has seen this reality start to filter through into the price declines seen in some of the key virtual companies. But inflation is not the only risk facing us in the real world. A global energy crisis and the transition to renewables, food shortages and the re-emergence of a new ‘cold war’ can all
have an impact on our investments.

We have been worried about some of these risks for a while, and so we have sought to mitigate them in the Orbis Global Balanced Fund by focusing on companies that are offering solutions to some of these issues.

Energy crunch

One example is in the energy space, which makes up more than 20% of the portfolio. Traditional major energy producers have performed well, but there are some interesting opportunities in the sector that are being overlooked, even as the world faces a global energy crisis.

In February, Russia’s invasion of Ukraine immediately rendered around 10% of world oil production and 30% of Europe’s gas supply insecure and toxic. However, while important, it’s not the only reason for the sharp increases in energy prices. We have been expecting a supply crunch in energy for some time, caused by a lack of investment in the sector.

Over the past seven years, oil producers have underinvested to the tune of hundreds of billions of dollars, chastened by the price declines of 2014-2015, the negative prices of 2020, and growing pressure around responsible investment issues.

Therefore, we have gradually been moving towards the more neglected services companies and owners of critical energy infrastructure such as gas pipelines. This includes those that will benefit from the rise in popularity of Liquified Natural Gas (LNG) as a transitional fuel source.

Kinder Morgan is a major beneficiary of this trend, as it owns 40% of the natural gas pipelines in North America and supplies around 50% of the gas to LNG export facilities. In addition to having the critical energy infrastructure already in place, almost all of its contracts are price-protected or fee-based.

This is a crucial benefit in an environment of higher inflation and it means around 94% of its revenues are insulated from gas price changes.

Contrarian expertise

Despite the growing evidence of these real-world risks, including the threat to global wheat supplies and the production of fertilizer caused by the war in Ukraine, the market appears unconvinced that the backdrop has changed and seems content to wait for ‘normal’ service
to resume.

However, as is so often the case, when the market is moving in one direction, we are going in the other, and this is most apparent in the extremes. For example, in 1990 during the Japan bubble, Japan made up 42% of the world index, yet as a firm we didn’t own a single Japanese stock.

It was a similar story in 2000 with the tech bubble and, over the past five years, we have held zero long-term conventional bonds as the yields simply weren’t high enough to offer anything except reward-free risk.

But it is during these extremes in the market when it is most important to invest differently. Today, we are in a similar situation, where a focus on investments to help combat these realworld risks accounts for around 35% of the Orbis Global Balanced Fund, compared with just 5% of our benchmark index.

The companies we are holding are promoting solutions to these real-world risks, and yet they’re not getting credit for it from the market in terms of their valuations.

These companies are currently at significant levels of discount, but we feel this gap will close, and these neglected solution providers could be the next generation of highly regarded ‘blue chip’ stocks over the next 20 years.

It is at times like this that we benefit from keeping to our investment philosophy of simply investing in a handful of investments which we truly understand, and that we believe are trading at a deep discount to what they’re worth, regardless of their asset class, sector or geography.

The result of this is a portfolio which is significantly cheaper than the market, despite having just as strong fundamentals.

Marcel Bradshaw – Head of UK Retail Investment

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