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The year to be selective

Headed into 2013, there are attractive investment opportunities for active fund managers according to portfolio manager Rob Lovelace.


Rob Lovelace
Portfolio manager
26 years experience

One of the remarkable features of 2012 was the resilience of corporations and their ability to create value in a highly uncertain macroeconomic environment. Return-on-equity averaged in the double digits, and U.S. firms, in particular, created considerable value. In late summer, Europe’s monetary authorities mitigated the risk of a largescale sovereign or banking insolvency through liquidity and contingency programs. With macroeconomic risks in Europe declining, investors began to focus on fundamental factors. Most financial assets rallied,
including stocks and credits, and global equities delivered strong returns for the year.

As we look to 2013, corporations overall remain in great financial health with solid balance sheets and lean cost structures. They have been cautious and have avoided major capital expenditures or aggressive hiring amid a weak economic recovery. But we may be at an inflection point. As the U.S. and China put political transitions behind them and corporate managements get better clarity on fiscal and tax policies, we could see a substantial pickup in private sector expenditure and employment.

Take your pick: Investing selectively will be key

The cycle of cost reduction and rationalization by corporations appears to have run its course, and a greater proportion of future earnings gains is likely to come from top-line growth. Yet several countries in southern Europe remain in a slump, China’s GDP growth rate has slowed, and the U.S. will have to implement its own debt reduction.

Stock correlations have started to decline: Can be good news for active managers

Source: Empirical Research Partners Analysis. Data, calculated using daily returns averaged over a quarter, reflect capitalization-weighted correlation of the top 750 stocks by market capitalization; this large-cap universe represents the S&P 500 Index plus the largest 750 stocks (approximately 800 securities in total), without overlap. Correlation is a measure of how the price of an index or stock moves relative to another over a specified period of time. For example, a correlation of 100% means that the price of the index or stock moved in lock step with those it was measured against.

 


“Do I think there are sectors of the market or individual companies that are going to do well, even in a slow growth environment? Absolutely. That’s what we do: seek out the companies that others have stopped looking at because they have moved away from equities or moved away from certain European countries because of the debt crisis.”

— Rob Lovelace


In these markets, we should expect to see much greater differentiation in corporate earnings and in investment returns among companies and industries. 2013 will undoubtedly be the year of investing selectively.

In this environment, we may not achieve the double-digit annualized stock returns of the 1990s, but neither may we see the relatively flat returns of the prior decade. “One could say we are back to normal,” says portfolio manager Rob Lovelace. “We had a period of pretty outstanding equity returns in the 1990s, but in the current environment of low inflation and low interest rates, I would expect single-digit stock returns.”

Invest in companies, not in markets

“Even as I make that general statement, I would emphasize that we invest in companies, not markets. To the extent that macroeconomic risks are becoming less pronounced and correlation among stocks and credits is declining, it’s a better investment environment for us as active managers,” says Rob. “We may not be out of the woods in Europe, but we may be past the stage of panic. When markets calm down a bit, they start to function properly and price stocks, bonds and other fi nancial assets more discriminately.”

“We have already started to see this play out,” says Rob. As correlations loosened up in 2012, “many of our funds distinguished themselves,” he says (see Chart). Heading into 2013, managers and analysts are finding attractive investment opportunities across sectors, particularly in biotechnology, the shale-gas boom, cloud computing, and products and services oriented toward consumer demand from rapidly growing developing economies.

 


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