Major stock markets have become very expensive, and there are many signs that the way from here is going downwards globally. Such a situation has already been experienced twice, in 1999 and around 2007. It will take a lot of patience, but there will still be cheap bargains – say Dániel Móricz and Tamás Cser, investment managers at Hold Asset Management. The aging of society will revolutionize capital markets over the next decade.
Dániel Móricz and Tamás Cser
Interviewer: At the Private Banking Class Awards, the HOLD Columbus Absolute Return Fund won the first prize and not for the first time. How is this fund different from the rest?
Tamás Cser: The interesting thing about this fund is that it is handled with the greatest freedom out of the products managed by the in-house portfolio management team of Hold Asset Management. This fund represents the added value of our analytics and portfolio management activities in the greatest extent. In Columbus, we are completely free to decide which instruments and which individual investment products we choose. Also, how much weight we give to each asset class.
Interviewer: Perhaps this fund is the most similar to the famous hedge funds?
Tamás Cser: This may be more similar to the way hedge funds started in those days. The original concept was that portfolio managers should take risks when and in what they see a good opportunity. But when there isn’t such an opportunity on the market, they should remain passive.
Compared to this, most American hedge funds look more like a mixed equity fund, and thus performs significantly alongside with the performance of the stock market. However, the basic concept would have been, that these products’ performance should be independent from the markets.
Interviewer: Just as the word hedge also means to carry out risk-reducing deals.
Tamás Cser: That’s right. Essentially, there is a very long bull market and these funds hold considerable number of shares, even in times when from the risk point of view, it may not be justified. We do not want to hold shares at all costs. Our fund is more cautious, it does not take as much risk as some of the famous hedge funds, and it has no huge fluctuations in its price. The attitude of our investors is not so risk averse. By the way, Columbus fund is the largest of its kind in our portfolio, currently holds around 45 bn. HUF (150mn. USD).
Interviewer: But can we say that you can hold stocks, bonds, shorts, longs on any continent and country? Do you use leverage?
Dániel Móricz: Yes. In the fund we can have short positions, however we do not wish to create an exposure that keeps the net equity ratio in short. In this fund, in the long run we would like to hold at least 50 percent shares on average, and I must admit that this goal has not been easy to achieve in the last couple of years. We are opportunists, but also value driven which means that we hold significant equity exposure when the stocks are cheap.
Interviewer: So, there are less and less cheap shares?
Dániel Móricz: Yes, and the whole market is getting more expensive. What has changed in the last couple of years is that alongside with long cheap stock positions we also hold short positions or put options on the expensive ones. As a result, our net equity exposure has decreased significantly. Compared to what it was in the beginning also compared to what amount we wish to hold in the long run.
Interviewer: Are you already below 50 percent equity exposure?
Dániel Móricz: It has 50 percent equity, but also short positions that we want to close at a level where we consider the market not expensive. There are assets that are very optimistically priced in the market, and others that are priced depressively, based on fear and a deteriorating worldview. We follow the contrarian approach; thus, we short the former assets and long the latter ones.
Tamás Cser: The markets are expensive, but the spreads have widened between the pricing of different assets.
Interviewer: Is this not a contradiction to the overall expensiveness of stocks?
Dániel Móricz: At the peak of January 2018, all sub-markets went to new highs in the MSCI World Index. Then there was a secondary peak in autumn, and another in April 2019. But less and less submarkets drive the index. Non-American and non-technological stocks no longer perform well.
Tamás Cser: The European EuroStoxx 50 index trades almost at the same price where it was 5 years ago. Perhaps investors could earn on the dividends during this period, however even the EUR weakened.
Interviewer: Do you also take foreign exposure/currency risks?
Dániel Móricz: We consciously shape it, therefore there are times when we take forex risks and there are times when we hedge our forex exposure. We analyse the market environment by global macroeconomic approach, so sometimes currencies, sometimes shares and sometimes bond can deliver the best returns.
Interviewer: What is your opinion about the Hungarian Forint (HUF)? Do you hold Hungarian equity?
Dániel Móricz: In the long run we believe the HUF will weaken due to the extra loose Hungarian monetary policy. Also, the expansion of the domestic consumption appears to be lasting, which will eventually deteriorate Hungary’s external balance, even if not to a dangerous level.
Tamás Cser: We hold few Hungarian shares. We think that the Hungarian economy has positively surprised the world over the last 4-5 years. In parallel to this, Hungarian equities have also performed very well and underwent a significant repricing.
Expectations are strong today, that the Hungarian economy will remain on a high growth path, however we are less optimistic about the situation. There may not be a major recession, but there may be a noticeable slowdown in a few years. In addition, cyclical companies like OTP and MOL are over-represented on the Hungarian Stock Exchange. These two represent more than half of the BUX index, thus the Hungarian stock market is cyclically vulnerable. Investors are overly optimistic compared to this.
Interviewer: Stock markets will go down for a long time then?
Dániel Móricz: In fact, we may already be in a bear market, it is often difficult to realize until large indices start to fall. But in a lot of cyclical sectors, equities have fallen a lot. There are plenty of signs that typically occur around such a market peak. By the way it should be added that the positive cycle has been going for a very long time, not everywhere, but in the US, definitely. US stock market accounts for more than half of the global stocks, so what happens there is very important. I don’t think the outlook for the American market is very good.
Tamás Cser: There is a near-ideal, the so-called “goldilocks” status, where economic growth is still quite good, but inflation has not yet picked up, so interest rates can be kept low. However, this state is not steady, with the US stock market tending to deteriorate, the growth outlook may be slower, or inflation may pick up raising interest rates, which is also negative in such a highly priced stock market.
Interviewer: Certain sectors have quite good dividend yields; can they provide protection if prices go down?
Tamás Cser: In my opinion, dividends are overvalued because of the abundance of interest. Investors struggle to find something with predictable yield, because bonds that provided this in the past are no longer able to provide it. More and more investors are being forced to buy shares for dividends.
Therefore, we think it is more of a psychological misbelief to consider dividends as a form of interest. In case of bonds, both interest and value at maturity are certain, unless the issuer goes bankrupt. In case of stocks, the dividend yield and the price can be extremely volatile. A stable dividend is just a guise, it obscures the fluctuations in the underlying processes. And stocks with stable, generous dividend yields have performed very well in recent years, by today they became expensive and vulnerable.
Interviewer: What’s next for bond markets, that they performed well for so many years? Is the much-anticipated bond market turnaround coming?
Dániel Móricz: This is one of the most common questions we ask each other. The discount factor used for pricing; the bond yield fundamentally influences the value of other investments. I think the global slowdown may cause yields to drop temporarily from where they are now.
But in the longer term, we are pretty much at the end of the period of interest rate cuts seen from the early eighties, and in fact the turning point probably will soon happen or has already happened in the last few years. Low interest rates over the last 30-35 years, have helped the performance of other asset classes, but this is likely to end now.
Why do we think that? The world’s cheap labour market reserves are running out. In the developed world, unemployment rate is on a 30-year low. As the labour force grows in the market, it helps reduce prices and thereby interest rates. However, this is over.
Tamás Cser: I consider it very important too. The prevailing view amongst economists is that the aging society has deflationary effect. Older people consume less, leading to lack of demand, permanently lower interest rates and permanently lower growth.
But this whole concept may be wrong. Older people do spend less in stores; however, they have increased health care costs. It is not true that they need less resources from a social perspective.
Globally, the proportion of employees relative to retirees and children has been steadily growing so far, so the so-called dependency ratio declined until now. This is reversing now, these years. This phenomenon may also reverse the period of declining interest rates and the disinflation process. For the next thirty years it will not continue as it has done so far.
Interviewer: Many effects are mixed. Many people save more because of low interest rates. Retirees will sell stocks and bonds, especially in Anglo-Saxon countries. In the emerging countries, hundreds of millions break out of extreme poverty.
Dániel Móricz: Technological advances have deflationary effect and they have played a major role in interest rate cuts over the past 30 years. They argue that technological advances are replacing the workforce, and everything will be made by machines. Then why is the developed market unemployment rate on a 30-year low? Retired people will consume their savings and consumption will increase relative to income generation. This has an inflationary and interest-raising effect.
Capitalism is fundamentally deflationary, reducing inflation because it creates competition while socialism destroys it. Recently there are many symptoms of social tensions caused by wealth and income disparities that have reached a critical level. Because of this, politicians can only gain power if they meet expectations and reduce these differences. One way is the populist method, blaming the foreigners and redistribute their income for the benefit of the poor. This reverses globalization and reduces competition on the market. Other way is the left-wing fiscal policy, where the government increases tax rates of the wealthy. It also has anticompetitive effects, raising inflation over time.
Interviewer: Does the latter include listed companies?
Dániel Móricz: Yes, that’s right. The US election in 2020 will be very interesting, because for the first time we will openly see political opinions and programs that are opposed to the views that have prevailed in recent decades. These will probably be very popular.
Tamás Cser: Going back to “goldilocks” status, even the US corporate tax has been reduced in recent years, so the environment has been very supportive for them. This can only deteriorate from here.
Interviewer: If interest rates rise, is it good or bad for us? Will there be real interest again?
Dániel Móricz: Not sure, as this happens with rising inflation. Demographics, the slowing (or halting) globalization, a possible left-wing turnaround, and the exhaustion of the labour markets all point towards rising interest rates in the long term. There is one thing that goes against rising interest rates: high indebtedness. Interest rates can rise, and inflation can appear if the part of the private sector’s debt gets transferred to the state, at least this is what historical examples show us. Then it will be in the interest of the government to inflate this debt.
Interviewer: But this debt inflation phenomenon is already happening in many places, isn’t it?
Dániel Móricz: It is ongoing, but so far, the monetary policy of the central banks has not directly reached the corporations and households, only very indirectly, through the price of financial instruments. In the future, it is very likely that fiscal policy will directly provide funds to economic actors. There will be helicopter money that goes directly to society, to the poor. This would then have a profound effect on consumption and inflation. Real assets may be relatively better investments in the next 10-20 years. Such things happen in monetary policy today that were unimaginable ten years ago.
Interviewer: In what asset class can one invest in such a situation, when we don’t expect much in return from stocks or bonds? Gold, oil, real estate? What can small investors do?
Dániel Móricz: We don’t like to label a single asset class, because we work in an absolute return approach, and where we find one or the other appropriate, the situation can change at any time. One important rule is that you need to diversify, so you must invest in multiple asset classes. Another rule is that you must reduce the risk exposure significantly and wait until you can invest again on lower prices. It takes a lot of patience, sometimes years until such an opportunity arises.
Tamás Cser: In addition, we will probably need to change the composition of our portfolio much more actively and frequently.
Dániel Móricz: If anyone can identify with this way of thinking, we have the good news that we are doing just this in Columbus. The fact that Hold Asset Management is 25 years old also confirms that our long-term strategy is viable and winning. Most of our portfolio is managed with a long-term contrarian and value-based approach. The bottom line is to reduce risk taking around the top of the cycle, even if we cannot hit the peak perfectly, because there will be better investment opportunities. At least within a 1-3-year time frame.
We have seen periods like this twice in our careers. Once in 1999 and once in 2006-2007. It took a lot of patience back then too, but lower prices came.
The Columbus Fund has won the “Best Absolute Return Fund of the Last 10 Years” and we are particularly proud of this. Luck has a great influence in investing, but as time goes by, while it loses weight, performance gains weight. Therefore, we believe that funds should be evaluated according to their 5-year- or even longer-term performance. The fund’s return over these ten years was 10.5 % yearly, with relatively low risk taking.
Dániel Móricz: Over the past 10 years, many investors have made very good returns, especially since March 2009, which was the bottom of the crisis. If the next few years do not offer such a good investment environment, the average ten-year yield will not deteriorate significantly in one avoids investment pitfalls. But it can be a grave mistake if one expects stock markets to repeat the last ten years’ uptrend in the next ten-year period.
Interviewer: We have discussed real assets; do you consider holding commodity products or real estate in the fund?
Dániel Móricz: Commodity investments may occur in the fund and we also have real -estate exposure. There are listed equities in this area that are relatively attractively priced compared to what we consider to be their fair value.
Dániel Móricz (CIO)
Tamás Cser (Senior Portfolio Manager)