Syz fund manager Mike Clements is actively tackling the rise of passives by investing in exchange traded fund (ETF) firms.
Among the holdings in Clements’ Oyster Continental European Selection fund are ETF trading firm Flow Traders and German stock exchange company Deutsche Boerse, which makes 40% of its profit from an index derivative business.
Citywire A-rated Clements (pictured) said both stocks are ‘long-term volatility plays’ which also take advantage of the structural growth in passive investing.
He started buying Flow Traders towards the back end of 2016 after its share price tumbled due to low volatility and hence little trading in ETFs. The share price has since jumped significantly.
Clements said: ‘The Ebit (earnings before interests and taxes) margin dropped from the mid-40s to the mid-20s and people were saying it’s a disaster, it’s not making any money, how can you invest in it?
‘It’s an example of one of those stocks where we accept we’re going to be six to nine months early. In the first week of February, the Vix went through the roof – I still don’t understand why – and Flow Traders’ share price jumped 60% in a month.’
He added: ‘It has 22% market share, it has a rock solid balance sheet and has been priced at a double-digit free cash yield, and it was being priced as if volatility was never going to pick up.’
On Deutsche Boerse, Clements said the idea was the same with the stock being a long-term volatility play: ‘It’s the same as Flow Traders. When markets are really volatile people are buying and selling these derivatives massively, but when the markets calm people don’t buy them as much.’
He also highlights IG Group as another stock along the same lines, but in the retail investment market, and said that around 15% of his portfolio is in these ‘volatility plays’.
Emerging market focus
Clements is also a fan of market sensitive stocks, including asset managers and in particular ones focused on emerging markets.
After the Chinese stock market turbulence between June 2015 and February 2016, Clements said share prices plummeted in two major areas in European stock markets, luxury goods firms and asset managers, both of which he moved to buy up.
He picked out UK-listed Ashmore Group as an asset manager hit particularly hard by the sell-off, adding: ‘They became extremely cheap as people pulled money out of emerging markets. Sentiment towards that part of the market was very poor.
‘Now my job was to say, “we understand why people are scared about this part of the market, but let’s do some research and see if we can buy these companies, because they can recover”.’
Clements started buying Ashmore around January 2016, when China’s central bank set the official midpoint rate on RMB to its lowest level since March 2011. This came after trading was halted due to a drastic sell-off in the Chinese stock market. Having been priced as low as 201.5p per share in January 2016, the stock is now hovering around 400p per share.
But overall, as asset managers recover, Clements is switching the portfolio into the aforementioned volatility plays as a way to protect assets.
He said: ‘As markets rise, that helps asset managers’ profitability as part of their revenues are linked to the amount of assets they have and as assets rise in line with markets. As those stocks played out we reduced our exposure to asset managers and bought volatility plays, because we thought if the markets came off that would protect our portfolios.
‘When the markets fell in early February, the asset managers got hurt as you would expect but our volatility plays did well and that protected our portfolio. Our portfolios were up 3-5% ahead of the market.’
In luxury goods, the stock he highlights now for being out of favour is Pandora, with market sentiment down due to a slowdown in the US luxury goods market, where the firm makes 25% of its profit. It has also been hit by the ‘Amazon effect’, the disruption of the physical and online retail market from e-commerce giants.
Clements said: ‘It’s one of the best jewellery brands globally, it’s growing its brand awareness, it’s got structural cost advantages and it’s growing organically.
‘And yet the stock’s priced at something like a P/E of 11x. It’s got a 5% dividend yield and a rock solid balance sheet. It’s an attractive idea, but in the short-term you can see why people are nervous about it.’
Over the three years to January 2018, Oyster Continental European Selection has returned 48.6%, compared to the sector average of 36.3%.