Volatility Forcing Tech Managers to Question Valuations

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Murdo MacLean

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Murdo MacLean, client investment manager at Walter Scott in Edinburgh.

What is our global equity outlook for 2022 and with respect to particular sectors and countries, as well as what risk and opportunities investors should know about? For many, many years, it has been almost unarguable that the United States will be the best performing economy. It has such high levels of innovation and entrepreneurial spirit, that we see more IPOs every week of significant sized businesses than we see in pretty much any other country in the world. That ensures that I think you see a very vibrant corporate landscape and as such, although we perhaps have less exposure to the United States than the actual benchmark in the MSCI World, we’re nonetheless pretty significantly exposed to that country. We tend to own businesses that are based in Hong Kong rather than based in mainland China. That reflects, I think, our comfort levels, the desire to have greater transparency, and so on.

Already, we’ve seen this year that AsiaPac particularly has been a lot less impacted by the sell off than the US has. And so maybe there’s been a bit of balance to address there and we’re certainly seeing that towards the end of last year, companies such as AIA, the Hong-Kong based life insurance company that we own, which has been a great performer since we first invested in it seven or eight years ago, that had a tough 2021. Just simply because of the restrictions that have been put on as a result of Covid and them being rather more draconian in nature than we see in the West. We also purchased a company towards the end of the year called Prudential, which is the U.K.-based life insurance company, which also has significant exposure to Asia, China, as well as Southeast Asia. And both of those companies certainly suffered as a consequence of softer optimism in that area because of the uncertainties that we saw. But of course, as soon as we look at the performance so far this year, both of them are actually having a much more positive start to the year.

Again, another example that we’ve probably talked about in the past is Taiwan semiconductor, TSMC. Again, because of the volatility in Asia, chip shortages to some extent but mainly I think the volatility and the sentiment, it didn’t necessarily have quite a stellar year towards the end of the year. Whereas this year it certainly has started off in root health. There certainly seems to be some asset allocation here between maybe away from the U.S. towards AsiaPac. At the end of the day though, as I’ve said before, we simply want to buy the best businesses. Where they happen to be located is secondary and it tends to be that the longest lasting driver of share prices is the wealth that these businesses are creating. Whether they’re in AsiaPac or in the United States or wherever they are, if they’re not growing, they’re unlikely to be a good long term investment.

When we look out, we see a great many risks, not at least Covid, although we see some positive development particularly in the Western economies, we’re far from out of the woods there. It’s proven itself to surprise us when we’re least expecting it so we shouldn’t discount that. That being said, I think there seems to be quite a strong impetus to try and begin to live with this as a virus. I think that’s positive for the overall opening up of economies. As you do so, however, we are already seeing now with the recent attack in Abu Dhabi, that conflict, global conflict, wherever it may be, we can look at Ukraine as well as flash points. Those represent clearly geopolitical risks. And those are not new. Certainly before Covid, we would’ve always counted those as risks.

I think valuation risk is something that we absolutely have to highlight. We’ve seen our investments do very well as has the market and it really comes down to I suppose, that relationship between that valuation. How much are you willing to pay for the growth that a business delivers? And how sustainable is that growth? And what is your confidence in our management team? And how strong are the financials of that business?

To us, if we can tick the boxes on the management team and the profitability on the business model, as well as having high conviction in growth, we can pay a reasonably full valuation. We don’t mind. And even if we pay a little bit higher than traditional levels, we know that we have all of those positive factors to fall back on. But if you invest in areas that are a little more speculative, as we’ve seen of late, where there aren’t those boxes ticked, it’s all really about hope rather than actual tangible evidence. Then I think that the valuations that you’re willing to pay for those types of businesses have to have a big question mark over it when we see the return of volatility and that could be driven by interest rate inflation, et cetera. And each of those also represent risks of sorts.