Buying some portfolio insurance and bucking trend on US and AI

In our latest Insider Interview, Jacob de Tusch-Lec, manager of Artemis Global Income I Acc, explains the fund’s longstanding underweight to the US stock market and its lack of exposure to the so-called Magnificent Seven stocks.

The fund manager explains that he prefers to invest in the ‘picks and shovels’ to gain some exposure to artificial intelligence (AI), and how he’s introducing some portfolio insurance in the form of adding to oil shares in response to the conflict in the Middle East.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to our latest Insider Interview. Today in the studio, I have with me Jacob de Tusch-Lec, fund manager of Artemis Global Income. Jacob, thanks for coming in today.

Jacob de Tusch-Lec, fund manager of Artemis Global Income: Thank you.

Kyle Caldwell: So, Jacob the fund has for a number of years had a notable underweight position to the US stock market. You own around 30% whereas the global stock market index owns more like 70%. How long has the fund been underweight to the US, and could you explain the reasons why?

Jacob de Tusch-Lec: We launched the fund 15 years ago, and I know it’s not a very exciting answer, but we’ve had the regional positioning more or less unchanged for the 15 years. It’s true that the relative underweight to the US looks quite pronounced, and it’s probably bigger now than it has been on average. However, it’s as much a result of the US becoming a much bigger part of our benchmark.

So, when we started with the fund, we thought a third, a third, a third. The US has growth, but not a lot of income. Emerging markets have income and growth, but some other issues like political stability, corporate governance, etc, and Europe for the past 15 years has some issues to deal with, but there’s a lot of income to be harvested. So, we always thought that if we can balance those three, we can get a nice balanced and growing income.

But it’s true that the US has gone from being about 30% of our benchmark to 60%, or at one point, almost two-thirds of the index. That, of course, means that even if we stay the same, our underweight grows.

I would say the US is not an income market. Had we had more in the US, we would have ended up buying value stocks in the US. It’s interesting that over the last four, five years, value - I know it’s a very broad term, but value stocks, cheap stocks - have done very well in Europe and emerging markets. They’ve outperformed growth stocks in Europe, and Asian value stocks have outperformed Asian growth stocks. But in the US, because the AI theme has been so strong, the Magnificent Seven theme has been so strong, growth stocks have outperformed value stocks.

So, for a value fund, having more US value stocks would not have helped us. That’s why we’ve had more in emerging markets and Europe because value stocks in those regions have actually done well.

Kyle Caldwell: You’ve mentioned artificial intelligence. How much exposure does the fund have to this theme, and could you run through some stock examples?

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Jacob de Tusch-Lec: It’s hard for us to get the obvious exposure. A lot of the biggest AI companies are private, and the Magnificent Seven we can discuss. There’s a lot of differences between a Tesla Inc (NASDAQ:TSLA) and a Microsoft Corp (NASDAQ:MSFT) and an Amazon.com Inc (NASDAQ:AMZN) or Broadcom Inc (NASDAQ:AVGO). But there’s a whole complex - and we can put Oracle Corp (NYSE:ORCL) in there as well - of companies that are investing. I mean, it’s the biggest investment story of our lifetime - the AI capex story - and I don’t know how that’s going to play out. Maybe they’ll get all their money back and amazing returns, or maybe we’ll find out that we’ve over-invested in it, and AI will become big, but not everybody will get the return on their investment. I don’t know how it’s going play out.

For us, it’s hard to invest in that Magnificent Seven-plus complex because the companies don’t pay dividends and their free cash-flow yields have come down even more now because now they’re taking up debt and are investing aggressively, to put it mildly. So, we’ve not been able to invest in that part of the AI boom. What we have done, and actually with better results, I think, to some extent than the Magnificent Seven, is we’ve invested in what we call the ‘picks and shovels’.

So, if you’re building a data centre, you don’t just need the chips and the racks, you also need energy. So, we have invested in Siemens Energy AG Ordinary Shares (XETRA:ENR), gas turbines. We’ve invested in Prysmian SpA (MTA:PRY), which is the world’s biggest manufacturer of voltage cables. You need to electrify the economy, you need to build out the grid, you need more transmission capacity. That’s Prysmian.

We have also invested in Samsung Electronics Co Ltd DR (LSE:SMSN). Well, they provide a lot of the memory. So, there are ways where you can basically be on the receiving side of the capex as opposed to investing in the companies that are doing the capex. And that has worked quite well for us. Again, those are more old economy companies that are second or third order but they’re benefiting from this.

Kyle Caldwell: You’ve mentioned Samsung Electronics, which is one of the biggest holdings in the fund. Over the past year, its share price is up around 250% at the time of this recording. What do you do in a scenario where a share price runs hard over a short period? And in regards to Samsung, have you been taking some profits or have you been running it as a winner?

Jacob de Tusch-Lec: Lots of questions in that one. First, we have been trimming it. So, that might answer your first and last question in the sense that I think when something goes up a lot, and when I say a lot, 200%, 300%, you get vertigo looking at the share price, [and] it becomes a crowded long. Even though valuations might look good, you have to worry a bit that small things could damage the share price. So, we have been taking some profits.

Fundamentally, the story is very sound, but it’s also very well understood, and there are a [few] cracks emerging in this capex story within AI. Private credit is going through some trouble now. With the recent geopolitical turmoil, inflation is going up. That maybe means fewer rate cuts, maybe even rate hikes, and then private credit will have even more issues.

I know it’s a little bit maybe the fifth domino, but we have to think about what could go wrong here when a stock has gone up so much. So, we have started to trim our exposure, but I must say fundamentally, the story is still there. They’re still receiving, and there’s still a shortage in the memory market.

We have visibility maybe two years out. Usually, you don’t have that much, but the market might say, what’s the situation going to be like in 2030? That’s much more unknown. So, we are now in that maybe slightly dangerous territory, and that’s why we’ve been taking a bit of profit without really disliking the story, but it’s just prudent to do.

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Kyle Caldwell: At the time of this recording, conflict in the Middle East is ongoing. How, as a fund manager, do you approach what is unfolding and the pick up in stock market volatility?

Jacob de Tusch-Lec: There’s a couple of things to say, because geopolitical turmoil in itself is not a problem. That just creates volatility, but in general, you want to see through it. Where it becomes a problem is when it creates a recession or creates inflation, so you don’t get rate cuts, or when it breaks something.

There is an old saying that investors overestimate the impact of shocks and underestimate the power of trends, and I think there’s a lot in it. That something happens, and we all readjust our portfolios, and then a year later, we realise that it wasn’t that important.

It’s not just geopolitical events. Just a couple of years ago, we had Silicon Valley Bank go under, Credit Suisse went down, and since then, banks have outperformed. So, sometimes you look back a couple of years later and say, actually, it was a bit of a non-event, but at the time it took up the front pages.

Likewise, trends can go on for a long time and we all want trends to finish and move on to the next thing, but you can just sit with something and [find] it has a longer runway. But that’s easier said than done. I think when you do have geopolitical tension, it’s very tempting to sit back and say we’re going to see through it, but I do think it’s prudent to take some portfolio insurance.

What we’ve done is buy some oil, for example. We know that a year from now, maybe the oil price is back to $50, $60, $70, not the $100 we’re looking at now. We’re going to look back and think that really was not a game changer for the sector. But there is that low probability that something will break, that oil will go to $150, for example, and you want to have that oil exposure in your portfolio as an insurance policy.

Like any insurance policy, you hope you’re not going to use it and you think back, why did I spend the money on it? But that is what portfolio construction is about. In theory, we’d like just to sit back and do nothing. In reality, with a global portfolio that is somewhat driven by macro trends, there’s always some kind of portfolio insurance you’re going put in there. Take a bit of profits in things that have done very well and buy some insurance.

Kyle Caldwell: In terms of that oil exposure, it’s companies that you’re buying as opposed to an exchange-traded commodity (ETC)?

Jacob de Tusch-Lec: I should have been clear about that. Absolutely, you buy more of what you already have. So, we have some Norwegian oil companies that have very high dividend yields that can act as a substitute if you can’t get oil from the Middle East, and now we don’t have gas and oil coming from Russia. So, we add more capital to names we already have where we can get a dividend, knowing that we might look back in six months and say, that was a waste of time, but you want to do a bit of that.

The other thing I would also say is that when you have geopolitical shocks, even though you might look back two years later and say, oh, that was a bit of a non-event, or it actually didn’t change the narrative in markets, what it does do is it often sucks out liquidity from the market. People sell equities to buy bonds or they want to go more cash. What do they sell? They usually sell what has done very well.

My knee-jerk reaction, if I may say, is to look at the portfolio and say what has done really well is no longer very cheap. There is a bit of downside in that if we get a change of narrative. We’ve talked about Samsung, we’ve talked about gold stocks. In the recent turmoil we’ve seen in March, what’s been interesting is that it hasn’t really been defensive assets outperforming cyclical assets per se. What it has been is momentum assets coming down. So, people have been selling what they own and where they have profits. European banks and financials have been weak, but that’s because of the impact on rates. Higher oil, more inflation, rates might not be coming down, and financials in the US, they like that.

But what we’ve seen in our portfolio, and it has been tricky for us, is the biggest drawdowns in names that have done very well, even though the fundamental story has not changed at all. That’s purely positioning in the market. But again, that’s a factor you have to take into consideration.

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Kyle Caldwell: You mentioned earlier that you hold around a third of the fund in Europe. Within that, how much exposure do you have to the UK, and could you provide some stock examples that you own in the UK?

Jacob de Tusch-Lec: We’ve always been very light on the UK. There are a number of reasons for that. One is you have a global universe and a lot of our retail clients, they have a lot UK exposure already.

It’s tempting to have some UK names in the portfolio because we are in the UK, we know the UK, we have some fantastic UK-focused funds at Artemis, lots of good ideas, But we’ve always almost tried to sort of on purpose not have too much exposure to the domestic UK because our clients already have that. What we really like to say is, here’s a stock from New Zealand, Colombia or Argentina, names that people don’t have.

I think it’s important to mention diversification here, and that it’s not always about finding the next name that will go up the most, but about providing something that both adds diversification to someone’s portfolio and some alpha.

So, we have exposure to UK names, it’s not that we don’t have that, but what we have right now, for example, is Standard Chartered (LSE:STAN). That is essentially global exposure by a UK-listed name. We don’t really have domestic UK exposure.

Kyle Caldwell: Finally, Jacob, do you have skin in the game?

Jacob de Tusch-Lec: A lot of skin in the game, yes. I think at Artemis, we’re all basically expected to invest in our own funds, and I invested in my own fund on day one and have been topping up since. So, that is part of the culture at Artemis, that we eat our own cooking.

Kyle Caldwell: Jacob, thank you for your time today.

Jacob de Tusch-Lec: Thank you.

Kyle Caldwell: So, that’s it for our latest Insider Interview. For more videos in the series, do hit the subscribe button and hopefully I’ll see you again next time.