Top stock performers and where fund is now looking for value

In our latest Insider Interview, Jacob de Tusch-Lec, fund manager of Artemis Global Income I Acc, runs through the key performance drivers behind the fund’s strong outperformance over the past five years. Performance over shorter time frames also stands out, with de Tusch-Lec addressing whether investors buying the fund today are potentially doing so at a time of peak levels of performance.

The fund manager, who has been at the helm since launch in 2010, explains his contrarian investment style, outlines where he is now looking for opportunities, and why exposure to emerging markets is at an all-time high.

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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, you have a value investing style. Could you talk through the way in which you invest and explain how the fund is very different compared to other global equity income funds?  

Jacob de Tusch-Lec: Sure. It’s a global income fund, so it is in the title. We’re looking for stocks globally, and we try to have as many countries as we can in the fund and as many currencies to get the sort of full effect of diversification because we have this big universe.

And it’s an income fund. So, we do focus on companies that have stable, dependable, hopefully growing, dividends over time. But dividends is sort of an outcome rather than a starting point. We also look at essentially free cash flow yield as our main valuation metric. When we say ‘value’, we like companies that generate cash. Some of them maybe have to invest it, some of them use it for share buybacks, some of them use it for dividends.

We’re not that dogmatic about the dividend, but, overall, we have a portfolio of dividend-paying stocks and the portfolio tends to yield about 3.5%.

Kyle Caldwell: You’ve produced strong performance over both short- and long-term time periods. Over five years, what have been the key performance drivers?

Jacob de Tusch-Lec: You mentioned that we like to have a contrarian tilt, and, you know, being contrarian is good because you’re doing things differently, so you’re increasing your probability of getting an outsized pay-off when you’re right. But you don’t want to be contrarian for the sake of it, and sometimes you want to go where the market is, there’s a strong trend. We saw for a number of years that tech was doing very well, growth stocks were doing very well. Quality growth was doing well when bond yields were very low after the financial crisis and we had quantitative easing (QE), people invested in quality stocks, almost bond-like characteristics from those equities.

I think what happened after Covid was that everybody was invested in the same stuff. Then we saw, and we’re still in the middle of it, a quite fundamental change to the zeitgeist, to the environment we’re in, rates started to go up after a decade of having been zero or negative. Quantitative easing was reined in and instead governments spent a lot of fiscal. They were stimulating the economy with fiscal stimulus, which has a different impact on the economy than when you print money.

After Covid, we also then saw a bit of a change in some of the characteristics of technology stocks. They went from being very cash regenerative to starting to invest a lot in capex (capital expenditure). AI capex is massive. So we saw a bit of a change in the environment. I think the reason we’ve done so well over the last five years specifically is that we tapped into that change.

De-globalisation started a bit of an acceleration. And we sort of invested in a lot of these, I would call them neglected types of assets, neglected sectors, that were actually very cheap. When you have these sort of contrarian value stocks, you don’t need a lot things to go right for them to start performing because nobody expected a lot from them.

Banks could be a very good example of that. You had a decade where, and I’m talking globally, the rate cycles are different and they’re slightly different dynamics, but broadly speaking, banks had had a pretty tough decade where rates were very low, inflation was very low, and nobody was really lending. So, there wasn’t really a credit cycle. These banks, they really cut costs, and did everything to survive in a zero-rate environment.

When suddenly rates started going up and you got massive fiscal stimulus and the economy was growing OK, suddenly they became very, very profitable and they were trading below tangible book value. That’s where you can probably make what I would call an outsized return for the amount of risk that you’re taking.

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Kyle Caldwell: The defence sector has been a big driver of returns in recent times. What names are you focusing on in this sector, and at what point may valuations make you nervous, given that share prices have risen significantly over the past year?

Jacob de Tusch-Lec: Maybe let me step back a bit, because obviously defence is very popular - maybe this is the wrong word - but it’s a very important sector to see what’s going on in the world, and I don’t think geopolitical tensions are going away anytime soon.

But I would point out that we bought the best-performing defence stock for us over the past five, eight years, Rheinmetall AG (XETRA:RHM) in Germany. We bought that in 2017, so that was after the first Ukraine war, the Crimea invasion, in 2014-15. So, we sort of tapped into the defence theme pretty early, and that’s, again, where you make the outsized returns because it was a sector that was neglected after 20 years of globalisation and relative peace globally. It was cheap. ESG (environmental, social and governance) didn’t do the sector any good, so not many fund managers could hold it.

So, again, it was sort of on the naughty step, and suddenly it became relevant and investable. As you mentioned, they are now not cheap. When we started buying defence stocks, whether it’s Hanwha in South Korea or Rheinmetall or BAE Systems (LSE:BA.), they were trading anywhere between 12 and 18 times earnings. Now, they’re trading anywhere between, let’s say, 20 and 40 times earnings.

The thing is though, they’re growing very quickly. So, if you give them the benefit of the doubt, you can look out to 2030 and say, actually, it might be trading on a 15 or 14 times. Their contracts are long term in nature. Their customers are governments, and governments don’t tend to cancel contracts, and they tend to pay up. The order books are growing quicker than they can produce.

So, I think it’s fair enough to look at the defence sector and say it is expensive on a next year price-to-earnings (P/E) multiple. It might not be very expensive on a three, four-year view, but there’s no doubt that the ‘easy money’ has been made because these stocks are now relatively well held. They’re well understood, and when you turn on the TV and you see what’s going on in the world, you can see why these stocks are relevant again, and why what they do actually has some kind of purpose. Their products will be in demand, whether we like it or not, but that’s just the reality.

But I agree with you, we’ve been cutting down our defence exposure because it’s no longer as easy to model the upside that we’d like. I still like the businesses, they’re good dividend payers, the dividends are growing, and they are sort of, in theory, stable companies. But, yes, I completely take the point that valuations have caught up with reality.

Kyle Caldwell: For investors who have not had exposure to the fund and are now sizing it up, is there a danger that they’re buying at a point in time when performance is at peak levels? What would you say to potential new investors?

Jacob de Tusch-Lec: Look, it’s a relevant question. When clients ask the question whether we’ve had a period of poor performance or good performance, and as you say, last year has probably been the best year for the fund on record, you can sort of break it down and say, has the fund become purely momentum, for example? Has the fund gone from being value to momentum?  Well, that would be a red flag. Has the fun gone from being cheap to expensive? That’s also a red flag. Has the fund gone from being full of under-owned, neglected stocks to being very well understood? Well, that may be.

So, if I break it down and look at it, the portfolio is still trading at a 40%, 50% discount to the market. So, from that point of view, our stocks have gone up a lot in value. Share prices have gone up, but earnings have grown very quickly. Defence stocks have re-rated as we discussed, banks have re-rated. But the whole market has re-rated, and a lot of our stocks have not re-rated as quickly as the rest of the market. So, the discount on a valuation basis is still in place. So, that’s quite positive, I think, after such a strong run.

Are the stocks neglected or misunderstood? No. It’s clearly that when bank stocks have done so well over the last three years, defence stocks have done well, some of our industrials have done well. When a lot of our stocks have outperformed the Magnificent Seven, maybe not NVIDIA Corp (NASDAQ:NVDA), but we’ve been talking about the Magnificent Seven, AI, and tech, as if it’s the only game in town. Now, over the last 12 months, investors have increasingly said, well, there’s something going on in Korea, there’s something going on in Japan, there’s something going in Latin America, where stocks have been very strong.

When prices go up, it piques investors’ interest and they start looking into it, and it’s clear when we look at our portfolio now that a lot of our names are not on the naughty step anymore, and that is something we’re cognisant about.

Likewise, a lot of quality growth stocks that are classic holdings in a global income portfolio that have done really badly over the last five years, we’ve done well not being in them. Food and beverage stocks, the Unilever (LSE:ULVR)s of the world, the Diageo (LSE:DGE)s of the world. There’s a reason why we weren’t invested in them and we’re still underweight the space.

But I would say going forward, some of them are starting to look interesting again. I think as a fund manager, you have to always look at the portfolio and be very humble and say, what could go wrong? And constantly rotate rather than just say, ‘this is my portfolio I stick with it, these are the best companies in the world’.

So, we have over the last three, four, five months added a bit more to pharmaceuticals, for example, that have become quite cheap and taken down some of our banks and defence exposure. Fundamentally, the portfolio is still the same. We’re overweight financials, we’re underweight tech, we’re underweight the US, overweight emerging markets. Those are the key building blocks, but the level to which we’ve taken some of these overweights and underweights, that has gone down.

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Kyle Caldwell: Within the pharmaceutical sector, which companies have you been buying?

Jacob de Tusch-Lec: Well, so we have some of the, I would say, deeper value names that are less growth-y. Fundamentally, they have some challenges, but Bristol-Myers Squibb Co (NYSE:BMY) and Pfizer Inc (NYSE:PFE) in the US are companies that really have some fundamental issues. They don’t grow very quickly, they don’t have any obesity drug like Eli Lilly and Co (NYSE:LLY). They’re trying. But the three names we have in the portfolio right now are AbbVie Inc (NYSE:ABBV), Pfizer and Bristol-Myers.

Again, I go back to what I said before about when you buy very cheap stocks, AbbVie is not very cheap, but Bristol-Myers and Pfizer are. You don’t need a lot to go right, you just don’t need things to go wrong. And with the geopolitical tensions we’re seeing globally, with increased uncertainty about AI capex - will it pay off in the long run? Suddenly people need safe havens to put their money in.

We’ve seen recently with the geopolitical tensions that gold has not worked as well as one would have thought. Government bond yields have gone up, so bonds, again, have not been a very good safe haven. So, then a defensive sector like pharma has a portfolio role to play, even if the stocks might not be the best idea you can come up with, it has a role in a portfolio.

Kyle Caldwell: As a result of share prices rising [over the past couple of years], we’ve seen dividend yields fall. As an income investor, how are you approaching this situation in which dividend yields are generally lower across the board? Or are you focusing on other metrics such as dividend growth?

Jacob de Tusch-Lec: I think dividend yield at the end of the day is not a great metric because it’s a number that the board decides we’re going to pay our shareholders this amount of dividend. Then you divide that with the share price, which they have very little control over. So, the dividend yield can go up and down based on a number of things.

You mentioned dividend growth. Some of our stocks that have done very well, they’re now yielding, let’s say, less than a 1.5%, which usually is too low for us to build a position. We bought them, and they might have been yielding 3%. But then we look at them and we say, well, they’ve been growing the dividend quickly, it’s just that they haven’t been growing the distribution as quickly as the share price has gone up. Should we punish the company for that? Well, not really.

Where we do have a problem with low dividends is if it’s because the dividend growth hasn’t come through. Likewise, you can turn it around and say there are companies out there that are not growing their distribution quickly because the share price is poor, the yield goes up. That’s not really the kind of yield you want.

What you really want is the dividend yield where the distribution is growing 10%, 12% a year. And if the share price goes up 40%, I think that’s a bonus. I don’t want to punish the companies for that. However, you’re absolutely right that you can’t have a portfolio full of momentum stocks that have rallied and suddenly you’re collecting 1% dividend yield. That’s not really what we’re about.

So, we do tend to top-slice when yields go so low that it’s almost, from a valuation point of view, no longer a good indicator for any remaining residual value in the holding.

Kyle Caldwell: A good portion of the fund is in emerging markets, and I think your exposure to that area is now at a record high. Has it been an area of the market that you’ve been adding to more recently, and could you give us a flavour of some of the companies that you own?

Jacob de Tusch-Lec: It is an all-time high in emerging markets and probably an all-time high overweight versus our benchmark. As a global investor, you do look at the benchmark. We’ve always said that we’re benchmark agnostic. And it’s true, we have some very big overweights, underweights, especially compared to our peer group.

But I do think it’s worth pointing out that when I launched the fund 15 years ago, the US was about a third of our benchmark, then it became two-thirds. So, I look at the universe of stocks that we can choose from, and we start with maybe 6,000-7,000 names, and then you start cutting away the non-dividend payers and the expensive stocks. But you end up with a very big universe of investable stocks. And if you didn’t know their market caps, you wouldn’t end up with two-thirds in the US. So, what we’ve really tried to do is not let the tail wag the dog here and end up too much in the US. So, that’s the first point I’d say.

Yes, it is true that our overweight to emerging markets is at an all-time high, but a lot of that is driven by the US just being a disproportionate part of the benchmark. A stat we often give people is that, let’s say the US is 60% of the benchmark, only 4% of the global population lives in the US. So, the market cap per capita is about 15 times higher in the US than on average. And it’s understandable, they have got big amazing companies. A lot of the US-listed names are global, but still it does seem that there’s a disproportionate amount of market capitalisation located in the US on a longer-term view.

That’s why I like emerging markets. You’ve got a bit more of a growth trajectory, better demographics. You’ve got less debt in emerging markets, and that is becoming a problem in developed markets, both government debt and private household debt and fiscal constraints in the Western world. So, that’s one argument.

The other thing I’d also say is, and this is sort of a second-order argument where we end up in emerging markets, not because we have a top-down view about emerging markets, but the kind of stocks we like, there’s more of them in emerging market. If you say that the US has a dividend yield of X, Europe tends to have 2X and emerging markets tends to 3X.

Second, emerging market indices tend to have more exposure to tangible assets, industrials, commodities, consumer stocks, and less tech, not a lot of software, not a lot of all the stuff that has driven US indices higher over the past five, six years.

So, I think our investment style where we talk about wanting real assets, commodities, inflation hedge, tangible assets. When we go through that road map, almost naturally we end up skewed a bit more to emerging markets in Europe than the split you would see in our benchmark, which is the MSCI All Countries World Index.

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Kyle Caldwell: And could you provide an example or two of a major market company that has real assets that you own?

Jacob de Tusch-Lec: In emerging markets, we have started building our exposure in Latin America. So, we will own Vale SA ADR (NYSE:VALE) in Brazil, one of the world’s biggest iron ore companies. In general, that is a very cheap stock, always is, because it’s Brazilian. There’s a lot of government meddling, etcetera. But that’s a stock that has done well for us.

In some emerging markets, what we’ve done is tried to tap into the economy of that country, and we do it via the banks. Again, in Brazil, we have Banco do Brasil, which is very cheap compared to most banks in the world. Again, there’s a reason for that. We’ve got elections coming up in Brazil and it could go better or worse. There’s always something to worry about in emerging markets. But that’s the opportunity.

We also in South Korea, for example, have exposure to KB Financial Group Inc ADR (NYSE:KB). I know Korea is somewhere between developed and emerging, but that’s another way of tapping into growth in Southeast Asia.

Actually, the one I would like to mention is Standard Chartered (LSE:STAN). I know it’s UK listed, but that is sort of a one-stop shop for the Global South trade, essentially. They have exposure to the Middle East, Southeast Asia, and Hong Kong. So, to some extent, our exposure to emerging markets very often we express via financials because that’s the easiest way of doing it.

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.