To go back in time…

I was recently asked when the best time to start a new fund might have been. Not that most fund managers really have control over this, however, if I could go back in time, around 1988 would be a good place to start.

Immediately you might think my answer has something to do with the stock market crash of October, 1987; but it does not. It has everything to do with the tailwind that increasing corporate profit margins and falling interest rates had on equity markets over the subsequent period.

As illustrated by the chart below, corporate profit margins have been on an upward trend for the last 25 years. Typically corporate profit margins have mean-reverted – thanks to competition and the laws of industry supply and demand; so the last 25 years has certainly represented an unusually good run.

Screen Shot 2015-08-17 at 12.16.20 pm

Furthermore, over the same period, interest rates have been falling. As illustrated by the chart below, the discount rate applied to future dividends – defined as the sum of the risk-free rate and equity-risk-premium – has either been declining or moving sideways. This has provided a boost to price-to-earnings multiples on equities (which can be roughly viewed as the reciprocal of the discount rate).

Screen Shot 2015-08-17 at 12.18.00 pm

So with margin expansion driving earnings growth; and with falling interest rates driving price-to-earnings multiple expansion, we can start to see why equities delivered stellar returns over this period.

Today is a very different starting point: corporate profit margins are at record highs; and interest rates cannot move any lower. It would seem sensible to conclude, therefore, that equity returns over the coming decades may be materially lower than they have been in recent decades.

Such conditions only strengthen the value proposition of Montaka – for two reasons:

  1. Montaka, with its dual long and short portfolios, significantly increases the scope for us, as the Investment Manager, to add value through superior stock selection. In finance speak, we are saying that, in a lower equity-returning environment, every 100 basis points of “alpha” is a higher share of the total return and, therefore, relatively more valuable; and
  2. Montaka’s dramatically reduced net market exposure (resulting from the short portfolio offsetting the long portfolio) enhances the downside protection of client capital.

We think the space of increased alpha generation and downside protection is a good place to be in the current market environment.

Screen Shot 2015-11-11 at 12.08.48 pmAndrew Macken is a Portfolio Manager with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.

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Our Montaka Global Long Only strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark.

Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our
Strategies

Our Strategies

Our Montaka Global Long Only strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark.

Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short