Ask a Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part three of this edition, we're rejoined by Adam Lund, analyst, head of trading & co-founder, Spheria Asset Management.
Motley Fool: Your focus is on the smaller end of the market with the Spheria Australian Smaller Companies Fund and Spheria Australian Microcap Fund. Are there any ASX shares or broader sectors you're looking to avoid in 2023?
Adam Lund: We try to avoid bubble-like themes and sectors riding excessive momentum.
The lithium complex is an area of the market that we're currently avoiding given the expansion in market cap that is being paid for negative earnings.
The lithium cost curve versus the spot price does not make any sense to us given even the highest-cost producers are able to turn a profit at current spot prices, which only invites more supply to the market.
MF: What's your outlook for lithium prices then?
AL: We're starting to see early signs of this unwinding with the spodumene price down more than 30% from recent highs and lithium carbonate down about 20% from recent highs.
Yet, despite that, ASX lithium shares continue to rally, perhaps on increased hope for China demand as the government focuses on stimulating consumption.
MF: So, that's an area you'll avoid for now. On the flip side, which sectors look promising in the coming quarter?
AL: We think that the retail sector has been mispriced by the market with quality retail players priced for a depression-like environment.
With consumer spending patterns holding, at least for the short-term, we're currently witnessing a re-rate to the sector as investors scramble to close their underweight to consumer discretionary exposure ahead of earnings season.
The market is starting to look through peak inflation and the rate hike cycle and investors will be watching inflation data closely over the coming quarter and positioning accordingly.
MF: Are any other sectors looking like they'll outperform in 2023?
AL: Another area of the market we like is what I'd describe as 'value tech'.
In the early stages of this year, we've seen a renewed optimism in the market which has seen a rotation into sectors such as growth tech – those which had been oversold with the market last year.
However, it's value tech that we view as an attractive part of the market today, given our valuation obsession. We expect M&A activity to heat up in this space over the short to medium term.
MF: What do see as the biggest threat for ASX shares in the year ahead?
AL: Inflation and the rate hike cycle is a key risk for markets. Further rate hikes will see pressure on equity markets.
But, should we start to see signs of peak inflation, the risk may shift to the upside as the market moves to price a holding pattern in rates and potential future rate cuts, which would likely see a rotation back towards equities and riskier assets.
The market often overplays macro factors which creates opportunities for long-term investors. We have been positioning the portfolio towards longer-duration assets with the view that the market has overplayed the rate hike cycle.
We are of the opinion that we are closer to the top of the rate hike cycle than the bottom and have been fully invested for this reason.
MF: If the market closed tomorrow for five years, which ASX share would you be sure to want in your portfolio?
AL: An ASX share named Deterra Royalties Ltd (ASX: DRR) would certainly be one to own under this scenario.
Deterra owns a portfolio of mining royalties including a 1.23% royalty on iron ore production at a site in the Pilbara region known as Mining Area C. The site is majority owned by BHP Group Ltd (ASX: BHP) and has an estimated mine life of more than 50 years.
Royalties provide an annuity-like income stream, and Mining Area C – the jewel in Deterra's crown – has a production capacity that's likely to more than double over the next few years, which will see investors benefit from capacity payments as the production profile expands.
Deterra currently trades on 11 times EV to EBIT [enterprise value to earnings before interest and taxes], pays a 6% fully franked dividend yield, has strong cash flow conversion, and operates on a 96% EBIT margin with a net cash balance sheet.
The royalty is paid on a percentage of revenue, thus offering investors inflation protection at a reasonable price, which is important in the inflationary environment we are currently operating in.
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If you missed the earlier installations of our fund manager interview series with Adam Lund, you can read part one right here and part two by clicking here.
(You can find out more about Spheria Asset Management's fund offerings here.)
