The metrics traditionally favoured by fundamental analyst have been upended by ultra-low interest rates and surging sectoral valuations, according to MLC Asset Management manager John Woods.

Speaking on a webinar panel during the third instalment of the MLC Investment Insight Series, Woods described the role of fundamental analysts as having been “significantly changed” by central banks’ lowering indicative rates around the world, a development which was further exacerbated by the need to soften the economic shock of the pandemic this year.

“Traditional valuation metrics are fundamentally challenged by the current environment we’re in,” Woods said. “Valuations for a lot of companies pose significant risks, whether that’s because they’re capturing unsustainable interest rates thanks to central banks or whether they’re pricing in aggressive but not impossible trends in growth.”

In an anecdote Woods provided that was emblematic of the ructions caused by ultra-low rates, he recalled Bloomberg having to update their terminals because they haven’t been correctly configured to deal with negative interest rates.

Low rates, combined with burgeoning valuations in trend stocks (such as ‘buy now, pay later’ companies) are combining to make equities incredibly difficult to mark, he explained.

“For equities, when you look at what’s on offer at the moment the gap between them is wider and wider,” he said.

Looking for cheap companies and outsized returns is one way to approach the equities challenge, Woods explained, but the other “more important side” to consider is whether the valuation a company is trading at is achievable.

“And I think that’s where the risk really creeps into the market and is potentially what we saw in the late 90s with the tech bust, there were valuations that really weren’t justifiable,” he said, before qualifying that the market isn’t quite as frothy as it was in 2000. “I don’t think we’re at that point at the moment.”

Woods was joined on the panel by Leo Barry, senior investment manager at small cap specialists Fairview Equity Partners, who highlighted the role of diversification as one of the “key tools to reduce risk” amidst the current valuation challenges. “That means being very thoughtful about duplication risk,” he added.

Also on the panel, Shaw & Partners senior adviser Felicity Thomas spoke on the dual role active and passive play in affording this protection, especially in Shaw’s model portfolios. “We like a combination of active and passive,” she said.

Woods agreed, adding that the active versus passive debate in the context of diversification shouldn’t be binary.

“What I mean is in a broad portfolio you want components that play a particular role at a time,” he said.

Value in the sunshine