Experience has taught me that adopting a top-down approach to investing will increase your probability of generating excess returns (over and above the market) in a portfolio. To do this, you need to adopt three important steps.
The first involves a thorough understanding of where in the business cycle an economy is positioned and where it is heading. The second step involves identifying which sectors will benefit most in such a scenario and last (but definitely the most important part of the process) identifying which stocks within those sectors are trading below intrinsic value. This is a dynamic thought process which will drive the tactical asset allocation of a portfolio.
It is also true that in today’s hectic world, an investor does not have time to go through this lengthy process. However, what’s for certain is that one would want to participate in any upside there is for grabs.
There is a way to simplify this process by investing in exchange traded funds rather than drilling deep into the valuation of individual companies.
I will give you an example to explain myself better. Moving towards to end of 2014, the market started pricing in the probability of quantitative easing in Europe. Looking at historical performance, one will find that one of the best performing sectors each time quantitative easing is announced by a country’s central bank is the automobiles and parts sector.
Rather than going into the detail of stocks within the industry, an investor can still benefit from the performance of this sector by adding the ishares STOXX Europe 600 Automobiles & Parts to their portfolio. This ETF includes 600 companies in the auto industry itself.
Year-to-date, this index returned 19.65% to shareholders compared to the ishares Euro STOXX 50 which returned 9.59%, this is an outperformance of 10.05%.
I still recommend this ETF to investors today because despite relatively high margins recorded by auto part suppliers I continue to anticipate further margin improvements in the coming years for the following reasons:
European production is still circa 10% below its 2007 peak level and global demand is being driven mainly by the emerging markets, especially China.
More stringent regulations across the globe in terms of CO2 emissions, harmful tailpipe emissions and safety should continue to support suppliers’ profitability in the coming years.
Last but not least, some suppliers still have opportunities to improve profitability by focusing on specific underperforming divisions or regions that are currently dragging down their overall performance.
For those investors who want to take it a step further and drill deep into individual company valuations, my top picks are Valeo, Michelin, BMW and Daimler.
For Valeo, I expect higher profitability to be driven by their convincing growth strategy.
For Michelin, I expect management to take advantage of the current market conditions and make up for the insufficient growth it generated in 2014 thanks to a weakening Euro a higher global demand.
For Daimler, we saw positive results showing much strong cash flow and an increase in its dividend. I expect this positive trend to continue.
For BMW I expect to see stronger growth in volumes of cars sold and increased profitability.
Disclaimer:
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.