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Opportunities we're seeing in equity markets

Rising inflation and interest rates made for a difficult environment for equity investors.
Published 26 Aug 2022   |   4 min read

Historically our ethical approach pushes us outside of Australia’s largest companies, and while we find good opportunities in the larger part of the market, we have found some of our best value adding opportunities through focusing on this part of the market and in sectors such as healthcare, information technology and renewables.

Whilst we typically expect a higher degree of volatility from investing in these smaller companies, through deep research over time we have been able to identify highly attractive opportunities that have delivered returns greater than the broader market.

Here’s what we’re seeing in some of these sectors now.

IT Valuations

When we look at smaller cap technology companies, we think it pays to be selective and we are looking for useful products with recurring earnings, attractive returns on investment and scale or customer advantages.

For example, smaller cap software and marketplace companies with value-adding products have many of the attributes we seek and some of these are currently available at historically attractive valuations with well-funded balance sheets.

Resources sector outperformance is cyclical

While resources have benefited from initial concerns over inflation, some of this has been factored into their share prices already. In terms of the underlying commodities, it is often said that the ‘cure to high prices is high prices’. Current very high rates of return on equity in the mining sector, in particular, seem unlikely to be sustainable in a slowing growth scenario.

Water bursting forth from pipes in sourcing hydroelectric energy

Opportunity for Renewable Energy Growth

Over the long-term, high commodity prices also incentivise additional supply - or in the case of fossil fuels, they can help to accelerate the development of green alternatives. Some of these companies, such as NZ renewable energy providers, have underperformed as the market views them as more akin to bonds, which are worth less in a rising interest rate environment.

But we think the opposite: companies we hold in our funds, like Contact Energy, Meridian and Mercury, benefit from increasing energy prices, have relatively stable cost bases and a significant opportunity to re-invest for growth in new sources of renewable power.

Insurance Sector

The insurance sector also stands out to us as attractively valued, with revenues that are relatively defensive to a slowing economy and an inflationary environment. As interest rates rise, insurers receive an enhanced return on their invested capital, whilst higher rates also decrease present value of their future liabilities. Our Australian Shares Fund has positions in both Suncorp and IAG, which we expect to benefit from these trends.

Equities outlook

We have deployed some of our cash holdings into selectively attractive investments based on our fundamental investment process and believe that volatility creates additional opportunities for active management. As we look ahead we expect less influence from top-down macro trends and more focus on the fundamentals of individual companies, like the examples we mentioned above. And if economic growth falters, we see our portfolios being positioned with high exposure to relatively defensive industries and companies that offer productive goods and services in a sustainable fashion.

Australian Ethical acknowledges the Traditional Owners of the country on which we work, the Gadigal people of the Eora Nation, and recognise and celebrate their continuing connection to land, waters and culture. We pay our respects to Elders past and present and thank them for protecting Country since time immemorial.

See our Reconciliation Action Plan