High inflation has changed the way many investors manage their portfolios. So which companies and sectors are providing a hedge against inflationary pressures – and where does gold and real estate fit into it?
Brian Arcese, portfolio manager at Foord Asset Management, tells Sean Aylmer why investors hoping for an inflationary peak and trough rather than a long-term high might need to have a re-think.
This is general information only, and you should seek professional advice before making investment decisions.
Find out more: https://fearandgreed.com.au
See omnystudio.com/listener for privacy information.
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Sean Aylmer: Welcome to the Fear and Greed daily interview. I’m Sean Aylmer.
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Sean Aylmer: High inflation has changed the way many investors manage their portfolios.
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Sean Aylmer: As one fund manager puts it, those hoping for an
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Sean Aylmer: inflationary peak and trough rather than a long-term high might
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Sean Aylmer: need to have a rethink. So, which companies and sectors
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Sean Aylmer: are providing a hedge against inflationary pressures and where does
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Sean Aylmer: gold and real estate fit into it? There’s plenty to discuss. Remember,
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Sean Aylmer: this is general information only and you should seek professional
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Sean Aylmer: advice before making any personal investment decisions. Brian Arcese is
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Sean Aylmer: a portfolio manager at Foord Asset Management. He joins me
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Sean Aylmer: this morning from Singapore. Brian, welcome to Fear and Greed.
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Brian Arcese: Thank you, Sean. Thank you for having me.
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Sean Aylmer: So, we’ve all heard about inflation and those of us
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Sean Aylmer: who are old enough have lived through inflation previously, but
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Sean Aylmer: inflation is a totally different environment for investors, isn’t it?
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Sean Aylmer: Explain why.
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Brian Arcese: No, it certainly is. I mean, I think that’s a
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Brian Arcese: fantastic question, but obviously for the past 15 years, central
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Brian Arcese: banks around the world have largely been fighting deflation. Even
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Brian Arcese: most portfolio managers haven’t been managing their funds long enough
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Brian Arcese: to have managed through a significant period of inflation previously.
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Brian Arcese: But it’s obviously incredibly important, and the main reason that
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Brian Arcese: it is is it erodes your purchasing power and as
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Brian Arcese: an investor it erodes your capital. So you need to
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Brian Arcese: invest in a way where you earn a return higher
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Brian Arcese: than inflation, you need to earn a “real return”.
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Sean Aylmer: Okay. So, how does this change the way an investor
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Sean Aylmer: should approach their portfolio?
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Brian Arcese: So, in our minds, there are a few things investors
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Brian Arcese: can and should do. I mean, if you look at
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Brian Arcese: equities in general, they are a reasonable hedge against inflation
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Brian Arcese: over the long-term, but it’s very important to focus on
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Brian Arcese: equities that have real pricing power. So they either own
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Brian Arcese: real assets, for example, or they have a strong brand,
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Brian Arcese: they have the ability to price at least in line
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Brian Arcese: with inflation, if not higher. So, if you invest in
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Brian Arcese: those high quality companies that can do that, then at
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Brian Arcese: least over the longer term, that will result in a
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Brian Arcese: portfolio that outperforms inflation. Now, during periods of higher accelerating inflation,
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Brian Arcese: equities can be volatile, and so other asset classes like
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Brian Arcese: commodities for example, are equities that would be linked to
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Brian Arcese: commodities might provide investors with a more real-time inflation hedge.
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Brian Arcese: But equities over the long- term are really one of
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Brian Arcese: the only asset classes or few asset classes that will
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Brian Arcese: give you that inflation plus return.
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Sean Aylmer: Okay. So let’s just deep dive into equities a little
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Sean Aylmer: bit further in terms of pricing power. So you are
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Sean Aylmer: talking about, it might be, and listeners, please seek professional advice for your
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Sean Aylmer: own personal circumstances so any names we are using here
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Sean Aylmer: may not suit you, but it may be a toll
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Sean Aylmer: road operator, for example, whose pricing is linked to inflation
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Sean Aylmer: within the jurisdiction it operates, or it might be someone
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Sean Aylmer: who basically has a near monopoly on a good or
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Sean Aylmer: service which people are prepared to pay higher prices for.
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Sean Aylmer: Is that the sort of thing you’re talking about?
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Brian Arcese: That’s absolutely correct. In some companies, for example, even industrial
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Brian Arcese: companies may have contracts with inflation linkages directly in them. So,
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Brian Arcese: if we look at a high quality company called Air
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Brian Arcese: Products that’s domiciled in the US, it’s an industrial gases company.
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Brian Arcese: So they supply not only cyclical gases to to industrial
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Brian Arcese: commodities complex, but also gas is like oxygen, for example,
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Brian Arcese: the hospitals, so it’s also a defensive company. But directly
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Brian Arcese: within their contracts, they have links to inflation. So not
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Brian Arcese: only is the brand strong in the company well- managed,
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Brian Arcese: but you can see directly in the contracts that they
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Brian Arcese: will be able to price at least in line with inflation. So,
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Brian Arcese: that gives you a very strong degree of comfort that
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Brian Arcese: through time if you invest in companies like that, you’ll
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Brian Arcese: be able to compound at least in line with inflation
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Brian Arcese: and earn a real return.
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Sean Aylmer: Are there certain sectors that an investor should look at
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Sean Aylmer: first? So, I’m not sure that it’s an industrialist company, but
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Sean Aylmer: are there sectors for people out there listening and you
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Sean Aylmer: want an inflationary linked return in equities? Where should they
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Sean Aylmer: start looking?
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Brian Arcese: Yeah. So commodities, as I mentioned, it does offer more
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Brian Arcese: of a real- time hedge against inflation. So, commodities typically
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Brian Arcese: run up at least in line with inflation, if not
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Brian Arcese: ahead of it. I mean, oftentimes they may even be
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Brian Arcese: a driver of the inflation itself. So, if we look
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Brian Arcese: either within the energy space for example, there are companies
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Brian Arcese: that one could purchase, whether it’s a traditional fossil fuel
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Brian Arcese: provider or an oil major that may be direct, the
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Brian Arcese: business may be directly linked to inflation or a commodities company,
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Brian Arcese: for example, where commodities broadly tend to be more closely
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Brian Arcese: linked to inflation. So companies like a Freeport-McMoRan, which would
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Brian Arcese: be the market leader or one of the two market
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Brian Arcese: leaders in copper globally. So, those are companies, because the
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Brian Arcese: revenue is really directly linked to the commodity price, offer
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Brian Arcese: more of a real- time hedge against inflation within an
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Brian Arcese: investor’s portfolio.
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Sean Aylmer: Stay with me, Brian, we’ll be back in a minute.
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Sean Aylmer: My guest this morning is Brian Arcese, portfolio manager at
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Sean Aylmer: Foord Asset Management. What about gold companies? And Australia has
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Sean Aylmer: a large gold company, Newcrest Mining, which is under takeover
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Sean Aylmer: offer from Newmont, which is I think it’s Denver- based
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Sean Aylmer: or Colorado-based organisation. In Australia, we talk a lot about gold,
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Sean Aylmer: is that a good hedge against inflation?
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Brian Arcese: So, we invest in gold in our portfolios as well,
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Brian Arcese: though we do so more as a hedge against volatility
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Brian Arcese: and geopolitical risk rather than as a direct hedge against inflation. So,
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Brian Arcese: I think if you look at gold over the long- term,
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Brian Arcese: it has a lower correlation to inflation than some of
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Brian Arcese: the other commodities would provide. So if you wanted to
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Brian Arcese: invest in a commodity directly to hedge inflation, then we
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Brian Arcese: would suggest the commodity like copper for example, or even
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Brian Arcese: some of the fossil fuel providers. We would certainly recommend
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Brian Arcese: investing in gold as well. It’s just that in our
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Brian Arcese: minds and in our portfolios, it’s serving a slightly different
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Brian Arcese: purpose and hedging a different risk, which is general volatility
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Brian Arcese: and/or political risk, both of which are increasing.
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Sean Aylmer: What about real estate? Again, Australians invest in real estate
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Sean Aylmer: in their own homes, we understand that. And then in
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Sean Aylmer: a commercial sense, many of us have money in some
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Sean Aylmer: of the larger real estate investment trusts, but we also
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Sean Aylmer: see plenty of bad news from the REITs (Real Estate Investment Trusts), the property companies
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Sean Aylmer: on the back of higher interest rates and working from home, etc.
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Sean Aylmer: Where does real estate fit into the inflation picture?
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Brian Arcese: I think that’s a great question. Now, it is somewhat
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Brian Arcese: incongruous in that real estate is often cited both as
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Brian Arcese: an inflation hedge and as a bond proxy. Now, obviously
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Brian Arcese: when real estate is wearing its bond proxy hat and
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Brian Arcese: interest rates are rising in no small part because inflation
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Brian Arcese: is high, then valuations come down. You’re obviously discounting future
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Brian Arcese: cash flows at a higher interest rate, and as a result
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Brian Arcese: of that, cap rates rise and the value of property
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Brian Arcese: can decline. Now, that’s really what happens in sort of
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Brian Arcese: the first period of an inflationary environment. But when you
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Brian Arcese: play that out going forward, what you then typically see
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Brian Arcese: is that inflation itself starts to really feed its way
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Brian Arcese: back into rents, for example, and incomes. So, property over
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Brian Arcese: the long-term is a very good hedge against inflation. It
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Brian Arcese: may not feel that way in the initial bouts of
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Brian Arcese: inflation or when inflation is high and accelerating, but over
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Brian Arcese: the long-term , there’s a sweet spot when inflation is
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Brian Arcese: sort of in this 2% to 4% range when real
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Brian Arcese: estate actually outperforms the rest of the listed equity market,
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Brian Arcese: for example, and offers and acts as a real inflation hedge.
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Sean Aylmer: I can’t not ask you, Brian, about tech stocks only
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Sean Aylmer: because of the run they’ve been on in the last
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Sean Aylmer: six months and the fact that Apple’s now worth $ 3
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Sean Aylmer: trillion, I can never get my head around tech stocks.
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Sean Aylmer: They run and they fall fast and sometimes not always
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Sean Aylmer: rationally in my point of view, but how do we
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Sean Aylmer: think about tech stocks in an inflationary environment?
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Brian Arcese: So, I think what we saw last year, so when
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Brian Arcese: an inflation was most acute and we saw interest rates
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Brian Arcese: rising rapidly, so I mean closer to the end than
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Brian Arcese: to the beginning, but certainly experiencing the fastest and most
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Brian Arcese: acute rate rise of the past 40 years. So, that
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Brian Arcese: can be quite problematic for long duration growth companies such
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Brian Arcese: as tech. So we saw the sector underperform significantly during
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Brian Arcese: 2022. Now that rates are nearing peak, we do think
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Brian Arcese: that there are more increases to come, but certainly they’re
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Brian Arcese: closer to peak than they were 12 to 18 months ago, these
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Brian Arcese: stocks have started to perform better, investors have moved back
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Brian Arcese: into long duration, including technology, and we’ve had a tailwind,
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Brian Arcese: an excitement around artificial intelligence.
Now, in our mind, other
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Brian Arcese: portions of the market offer more value than technology companies
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Brian Arcese: currently. It’s been quite a narrow rally and not only
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Brian Arcese: within technology, but in a small subset, sort of six
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Brian Arcese: companies within that technology space that have really driven most
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Brian Arcese: of the return. So, over the long- term, it’s a
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Brian Arcese: fine place to look for investment candidates, but where we
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Brian Arcese: sit today, we do think that investors would be better
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Brian Arcese: served looking in other sectors first.
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Sean Aylmer: Okay. So we’re just wrapping this up. So if we’re
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Sean Aylmer: looking in other sectors in terms of equities, I mean,
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Sean Aylmer: we’ve spoken about commodities and gold companies, but let’s leave commodities
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Sean Aylmer: out, what are some of the sectors that you would
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Sean Aylmer: prefer most?
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Brian Arcese: Sure. So, for us, the energy and material space, which
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Brian Arcese: would include companies like an Air Products, so not directly
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Brian Arcese: linked commodities, for example, comprise sort of 20% plus of
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Brian Arcese: our portfolio. And that’s a very meaningful allocation if you
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Brian Arcese: take for example that those two sectors combined in a
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Brian Arcese: global equity benchmark are only the high single digits. So,
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Brian Arcese: relative to how the benchmark is constructed, we’re quite overweight
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Brian Arcese: there. Now, each of the companies that we invest in
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Brian Arcese: need to be high quality sound investment candidates from a
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Brian Arcese: bottoms up standpoint in their own right. So it’s not
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Brian Arcese: only a top down allocation, but really when you look
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Brian Arcese: at the opportunity set across all sectors today, those are
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Brian Arcese: the ones that are screening the most attractive and where
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Brian Arcese: in our minds, investors should start to turn over rocks
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Brian Arcese: and see what companies within there may be appealing to
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Brian Arcese: them or fit their own investment profile.
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Sean Aylmer: Brian, thank you for talking to Fear and Greed.
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Brian Arcese: Thank you.
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Sean Aylmer: That was Brian Arcese, portfolio manager at Foord Asset Management.
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Sean Aylmer: This is the Fear and Greed daily interview. Remember, this
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Sean Aylmer: is general information only and you should seek professional advice
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Sean Aylmer: before making investment decisions. Join us every morning for the
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Sean Aylmer: full episode of Fear and Greed, Australia’s most popular business
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Sean Aylmer: podcast. I’m Sean Aylmer. Enjoy your day.