Group's 'survival of the fittest' approach will focus on companies in troubled sectors that have powerful cashflows or that are capital rich
Sarasin has added a fifth theme to its EquiSar Global Theme fund, that of using balance sheet strength and credit quality to select equities.
Guy Monson, chief investment officer of the group, said the theme, dubbed the survival of the fittest, focuses on the strongest companies in an injured peer group ' those with powerful cashflows or that are capital rich.
The addition of the theme to the £101m fund ' alongside the themes of pricing power, corporate restructuring, e-business and aggressive automation and oil ' comes against a backdrop of what Monson calls an unprecedented credit crunch.
In such times, it is only the strongest companies that will be able to tap the credit and equity markets to raise cash, giving them a significant ability to increase market share against weaker rivals.
The reason for these conditions arising is simple, Monson said, with investors hurt by unparalleled levels of defaults.
'The scale of bond defaults reported by Standard & Poor's in their 2001 report was extraordinary,' he added. 'Some 216 issuers defaulted on a breathtaking $116bn of debt, representing more than 4.1% of corporate bonds issued.
'The average recovery rate for investors holding defaulted bonds was also just 21 cents on every dollar, an all time low, according to Moody's.
The latest numbers suggest the problem is worsening from here, with a further 94 issuers defaulting on $33bn of bonds in the first quarter, led by Kmart and Global Crossing.'
The second quarter, Monson said, could be even worse. 'While it is normal to see bankruptcies and defaults rising sharply just as a recession ends, the scale we are seeing today is quite unprecedented,' he noted.
Investors are feeling bruised after more than a decade in which equity has been aggressively withdrawn and replaced with corporate debt. Since 1984, the value of corporate debt in the US has risen to $3.6 trillion. In the same period, equity worth $1.4 trillion has been withdrawn.
With such a climate of caution among bond and equity investors, who are behind bondholders when a bankruptcy occurs, the equity market has been quick to punish companies asking for funding.
Monson gives the examples of Nortel and Ericsson. 'Where, out of necessity, companies have approached shareholders, they have found, in most cases markets to be extremely hostile,' he said.
'For example, on the announcement last month of its intention to raise $2.5bn, Ericsson saw its stock fall 27% in just 36 hours. Nortel suffered a similar fate a few days later as it approached investors for $2.5bn.'
The implications for equity investors are stark, Monson believes. 'We will start to see a strong credit rating become one of the key drivers of strong equity returns,' he argued.
'At first sight this might seem obvious but remember, for most of the mid and late 1990s, a booming equity market meant funding for new issues and many secondary offerings was effectively free.
'In this hostile credit environment, we should see the strong companies getting stronger as they consistently take market share from their financially weakened peer group.'
Monson draws a parallel between the US market today and the Japanese market in the mid 1990s.
Low nominal interest rates, retail price inflation close to zero and producer price deflation are all problems Japan faced. At the same time, the Japanese market was overvalued.
'A similar effect is making itself felt in Western markets and will, we believe, provide one of the greatest opportunities for active managers to outperform the main indices.
Put simply, we are looking for companies that can effectively use their superior balance sheet strength and lower cost of capital to outperform their peers.'
Consequently, Sarasin has created a portfolio of companies that satisfy the criteria of the survival of the fittest theme, including Portugal Telecom, SBC Communications and Ricoh. Monson, believes, it could soon be time to buy into Nokia and Cisco, both of which are leaders in 'injured' peer groups.
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