Fund manager profile with Richard de Lisle: ‘Invest for the environment you’re in’

The modern US equity market is often seen as highly concentrated and expensive, and there are valid justifications for that, to some degree. 

The S&P 500 has roughly 40% of its total allocation in tech stocks, and its 10 largest names represent nearly two-fifths of the market’s total allocation. In terms of cyclically adjusted price-to-earnings, the US market sits on a 39x ratio, a level comparable to the dotcom bubble, according to data from Barclays.

Comparisons to previous market bubbles then seem tempting. However, Richard de Lisle, manager and founder of the US small and mid-cap equity boutique De Lisle Partners, says the differences are also crucial.

De Lisle has been investing since 1979 and has seen everything from 1987’s Black Monday, the collapse of the dot.com bubble and the global financial crisis.

Certainly, he concedes there were some similarities. The top five stocks in the US are worth almost $16trn (£11.9trn) in market cap, and the US market is tilted towards tech in a way that has never really been seen before, he explains.

But he cautions investors against sweeping comparisons. 

“There’s this wonderful quote from Merrill Lynch’s Bob Farrell: ‘If you live long enough, you will see every type of market once’,” he says. “What that means is that a market can’t repeat itself until it’s gone from your memory, because if you remember it, you’ll behave differently.”

For example, he points to the 1987 market crash. Any investor who was around during that crash is always investing with these downturns in the back of their mind, to prevent getting caught in them again. 

“If I was affected by that, rationally what do I do?” he asks. “Well, when the market was awful last week, maybe I was already selling, so there can’t be a crash today.

“For people in my generation, we almost have PTSD over 19 October [Black Monday],” he tells Portfolio Adviser.

In this sense, he argues many investors who don’t have the benefit of these experiences may have developed misperceptions about the US market.

The curate’s egg of financial markets

“There are so many different markets in the US, to say it’s speculative or expensive is to focus on just one part,” he explains. “You could also, for instance, say house builders are trading on cycle lows, the kind they would usually trade on during a recession.”

Even the dominance of tech stocks, while seemingly like the dotcom bubble, is much different. It’s “not at all” the same as the 2000 bubble, when tech stocks lacked real earnings, he says, because the modern hyperscalers have strong fundamentals and monopolies.

That said, there is speculation in parts of the US equity market. As an example, he points to semiconductor names, which represented 22% of the S&P 500 by summer this year. This is much higher than previous levels for an industry known for its booms and busts.

“Consider that the leading semiconductor company, Micron, peaked in 2000 and you had to wait 24 years to get your money back,” he says. “That I think is people jumping on the bandwagon.”

“People who go chasing the latest trend may do very well for a while,” he concedes, “but they tend to have an inherent behavioural bias, which means eventually they’ll have to give it back.”

In this sense, the US market is increasingly a “curate’s egg” or a market that is “good in parts” and bad in others. As active managers, the aim is to find where these best opportunities are.

For De Lisle, US small and mid caps seem poised to offer the strongest long-term returns, with the lowest risk. This is the asset class the fund was first set up around in 2005 and remains the team’s area of focus, based on the idea that value, more than anything, is the best forward predictor of a stock’s long-term potential.

This set of stocks remains highly compelling, even after decades of investing in the asset class, he says.

While the team’s value discipline and small and mid-cap focus prevents investing in some of the enormously well-performing hyperscalers, there are still opportunities to gain exposure to some of these tech beneficiaries.

For example, he points to John Deere, an American manufacturing company that aims to use AI to automate harvests. It is one of the most “switched-on” agriculture companies in AI, and so is much better positioned than less sophisticated competitors.

That said, he concedes it’s been more difficult for US small and mid caps recently, particularly as rising interest rates and inflation have been headwinds for more domestic names.

He references Build-A-Bear as an example. While one of his top 10 holdings, he spent most of the year selling and reducing his position. Year to date, the stock price is down roughly 60%, according to data from Google Finance (as of 20 October).

“High interest rates and the general political background see the University of Michigan consumer confidence survey at its second-lowest level since it started,” he says. “The consumer is just despairing.”

Tariffs have also been a headwind, he admits, making it difficult to get proper stuffing from regions such as China. 

But even “after throwing all this mud at it”, the stock still has plenty of value. It remains incredibly cheap, with a single-digit P/E multiple. Sales are unlikely to collapse, it remains low-debt and one of the most trusted brands in the US.

Invest for the environment you’re in

This reflects that the common perception of the US market as overvalued and speculative is only diminishing the opportunity set for investors, according to De Lisle.

It also demonstrates how traditional ideas of stockpicking have been thrown by the wayside by macro volatility, he says. 

In recent years, it became popular for fund managers to style themselves as stockpickers who focused on company fundamentals and were unconcerned by market or macro noise. De Lisle argues this developed because investors benefited from a highly unusual market environment for the past four decades.

“The period between 1980 and 2020 was a disinflationary bull market,” he tells Portfolio Adviser. “The yields on bonds went down and down until just before the vaccine was announced, which pushed growth stocks to a higher multiple.

“This created a whole generation of fund managers who could describe themselves as stockpickers because they could pick a good growth stock and sit with it for 40 years.”

In the modern investment regime, with more volatile interest rates and inflation, and deglobalisation impacting supply chains, this thesis no longer holds up.

“You can’t just say that in this sort of market a stock like McDonald’s should go up 20x, because change happens and things go wrong,” De Lisle explains. “Tariffs, blockages, fuel costs all these seemingly random things happen and might affect McDonald’s margins.”

Similarly, judging which opportunities are most attractive should also use a macro-overlay, he says.  

Perhaps the clearest example is energy stocks, to which he had high exposure this year. 

“It was reasonably easy to predict earlier this year that the Middle Eastern problem and the Ukrainian problem would go on for longer than people thought, so a position in energy looked sensible.”

The oil price surged to about $100 in March, but stock prices did not reflect this because the market expected the surge would be short-lived and prices would eventually fall. As a result, he notes many oil stocks were more expensive at the time of writing (19 October) than in March.

There was also a case that rising energy prices were likely to prompt more inflation and higher interest rates, which means it made sense to “hide” in lower P/E stocks that were likely to get thrown around more.

“We’re not taking a view on who is getting the oil out of the ground better,” he says. “That’s entirely top-down analysis.

“Stock-specific valuations are based on how people see the top down,” De Lisle says. “Nowadays, it’s important to invest in stocks that are right for the environment you’re in.”