State Street Global Advisors (SSGA) head of portfolio management Bruce Apted said Australian growth companies are three times more expensive than growth companies across the MSCI universe.
“The cohort of Australian growth companies are expected to grow 38 per cent on average compared to the global high growth companies at 31 per cent,” Mr Apted said. “While the higher growth is a consideration it isn’t enough to justify the valuation differential.”
The fund manager said the lack of growth opportunities makes the few companies with growth more attractive to investors, particularly in a small market like Australia. He believes the growth anomaly has also been accentuated by the prevalence of low interest rates.
“Many high growth companies tend to have expectations for greater cash flows in outer years and those future cash flows are worth more today if interest rates decline. This is similar to the value of a longer duration bond that is more sensitive to interest rates than a shorter duration bond,” Mr Apted said.
“In addition, easy monetary policy has had a positive wealth effect especially on those with exposure to property and equities encouraging further risk taking within the growth segment of the market.”
There is also a positive feedback loop whereby the success of growth companies gives investors greater confidence to invest further in these companies, Mr Apted explained: “The fear of missing out also plays on investors when they hear about friends and colleagues that have made money by investing in these growth companies and provides greater impetus to invest as well.”
These feedback loops, further fueled by behavioural characteristics such as confirmation bias and overconfidence, can occur for longer than people expect, Mr Apted said, and lead to prolonged periods of distortion within markets.
“As the imbalances build over time and valuations become more and more stretched the risk of investing in these companies increases for investors,” he explained.
While the fund manager admits that growth companies are preferable, they become riskier when they become “excessively expensive”.
“No one wants the fear of missing out to become the pain of not getting out when the growth company that has been priced to perfection hits an inevitable soft patch,” Mr Apted said.
