Dear Investor,
The 2025-26 financial year was another remarkable period for equity markets. At the start of FY26, few would have predicted that global equities would return approximately 15% for the year.i
Markets navigated a succession of risks, including the US tariff war early in the financial year, persistent inflation, the prospect of higher-for-longer interest rates, China's economic slowdown, concerns over private credit and, later in the year, the Iran conflict.
As the financial year progressed, investor attention shifted to the boom in artificial intelligence, with AI-related companies and the capital investment supporting AI becoming the dominant market theme.
Despite the strong headline return for global equities in FY26, the investment landscape remains one of significant valuation divergence. A narrowing group of companies - led by the ‘Magnificent Seven’ technology stocks - trades on valuations we cannot justify. At the other end of the spectrum are businesses, such as European banks, commodity producers and selected small-cap companies, that continue to trade at historically attractive valuations.
For several years, we have highlighted this divergence, likening the market to a ‘barbell’ of valuation extremes. The growth of passive investing has amplified this divergence by directing more capital into the biggest companies, regardless of valuation. That has narrowed market leadership and increased concentration risk for index investors, while simultaneously creating some of the most compelling opportunities for active investors we have seen in years.
We’re pleased to report that the PM Capital Global Opportunities Fund Limited’s (PGF) portfolio returned 32.9% in FY26.
PORTFOLIO CONTRIBUTORS IN FY26
PGF’s portfolio return in FY26 was driven by our investments in European banks, copper producers and gold companies.
We continue to view European banks as significantly undervalued compared to Australian banks. UK and European banks may benefit over time from fiscal stimulus in Europe, a more supportive regulatory environment, continued M&A activity and relatively attractive valuations, although outcomes will depend on broader market, macroeconomic and geopolitical developments.
Within commodities, we remain positive on the long-term outlook given constrained minerals supply and the likelihood of a higher inflation environment. We reduced our exposure to copper producers during FY26 as valuations reached our targets. We continue to hold gold producers, where we believe valuations remain attractive. Our longstanding investment thesis is that valuations of gold equities do not sufficiently reflect underlying gains in the gold price over the past few years. After two decades of underperforming the gold price, gold equities could have much ground to make up.
Healthcare is an emerging portfolio theme. Valuations of some leading US and Australian healthcare companies have more than halved from their peak. Healthcare is a complex part of the market because it is influenced by government regulation. One of our key healthcare positions – Royalty Pharma – delivered strong returns in FY26. Royalty Pharma invests in a portfolio of royalties on pharmaceutical drugs. We believe royalty funding has good long-term growth prospects as more drug developers, and even multinational pharmaceutical companies, fund drug development by raising capital from royalty funders, such as Royalty Pharma, which leads its field.
Overall, the PGF portfolio trades at an average Price Earnings (PE) ratio of around 12 times, which is well below the average PE of the MSCI World Index (AUD).ii Several key portfolio positions, such as our European bank holdings, trade on single-digit PEs. We continue to view companies within the PGF portfolio as significantly undervalued relative to global equity indices, and against historical valuations for companies in their sector.
FY27 OUTLOOK
We believe three issues will dominate markets in FY27: inflation, artificial intelligence and government spending.
1.Inflation
Before COVID-19, we identified inflation as a key risk for the decade ahead. Years of ultra-low interest rates had created a fragile economic environment, with rates approaching zero in many countries and German Bunds even trading at negative yields for a period. We anticipated a major turning point in inflation this decade that would reshape investment markets and portfolio composition. In that environment, investors would need to own businesses that could perform as inflation and interest rates moved higher.
Our view on inflation was unpopular at the time. With interest rates near zero, the market was more concerned about disinflation or deflation than inflation. We saw things differently. In the short term, we expected ultra-low interest rates to stimulate economic demand and drive prices and interest rates higher. Longer term, we saw inflation headwinds. These included rising energy costs, manufacturing onshoring as companies returned more production to their home country and excessive fiscal spending worldwide, which we discuss later.
Our longstanding investment thesis of persistent ‘sticky’ inflation and higher-for-longer interest rates became apparent in FY26. Markets accepted that central banks are struggling to return inflation sustainably to target, marking a significant shift after four decades of generally falling bond yields.
We continue to view inflation as a dominant theme this decade. The ongoing economic decoupling between the US and China could add to inflationary pressures. While globalisation helped reduce inflation over recent decades by encouraging companies to manufacture in lower-cost regions, the reversal of this trend – through deglobalisation, reshoring and the rebuilding of supply chains – could increase costs as production moves closer to home markets.
Geopolitical tensions are also adding to inflation risks. The Iran conflict, alongside broader instability in the Middle East, highlights the vulnerability of global energy supplies and the risk of higher oil prices. A potential escalation involving China and Taiwan later this decade could have significant implications for inflation, particularly if disruptions to the Taiwan Strait affected semiconductor supply chains. The recent volatility surrounding the Strait of Hormuz demonstrates how restrictions on critical trade routes can quickly impact energy prices and broader inflation expectations.
The PGF portfolio, through its exposure to banks and commodity producers, remains well positioned for an environment of higher inflation and rates.
2.Artificial intelligence
The investment boom in artificial intelligence (AI) infrastructure was a defining theme of FY26, driving economic growth expectations, corporate investment and equity market returns, particularly in the US. We expect AI to remain a key market theme in FY27 as investors look for evidence that the capital expenditure flowing into AI is translating into productivity growth and stronger corporate earnings that justify high valuations of AI-related companies.
We believe AI has the potential to be a transformative technology with applications across almost every industry. However, investors must distinguish between a compelling business opportunity and an attractive investment opportunity. The two are not always the same.
Many of the world’s highest-quality businesses – including several mega-cap technology companies leading the AI revolution – are companies we admire. They possess valuable competitive advantages, strong balance sheets and have significant growth opportunities. SpaceX is another example of a company with exceptional technology. However, the price paid for even the best businesses ultimately determines investment returns.
Apart from briefly owning Alphabet (owner of Google) during FY26, which we sold after its valuation quickly reached our target, PGF does not own the ‘Magnificent Seven’ tech companies, SpaceX or other highly valued AI-related businesses. Our decision is not based on a view that these are poor businesses; rather, we believe valuations in parts of the AI ecosystem are too high.
We are reminded of the Technology, Media and Telecommunications (TMT) boom of the late 1990s, which culminated in the dot-com crash in 2000. The internet was a genuinely transformative technology, but investor enthusiasm drove valuations of many TMT companies to unsustainable levels. When the bubble burst, many of these companies experienced significant declines, with some falling for the best part of a decade. Investors often underestimate how far and for how long companies can fall when booms turn to bust. During that period, some of the strongest investment returns came from companies in the so-called ‘old economy’ that were overlooked during the internet boom.
The lesson from history is that transformative technologies can create enormous economic value, but investment returns ultimately depend on the price paid. All investment booms eventually mature, and at some point the AI investment cycle will slow, whether through a gradual normalisation or a significant correction. While it is impossible to predict the timing of these turning points, a sharp decline in AI-related valuations remains a risk we are closely monitoring in FY27.
3. Fiscal spending
We view government policy as a ‘sleeper’ issue for markets in FY27. For too long, investors have largely ignored the consequences of reckless government spending, rising public debt and policies that increasingly transfer capital from the private sector to governments. Debt levels in developed economies have reached staggering levels, yet equity markets continued to rise in FY26.
That complacency may be tested in FY27. Government spending, debt accumulation and policy settings are increasingly important market considerations. These factors can be reflected in higher bond yields, which put downward pressure on asset valuations and increase the cost of capital across the economy. We believe investors will pay closer attention to fiscal sustainability in FY27, as it has the potential to become a defining theme for markets in the years ahead.
Australia highlights the challenge. Despite a cost-of-living crisis, federal and state government spending has continued to expand, contributing to inflationary pressures and complicating the Reserve Bank’s path towards lower interest rates. The consequence is that fiscal policy, rather than helping ease economic pressures, is keeping inflation and interest rates higher for longer.
Rather than make tough spending cuts, the Australian government announced higher taxes. In its 2026-27 Federal Budget – which we regard as the nation’s worst budget – the government announced a reduction in the Capital Gains Tax discount, changes to negative gearing and the taxation of trusts. Taken together, these changes will increase the tax on capital and reduce economic incentives for individuals and companies.
Australia could be at a major inflection point in its wealth and per-capita income. Markets, however, are yet to reflect these risks through bond yields and equity valuations. This problem is not unique to Australia. The United Kingdom and some European countries have damaged their economies through excessive government spending, over-reliance on social welfare and a succession of political leaders.
We believe these risks will become a bigger consideration for markets in FY27. The culmination of decades of rising government debt, poor public policy and deteriorating government performance in many countries has created a significant threat for economies, consumer spending and corporate earnings growth, which markets at some point will be forced to recognise through lower valuations.
CONCLUSION
Our core investment thesis on markets remains unchanged. Central banks will struggle to lower inflation, and interest rates will be higher for longer. Large valuation dispersions will remain: a narrowing group of significantly overvalued companies at one extreme and many undervalued companies at the other.
Navigating these valuation dispersions in FY27 will require an active investing approach in the context of a long-term investment framework. While valuations in parts of the market are attractive, we suggest investors adopt a more cautious approach in FY27.
As always, valuation matters most. More than ever, a disciplined, patient investment approach is required. We have long argued that the best form of risk management is owning undervalued assets. We would like to think PGF’s portfolio performance in FY26 demonstrates the benefits of owning high-quality assets when they trade significantly below their intrinsic value.
On behalf of the PGF team, we thank the PGF Board and our fellow PGF shareholders for their continued support. We encourage you to follow PM Capital’s investing insights (www.pmcapital.com.au/insights) in FY27 and beyond.
Yours sincerely
Paul Moore
Chief Investment Officer
PM Capital
i PGF’s benchmark, the MSCI World Net Total Return Index (AUD), returned 14.8% over one year to 30 June 2026. Source: MSCI World Index (AUD) Fact Sheet. 30 June 2026.
ii The average PE for the PGF portfolio is at 30 June 2026. The average PE for the MSCI World Index (AUD) was 24.57 times at 30 June 2026. Source: MSCI World Index (AUD) Fact Sheet.
