Freelance Journalist Zilla Efrat – Sydney Allan Gray Investment Forum Tuesday 3 May 2016
Addressing the recent Allan Gray Investment Forum in Sydney, he noted that the market was currently driven by low interest rates, an insatiable desire for yield and an infatuation for investing in companies with growing and stable earnings.
He said real estate investment trusts, infrastructure, utilities, the banks, healthcare, pizza companies and milk formulae producers had done well. At the same time, investors had shunned stocks that were cyclically exposed, such as those in materials, energy, consumer discretionary and, more recently, consumer staples.
“The market has benefited from momentum… In recent years, investors have been happy to pay up for growth companies. Currently the market is paying much more for growth stocks than on average,” said Mawhinney. “The opportunity for value amongst the more depressed sectors is far greater than it has been for a while.”
“Mathematically the continued underperformance of value investing will end. We can’t tell you exactly when, but we can tell you it will and our portfolio is positioned for that reversal.”
Mawhinney said there were certainly lots of opportunities out there for value investors – that is, cheap companies with great assets. “The opportunity for contrarian investors to find deeply depressed companies which can generate long-term value is huge at this stage. There are always a few irons in the fire.”
At present, Allan Gray favours select materials and energy stocks. It is avoiding financials and looking at other opportunities that are disliked by the broader investment community, such as retailers.
Chris Inifer, Allan Gray’s Head of Retail, agreed it was a difficult environment for contrarian investment conversations, with momentum investment styles performing much better. But he noted that momentum had given away a tiny bit over the past three or four months, enabling Allan Gray to strongly outperform over this period.
He pointed to recent research by US academics Marijn Cremers and Ankur Pareek which found that a true contrarian approach with high conviction, coupled with a low portfolio turnover, could lead to long-term outperformance. The study revealed that among high active share portfolios – whose holdings differ substantially from the holdings of their benchmark – only those with patient investment strategies (which hold shares for at least two years) outperform their benchmarks on average. Funds trading frequently generally underperform, regardless of their active share.
Inifer said Allan Gray’s philosophy focused on buying stocks that were “disliked, vilified and unpopular”.
“Our first entry is when the price of a company is much lower than the intrinsic value of the business. But we also acknowledge that the market is not stupid. Someone has made a decision to sell a business for much lower than its worth. There will always be a reason for this and we spend a lot of time trying to find the downside risk and what that reason is.”
If it made sense, the manager bought into the stock and then waited for sentiment to turn.
“This strategy is enduring,” said Inifer. “If you think people are going to all of a sudden become more knowledgeable in investing and make rational long-term decisions, then you shouldn’t invest with us. But what are the odds of people becoming more rational in the way they invest?”
He also noted that it had been difficult to achieve high returns in equity markets in general over the past 10 years.
“The price index shows the market has moved sideways, with investors benefiting only from income of around 4 to 4.5 per cent per year on average. So it’s unsurprising that people are looking to other assets to satisfy their needs and yield an income. Investors are leaving traditional asset classes like Australian equities in droves and are pursuing other forms of investment, such as fixed interest, cash, property and alternative investments. But some alternative investments are unbelievably complex.”
However, he noted that Allan Gray didn’t believe in complex structures. “We believe that we should just do few things and do them well. You can keep it simple – like this idea of buying stocks for less than they are intrinsically worth. In many areas of our lives, it’s what we do. I am yet to meet a person who thinks it is a great idea to pay the full price for anything, but that’s effectively what many people do in the share market and they do it with very little research.”
Inifer added: “You do have to expect that if a manager is going to deviate so substantially from the broader popular market, there is not always going to be outperformance. In fact there have been periods of significant short-term underperformance. But it’s this deviation from the index that creates the opportunity for alpha.
“You can’t expect to perform better than everyone else if you invest in the same way as everyone else. And right now the fund, with its exposure to value stocks is positioned very differently from the market. If momentum investing continues to rollover, as it has done since the start of the year, and value stocks revert to ‘normal’ valuations as we expect, then there is potential for great outperformance from here.”