Freelance Journalist Zilla Efrat – Sydney Allan Gray Investment Forum Wednesday 29 March 2017

There are still pockets of value to be found in the sharemarket even though equities are looking expensive, according to Allan Gray, Morningstar’s top performing Australian equities fund manager over the 12 months to the end of February, and its sister company, Orbis.

Speaking at an investment forum in Sydney last week, Allan Gray managing director and chief investment officer Simon Mawhinney pointed to the extreme gap between the earnings of Australian companies and their market values, describing it as amongst the biggest gaps we’ve had in the history of the local stock exchange.

Mawhinney said earnings multiples were probably lower in 2008, just before the global financial crisis, than they are today. “In the lead up to the GFC, earnings had gone up significantly and were very high relative to historical inflation-adjusted earnings. So at the time, you were paying high multiples for very high earnings. Today, you are paying very high multiples for, arguably, somewhat depressed earnings,” he said.

Dividends have grown

He added that Australian companies were paying out an ever-increasing proportion of their earnings as dividends.

“That’s because investors want them to. Investors can’t get great interest rates from their banks, so they’ve been seeking out yields in the sharemarket and forcing companies to pay out bigger dividends.

“That’s probably the least cynical view of the world. Probably the more cynical and more accurate view is that management is being remunerated according to how the company performs. And we have all rewarded companies paying out more of their dividends with higher share prices.”

But Mawhinney cautioned that companies paying out more in dividends were reinvesting less and less of their earnings in their operations. “So it’s not unreasonable to think that their future growth rate in earnings will be lower than might have historically been the case.”

Finding value

Nonetheless, he said there were still cheap pockets in the Australian sharemarket, especially in the energy and materials sectors, but also increasingly so in other sectors such as consumer staples.

That’s good news for Allan Gray Australia, which describes itself as a long-term, contrarian value manager that focuses on fundamentals. But it also means that Allan Gray’s portfolio has become more concentrated.

“We don’t feel compelled to own some of everything,” said Mawhinney.

“We are channelling more of our client’s money into fewer and fewer cheap sectors in the market and it has resulted in a concentration towards energy and materials. Woodside Petroleum is our largest investment and our favoured oil and gas company. It’s not the first time one particular sector has appeared massively undervalued relative to the broader sharemarket. During the global financial crisis it was the REITS and we invested a similar proportion of our fund in REITS then as we’ve invested in energy shares today.”

The Allan Gray Australia Equity Fund, which has returned 35 per cent over the 12 months to the end of February after fees and has outperformed its benchmark by 2.8 per cent per annum over the last ten years, currently holds shares such as Origin Energy, Alumina, Newcrest Mining, Metcash, AusNet Services, Sims Metal Management, National Australia Bank, WorleyParsons and Austal.

Opportunities offshore

Chris Kanand, an analyst in Orbis’ San Francisco office, perhaps surprised the forum by revealing that the Orbis Global Equity Fund had found good value in technology shares and that these made up about 20 per cent of its portfolio.

A sister company of Allan Gray, Orbis follows the same investment philosophy when investing in global equities and has enjoyed a return of 21.5 per cent net of fees over the 12 months to the end of February 2017, making it Morningstar’s top performing global equities fund.

Kanand believed Orbis had an advantage in analysing technology shares because it operated on the US’s West Coast, where two thirds of North America’s technology companies were located.

He explained: “First, technology moves quickly so being on the ground helps you observe trends. Second, when you are investing in technology shares, you often need to think about management quality. It’s not about buying an asset for, hopefully, a cheap price. It’s more about the company’s long-term innovation profile and being on the ground is pretty informative in that sense.”

Kanand added that investors in technology were often overly optimistic or pessimistic, particularly about near-term trends.

“This provides opportunities,” he said.

For example, when Orbis bought Google during the GFC, investors were concerned about short-term issues such as advertising support in the US. But when Orbis looked at Google with a three- to five-year view, it saw a high quality company which was gaining market share in online advertising and would do even better when economic growth returned.

Kanand said some technology companies were almost like cyclical or industrial companies. Others just offered good value.

Chris Inifer, Allan Gray Australia’s head of retail, closed the forum by saying that both the Allan Gray and Orbis funds shared the same single investment philosophy, focus and excellence in approach.

“While markets are generally expensive, this approach is identifying significant pockets of value and creating great opportunities for our clients,” he said.