Did you miss our October 2019 Allan Gray and Orbis Investment Forums? Don’t worry it’s not too late. You can now watch the recording of the webinar at your leisure, or read the transcript. See our Analysts and Portfolio Managers discuss the current investment environment, our Funds and where we are finding opportunities. CPD points are available for advisers who register to watch the webcast. Watch the webcast now or if you prefer you can read the transcript below:

Webinar transcript

Chris Inifer:

Wonderful to be back in Sydney. The venue is amazing as it always is. So congratulations to the team for putting together such a great lunch. Welcome to all those that have live streamed as well. We haven’t got you lunch. Unfortunately, we didn’t send you a sandwich, so you’ll have to do it from the comfort of your offices or your homes, but we do hope you enjoy today’s session. We’ve got some fantastic speakers lined up that I’m sure you’ll get a lot out of.

Chris Inifer:
We do value your questions. We think they’re really useful and constructive they don’t help just you and your clients, but also all the other people in the room and those live streaming. For those in the room, if you’d like to participate in the Q&A, which will be held at the end of the presentations, then please log on to slider.com type in #allangrayorbis. And we’d encourage you to leave your name when you ask the questions because as is always the case we’ll answer the ones that we feel good about and will leave the rest to a later point.

Chris Inifer:
We would encourage you to put your name against those questions. We will try and deal with as many as possible. For those live streaming there’s a little blue tick just above or blue arrow just above the video, you can click on that and ask a question at any point in time. For those that have dietary requirements, please let the staff know. That would be very helpful. We don’t want anybody experiencing a mishap. I didn’t bring an EpiPen so please let the staff know if you do have any requirements.

Chris Inifer:
CPD points will be awarded to you tomorrow. And the surveys and questionnaires or surveys, sorry and presentation will be sent out to you this afternoon. We do value the surveys. If you can take the time to complete them, it does help us to continue to improve these events every year it grows. We’re really pleased that you’ve joined us today. We know you have a lot on your plate. FASEA is occupying the mindsets of many of you, changing business valuations, legacy revenue streams to deal with, so we appreciate you have a lot on your plate.

Chris Inifer:
It’s been an interesting time for us as a business over the last 18 months. We’ve underperformed quite meaningfully in our portfolios. So you’ll get some good explanations as to why that has been the case and what you can look forward to in the future, so see if this thing works today. There we go, it’s working slightly as the slider chart. I thought it’d be worth just revisiting what we do for those particularly that are new in the room. For many of you, this is old hat. It’s a pictorial, a graphical representation of buying low and selling high, which is everybody’s dream. But the reality is, it’s quite difficult to do.

Chris Inifer:
We tend to buy things that are experiencing challenges, difficulties, whether it be mismanagement, or perhaps a failure on a product or perhaps it’s a collapse in a commodity price. Could be a whole range of things that causes or creates the opportunity for a business to be bought for much less than you believe it to be worth. And that’s that first dot on the left there. So we’re buying at meaningful discounts to the broader market. We believe that that only happens or that opportunity only prevails when there is something wrong occurring in that particular business. And then we take a very long-term view on owning that business.

Chris Inifer:
We typically own our stocks for four to seven years. Some have been in there for much longer periods of time. In a perfect world, it would be good to be done and dusted in 12 months, walk off with the CGT discount and go and buy something different, but it doesn’t always work that way. When the businesses are experiencing challenges, you do have to take a very long term approach. And you need to be very disciplined about when you get in, you have to be equally disciplined about continuing to buy through the troughs, and then you have to be highly disciplined about when you get out. And that’s that far right dot.

Chris Inifer:
For those in the room that aren’t familiar, that’s what we do. We only manage money one way, this singular long-term contrarian approach to managing equities. What it results in is a portfolio that’s meaningfully different to the broader market, and that doesn’t matter whether you’re talking about Allan Gray in the domestic portfolios or Orbis on the global equity portfolios. Why should you pay to look the same? Active management is under enormous scrutiny in the industry today, we need to be different, not for the sake of it, because that’s what results in very different performance to the broader market.

Chris Inifer:
This is a chart of the top 10 stocks in the Australian space. You can see the weight of those stocks in the market. And you can also see the weight of those stocks in the average large five or the average of the largest five fund managers in our market. What’s noticeable is those percentages are very similar to one another. We only are in three stocks, NAB, ANZ and Telstra. NAB and ANZ we’ve owned in different proportions since about 2011, and we built the position of NAB more recently, perhaps Suhas will talk to that a little bit later. And Telstra is the more recent addition over the last 18 months or so.

Chris Inifer:
Then what you also see is 88% of the fund is outside the top 10. So you do end up in a dramatically different looking portfolio. How that’s made available to you as advisors and your end clients? Well, it’s in a multitude of ways. As it applies to Allan Gray, there’s three options, you can invest through the Stable Fund, which is our cash and shares very conservative strategy that will never be more than 50% invested in shares. You can invest via the Balanced Fund, which seeks to take advantage of Allan Gray for the domestic capability for equities and fixed income. And Orbis’s global capability in equities, fixed income and commodities. So if you’re looking for a de-risked way or a lower risk way of accessing contrarian investing, perhaps those two vehicles are things you could look at.

Chris Inifer:
Then of course, we have our flagship equity fund that many of you have been familiar with in more recent years, and that’s available in both the class A and class B, with the class B being a zero base fee option. So if you looking for the ultimate alignment of interests, well, I guess that’s possibly it for you. From an Orbis perspective, you have the Orbis global equity strategy, a fully invested offshore approach that Ben and Charlie are going to talk to today. And you have the Orbis Balanced Fund, which allows you to access pure offshore strategy, so it’s equities, fixed income or commodities purely from abroad with no domestic Australian exposure.

Chris Inifer:
Then late last year, we thought it’d be a great idea to launch into the platform space, people thought we were a bit strange and that wasn’t the smartest thing to do. It was challenging because it was a soft launch at that point in time. We figured we didn’t have all the answers at that point in time. We probably don’t today. I think as an example, when we launched it, we thought having a curated list of around 60 or 70 funds would be a good idea and people would appreciate that. Turns out you don’t care. Turns out you just want to use what you want to use. So we’ve made some changes and some improvements and one of those is to really expand the list. We now have north of 350 funds, ETFs, LICs, managed funds, shares TDs cash et cetera.

Chris Inifer:
So it is a fully functioning platform that we think has been built for the end investor in mind, but with all the functionality that an advisor would need. And so now you can access all of these things through Superannuation Pension and Investments. The principles upon why we did it remain unchanged, though. We wanted to ensure or provide access to the same in a very equal and fair way. So we felt it didn’t matter whether you’re a large practice, small practice, big dealer group, little dealer group, advised, not advised, should have access to exactly the same thing, always and forever. We felt equality was important and that people shouldn’t be penalised for tenure. In other words, it shouldn’t matter whether you’ve been in a platform for five minutes or 15 years, your price should be the same.

Chris Inifer:
Equality was particularly important. And obviously price is important too. We wanted people to be able to control the price they pay, but not be hemmed in or channelled into a particular segment or have very limited choice. We felt that we will give people real control, you choose what you want to choose, but understand that the choices you make will influence the fee that you pay. And then if you’re going to do that, well, then I think the key is to ensure that people fully understand what they pay. So we did build a tool late last year, we’ve revisited and rebuilt it, the team spent a lot of effort and energy on it. And I think it’s come up pretty good I’d encourage you to have a look at it later on today if you get the chance. Log on to the website, run through some scenarios, run through what client portfolios may or may look like and do a price comparison.

Chris Inifer:
One of the things we really wanted to do was to make sure that Allan Gray was as cheap as possible. That you couldn’t buy Allan Gray funds any cheaper elsewhere than you could directly through us, regardless of your tax structure, whether it’s Super Pension, or Investment. So that’s our black circle there. Should be very cheap. And we think we’ve created something very cheap in that space. In order to expand and to go into slightly different investments bit more choice, then you get into the grey area, which is slightly more expensive than then the red’s a little bit more expensive again, but it’s really up to you what you choose. But understand that we will then ensure that you understand what the minimum you have to pay is and what the maximum you will pay is, and then provide you with the actual dollar figure that you will pay based on the dollars that you have entered.

Chris Inifer:
What does it look like? Well, this is what it looks like. And we’ve run a scenario up there, we put a few hundred thousand dollars in, we’ve said, “Well, the maximum you’re going to pay is around $1,040 based on that scenario, and the minimum would be $643. The actual figure you’re paying is $790, or 0.26%. But you can run your own portfolios and doing your own experiments and see what it might come up with for you. We believe it’s a really compelling pricing structure, particularly for the lower-end clients. We think we’re pretty competitive even in the higher end, but particularly, we wanted to look after the majority.

Chris Inifer:
That’s my introduction done. At this point in time, I’m going to introduce Charles Dalziell and also Ben Preston. Charles has recently joined us and by recently, I say that in about the last year or so, but he ran money for Maple-Brown Abbott for over 20 years as a portfolio manager and analyst. He’s joined us in the role of investment director for Orbis. Charles is going to run through value versus growth where we’re seeing opportunities and risks in the broader market. And then Charles will introduce Ben Preston.

Chris Inifer:
Now Ben’s out from London. He arrived in Melbourne 5:30am yesterday morning. Pretty impressive effort Ben. He had some decent sleep hopefully and he should present beautifully today. Yesterday was his warm up, so I’m sure he’ll do an extraordinary job today. Is that right Ben? A nod of the head and the thumbs up. Thanks very much. So Ben joined the firm despite his youthful looks over 20 years ago, joined in 2000. He holds a masters in mathematics from Oxford University. He’s a Chartered Financial Analyst, he’s a portfolio manager for the global equity strategy as well. But initially, please join me in welcoming Charles Dalziell.

Charles D.:
Good afternoon, ladies and gentlemen, thanks very much for coming. Today, I’d like to tell you why it’s an exciting time to be a contrarian investor. For the last 18 months or so, global markets have been primarily driven by high momentum growth stocks and low volatility defensive shares as investors have flocked to perceive safe havens in a time of geopolitical and economic uncertainty. This market environment has created some extreme value dispersion between those sectors and the rest of the market, which has been tough for Orbis being a manager with an eye on intrinsic valuations. But it’s also created some wonderful opportunities for us.

Charles D.:
First of all, we’ll give you some colour around the last 18 months in particular, but first of all, I’d like to address something that’s quite unique to us for the last 30 years. For the first time our 10-year Alpha has dropped below zero. This is worrying for us and it’s worrying for our clients and the last 18 months has been quite difficult and we’ve experienced one of our biggest drawdowns in our 30-year history. But the question is why hasn’t our longer term performance been strong enough to withstand the drawdown that we’ve had over the last 18 months? It’s not unprecedented within our group, in fact, our sister company, Allan Gray in South Africa, over its 45-year history has had one period where their tenure offer has gone negative. And that was during the inflating tech bubble in 1998, in South Africa.

Charles D.:
The other thing I’d like to point out on this chart is that Allan Gray in South Africa and all of us have had a remarkably similar experience of the last decade or so. So what’s been going on? What’s really been driving that longer-term performance? And the answer is primarily that it’s been a very difficult time for value managers around the world really for the last 13 years. This chart shows you the performance of value shares relative to gross shares, and by value shares, for simplicity sake, let’s say cheap stocks relative to gross shares, which we might call expensive stocks over the last 94 years. And you can see for 80 years from 1926 through the 2006, you could beat the market by simply buying the cheapest shares in the index. And that was a pretty consistently good strategy.

Charles D.:
But over the last 13 years since 2006, growth’s very much dominated. Which has created a very challenging environment for value managers. In fact, Bloomberg counts 290 value funds that have gone out of business in the last 10 years. But it’s also meant that a whole generation of fund managers has now emerged that have only really seen one style of investing win. And a lot of those experts have now come out and said that value investing is dead. But if you look at the history of value and growth, you can see that they’ve been at least eight other periods where value has significantly outperformed growth in the past. And if you’ve been lucky enough to invest in value at those times, you’ve been extremely well rewarded in the past, as you can see, on the right-hand side of that chart.

Charles D.:
The interesting thing is, in all of these periods, they have occurred either during periods of extreme economic stress. Four of them happened to happen during the Great Depression. Two happened during the oil shocks of the 70s or during equity market bubbles and we’ve highlighted there the TMT bubble in the late-1990s, and the Japan bubble in the late-1980s. So what’s going on today? Well, history will no doubt give it a name, but given the amount of money that’s been created over the last 10 years, perhaps we could call it the money bubble.

Charles D.:
What we’ve found is that there’s been a massive dislocation that’s occurred, particularly over the last four years. And this chart turns the value growth chart upside down. So when the red line’s going up, growth’s outperforming, and when the red line’s going down, values outperforming. And you can see from 2000 through to 2006, value had one of its best five year periods or six year periods in its 94-year history relative to growth. It was a great time to be a value investor, post the popping of the TMT bubble. And in 2006, everybody wanted to be a value investor. Everybody was quoting Warren Buffett and they were the disciples of the value style of investing.

Charles D.:
But after 2006, growth really went on a tear. And for at least eight years, that was entirely justified. If you look at the blue line, the blue line shows you the relative earnings performance of growth to value. So for the best part of 10 years, you saw the emergence of Amazon, Apple, Google, Microsoft, the profitability of those companies, and the profit growth of those companies certainly justified the performance of growth stocks over that first eight years. But look at what’s happened since 2015, there’s been an enormous gap open up between the continued price performance of growth shares over value shares. But in terms of profitability, you can see there’s been very little difference between the two groups. And that’s created an enormous valuation gap and dislocation between economic fundamentals and price, which we think is extremely dangerous to the owners of those stocks, but also creates some fantastic opportunities for fundamental investors like Orbis.

Charles D.:
Another way to look at those dispersion is to look at the expected return of the cheapest half of the market relative to the expected return of the most expensive half of the market. And you can see over 30 years there have been a number of times when the spreads have been extremely wide, and they’ve really been wider than they are today. And therein lies the opportunity for a firm like Orbis. But let’s look at the last 18 months or so. As I mentioned at the beginning, the markets have really been driven by high-momentum growth stocks and low volatility defensive shares. But what price are you paying for that safety today? What price are you paying to feel good about your portfolio and feel safe in this economic environment?

Charles D.:
This blue line just shows you the MSCI low volatility index against the MSCI value index in the orange. And you can see there’s been a vast difference in the relative performance of the last 18 months. But when you look a bit deeper, and we’ve tabulated 10 of the best known low volatility stocks in the market today and you’ll recognize the names. There’s Coca Cola, there’s Johnson & Johnson, there’s McDonald’s, there’s PepsiCo, there’s Unilever, household name in most cases. But what I’d like to point out to you is that these stocks on average are trading at 33 times earnings.

Charles D.:
Now 33 times earnings is the sort of multiple you would only pay for a very high quality fast growing company. It’s not the sort of model where you pay for a portfolio of stocks that have only managed to grow revenues by 2% per annum over the last decade. These are slow-growing, boring companies, but we’re paying extremely high multiples to feel safe within them. Compare that to the Orbis global portfolio, it’s on 15 times earnings. And it’s delivered 9% per annum growth over the last decade. So you get more than four times the level of growth for less than half the price.

Charles D.:
It’s quite extraordinary just to feel safe, just to avoid any sort of disruptive economic or geopolitical risks today. The other thing I’d like to point out to you is while these defensive businesses have been so slow going, management have only been able to grow earnings per share over time, by heavily leveraging the balance sheet. So they’ve been borrowing money and buying back their own stock. And what you see today is that most of these companies have extremely leveraged balance sheets, more than twice as much debt as equity today. That creates a large amount of financial risk, but it also means that their ability to continue to grow by doing these buybacks is limited from here. That lever they’ve been pulling on for a number of years now is pretty much finished. And the balance sheets we have in our portfolio are far stronger, net cash in a lot of cases.

Charles D.:
But hold on, say the growth manages this time, it’s different because rapid technological change has led to a quantum shift to growth investing. Value investing won’t work in this technological environment because you can only invest in the companies that own the rapidly evolving technology. Every other company will have a competitive advantage eroded away over time. But is this true? Is technology evolving faster today than it has over the last hundred years? One way to test this theory is to look at productivity growth in the US. So if technology is evolving, and if it’s genuinely useful, surely it’s improving productivity growth within the economy over time.

 

Charles D:

And what we’re charted here is just US productivity growth as measured by US GDP per capita since 1960, so 60 years of productivity growth, it’s been incredibly consistent over that 60 year period at about 2% per annum. We’ve highlighted in the red the post-GFC period and this is the period where value has beaten growth. Productivity growth has only been 1.5% over that period, so 2% over 60 years and 1.5% in the past decade. Just prior the GFC, productivity growth was actually 1.8% in a period where value was beating growth. So the argument that technological change is more rapid now that in the past, we would argue strongly against because who is to say that commercial air travel, television, personal computers, mobile phones and the internet are less productivity enhancing to our economy than Facebook and Netflix. (Audience laughs). Hey I finally got a laugh on that. I quite like that joke because my son is supposed to be doing the HSC and I know well enough that Netflix is doing nothing for his productivity heading into his exams. (Audience laughs). At that point I’ll hand over to Ben Preston who’ll give you some more flavour around the numbers.

Ben Preston:
Good afternoon everybody. Thank you for having me in Sydney, beautiful city. So it says here “in contrarian thinking, invest differently”. The encounter I had with a contrarian investor embarrassingly enough was at my interview with Orbis, which is coming up to 20 years ago and they asked me which stock I would buy today to get a good return in the years that followed. This was in February 2000, very close to the top of the tech, media and telco bubble which was raging at the time. And my pick was Vodafone which is the UK’s largest telecom provider. It had been tremendously strong, I thought it was going to take over the world. As a 23 year old, I had looked down the list of stocks in the Orbis Global Equity portfolio. It was full of food producers and cement makers. All these old economy stocks which were bound to be left behind. Anyway, I look back and Vodafone had been priced at £4 per share at the time of that interview nearly twenty years ago. Today, its £1.58.

 

Ben Preston:

The reason I mention that is because I think it’s a similar environment that the stock market had been driven then, as it has recently by one particular type of stock which had done very well and captured the attention of investors. And left other types of stocks, perfectly reasonable businesses, at valuations which were inappropriately low in our view. So I’m going to talk about three things today, firstly to address and review our performance briefly. Then to talk about how we’re positioned today, how our contrarian thinking has led us to the stocks that we have. And then thirdly to finish with a couple of examples of shares that we own and think are good value today.

 

Ben Preston:

To start with the performance, it has been a tough period as you’ve heard from Charlie there. As the MSCI World Index has returned 9 percentage points over the last year, Orbis Global Equity Fund has fallen well short of that. It’s well below our standard and obviously it’s been a tough period. So hard has it been over the last 12 months that that period has dragged our 3, 5 and even the 10 year track record into underperformance for the first time. Since inception, we’re still well ahead. Obviously those longer term performance periods weigh heavy on us.

 

Ben Preston:

If that’s the cloud, then the silver lining is the valuations that it has left us with today. Typically our deepest periods of underperformance are times in the market where valuation dispersions are widening and then as those reverse, we tend to have done quite well. So the good news is that we have been here before, in performance terms. This chart shows our cumulative, relative performance since inception in 1990. When the chart is sloping upwards then that’s us outperforming. When the chart is sloping downwards, that’s us underperforming. So the most recent period where you see a deep underperformance of 19% is large.

 

Ben Preston:

We have had similar drawdowns in the past. In fact, if you look back there was one at the peak of the dotcom bubble when that interview anecdote about Vodafone took place. You can see what happened next. I’ve never been given quite the credit I deserved for what happened after that. Charlie talked through the value growth dispersion that we’ve seen in markets recently and I’ve got a similar table here….shows those periods of underperformance that we’ve just charted and goes through each of them to show what the depth of the underperformance was for Orbis Global Equity Fund relative to the stock market average and then what happened next as those valuation dispersions restored and went back to normal. Obviously there’s no guarantees but you can see that in all of the times in the past where we’ve had an underperformance of 10 percentage points or more then the subsequent 1, 2 and 3 year performance has been rewarding for those investors that were fortunate enough to have invested or stuck with us at those times.

 

Ben Preston:

To delve a little bit deeper into the performance, we can break down our portfolio into shares that were relative winners, so the ones that outperformed, and stocks that were relative losers that underperformed. That doesn’t mean that they lost money in absolute terms. It just means that they underperformed the benchmark index. So if you look all the way back since our inception, you can break it down and see that typically we’ve had about 65% of the capital in winning shares or outperformers and the minority in underperformers. Even when we are doing really well, we’re going to get a lot of mistakes or shares that underperform.

 

Ben Preston:

So the important this is the ratio and obviously how well the winners do and how badly the losers do. If you compare that to what’s happened over the last 18 months, then you can see where things have changed. So for a start the most striking thing is that the percentage of our portfolio invested in stock that turned out to be winners is well below where it’s been in the past. When you go through a period of tough performance, it’s natural to look at the losers and we’ll do that in a minute. But I think the key thing from this chart is that you always have a fair share of stocks that lose and the amount of the loss in the last 18 months has actually been quite normal. Where we’ve really suffered is the absence of winners and the performance of the stocks that we’ve had that have been winners have not won by as much as historically we have experienced. And that’s very much to do with what Charlie was talking about.

 

Ben Preston:

The areas of the stock market that have done very well have typically been the areas where we have found less attraction and therefore we have not participated to the degree that the overall market has. So to take a deeper look at some of those detractors from our performance, what we’ve done here is plotted the main detractors. Each of the numbers here shows how much performance each of these stocks detracted from our overall portfolio. We’ve coloured some of them green and some of them red. We always will have our fair share of losers, the important thing is that we are honest about the stocks where we have made a mistake or there’s been a fundamental impairment or we must go and sell those versus other shares that may have just underperformed temporarily where things are just as attractive on a fundamental basis and in those cases we will add more capital as the share prices come down. We’ve coloured in green the ones that fit that pattern where they may have underperformed but we’re still enthusiastic.

 

Ben Preston:

You can pick out a couple of examples there. Netease which is one of the largest online gaming companies in China. XPO Logistics which is a US logistics company had a speculative short attack against the shares nearly a year ago which accounts for much of that underperformance. Having reviewed the analysis in that report, we felt it to be not credible and actually bought more shares. The management team also started a big company share buyback and the shares have nicely appreciated since then and we have taken advantage of that by reducing the position. But those who want examples of shares that we’ve added more capital to over the last period then we’ve added 8.5% of our portfolio to those stock which had underperformed. And in the red, we’ve got the opposite. There are shares which have underperformed and where we’ve actually concluded that fundamentals have been impaired.

 

Ben Preston:

The obvious example would be PG&E. That was the Californian electrical utility which was responsible for some of the wildfires that were there last year. It was a clear impairment of their fundamental value. We sold and that decision has proven wise with the benefit of hindsight. Symantec, we misjudged the quality of the management team. We also have sold our shares and that’s proven to be a good decision with the benefit of time as well. So if you separate the losers in the portfolio to the ones where we’ve really got it wrong and felt we have to change our mind, that was only 4.5% detractors and there’s actually a greater share where we believe that the stock market has been against us and in terms of the sort of trends that have been prevalent and we’ve been able to add more capital to those names.

 

Ben Preston:

So that leaves us with a portfolio that looks like the following. This is our top ten holdings today. And you can see that’s very different from stock market average. There are none of the likes of the Microsofts and the Apples that really have really led the tech charge. Or the defensive Coca Colas and the McDonalds and the Visas which have in our view been bid up to such high prices that no longer did they offer the safety that investors might have believed they did. In fact some of the shares prices look quite risky for us. So instead we’ve got a portfolio that looks quite different and that’s what you should expect from a contrarian manager like us.

 

Ben Preston:

And if you look at the overall valuation that leaves us with today from our portfolio, we’ve compared that to the FTSE world index. Very much as Charlie was saying, we believe that the shares that we’ve got in our portfolio today which are trading at 15 X earnings, a significant discount to the 26 X prevailing for the world stock market average. And normally there’s a trade-off, if you’re going to buy something better you normally have to pay a little bit more. If you’re going to buy something a bit cheaper, you might pay less but be careful. What’s interesting about the current time is that although we are paying less, we are actually getting a return on equity, the key measure of a company’s quality, which is in excess of the stock market average with a growth rate which is in excess and with gearing which is very comparable.

 

Ben Preston:

So we don’t think these periods come along very often where you are given the opportunities to invest that way. So notwithstanding the tough run of performance that we’ve had, we’re relatively excited about what that means for the future. And I’d like to finish by just talking about a couple of stocks that we own today, both of them are in the automotive industry, making cars. The first one is a company called Honda, we all know the slogan “the power of dreams”. Given what’s happened to the share price recently and the investor fear that’s out there, we think it might be more appropriate to call it the “power of nightmares”.

 

Ben Preston:

And there’s a number of things that investors are very concerned about when it comes to Honda and indeed the other car makers. One of which is the fear that in the future we might not need as many cars, we’ll be sharing with these autonomously driven cars and ride sharing. Another is the trend of electrification and is the market going to be taken by Tesla. And the third which is rather mundane, what about the cycle? Is the cycle turning? And these fears have been so prevalent that invariably investors have been quite worried about shares like Honda.

 

Ben Preston:

And we think the sort of hype that’s out there about electric vehicles and autonomous driving have been taken to a level which has become quite divorced from reality. At times like these, such trends when they get established in investor consciousness, can make their way into the media. There was a headline recently in Bloomberg Business Week, “Peak Car”, the notion that though there are 1.3 billion cars on the road, then we won’t need anywhere near as many cars in the future because we are going to be sharing, we are going to be ride sharing and there’s going to be these autonomous vehicles that are taking us around. And that’s quite an appealing theory in theory. The headline stack there that people like to refer to is that the average car is only used for one hour a day so 95% of the time, its standing idle so shouldn’t we all share?

 

Ben Preston:

That’s quite appealing but actually if you think about when people used their cars, it’s often at the same time of day. Can we really survive with a lot fewer cars on the road? And there are other things that we use for only a short time in a day, but don’t necessarily want to share.  I use my toothbrush about 6 minutes a day, I’m not necessarily going to want to share that with everybody else. So I’m not sure that a lot of these argument really stand up to scrutiny.

 

Ben Preston:

When the media catches these things with a big headline, it’s worth remembering that the track record of those type of headlines and covers is not particularly good. So there was a famous story, “the death of equities”, that came out in the late 1970s, just before one to the longest and strongest bull markets of all time from 1982 to 2000. Towards the end of that period, there was the opposite, there was the book “Dow 36,000” saying that the stock market was going to go to the moon, just before one of the biggest crashes on record. In the late-90s, there was the Economist article “Drowning in Oil” written when the oil price was $10 and the article was projecting it was going to go down to $5. It didn’t go down to $5, it went up to $140. This is not to poke fun at the writers of these articles. It’s just by the time these theories get so widespread that they’re on the covers of magazines, tends to mean that these are already well run stories and often towards the end of hype rather than the beginning.

 

Ben Preston:

The other great fear is electrification and the worry that Tesla is going to take the market of cars with its new electric cars. So it’s worth remembering that despite the hype of Tesla last year only 2% of the cars that were sold globally were electrified. And in fact, demand has been a little weaker than many people would have expected for some of the obvious reasons. So electric cars are more expensive, the range that you can drive them is still much lower than a normal combustion car and it takes longer to recharge. And even among electric cars, Tesla only had something like 15%. And the reality is that all of the major automakers including Honda have their own line-up of electric vehicles. The reason they’re not selling them aggressively, is a much simpler one, it’s not because they can’t recreate the technology. The technology is easy. It’s a battery that connects to the wheels. The reason they’re not selling them is because they’re loss making. So we have 40 years of data on Honda in our databases and it’s been profitable in every single one of those 40 years.

Ben Preston:
We have 10 years of data on Tesla and has been loss making in every one of those 10 years but such is the hype. The stock market does not reflect this reality. So we have a comparison here, side by side comparison of Honda versus Tesla. And this is again not to mock Tesla, but just to show the contrast in valuation that’s on offer. So if you look at Honda’s revenues, over time, actually, it’s growing, it’s growing quite nicely and to quite a high level. If you compare that to Tesla’s revenues, you can see it’s actually a fraction of the size. In fact, Tesla’s entire revenue base is about as big as Honda’s motorbike business, with the only difference is that that’s a very profitable business.

Ben Preston:
So this is what the fundamental reality looks like and then if you compare that to what the stock market says these companies are worth, Honda which had been tracking its revenue chart at the time. A few years ago, when the hype of electric vehicles started to come out, the share price really started to underperform and Tesla the new kid in town, has overtaken and is now viewed by the stock market as being approximately equally valuable. But if you think of how much revenue one gets for your money when buying these two shares, to us it’s night and day. So we think this is a good example of a contrast between those really kind of those exciting stocks that investors have loved to love in the last little while versus the left behind stocks that investors have loved to hate.

Ben Preston:
When we look at shares, as you guys know, we look at intrinsic value. What we think the business is truly worth if you were to buy the shares today, and then hold them forever and receive the cash flows and the earnings that come with it. What is the company actually worth? And for Honda, we can break that into its constituent parts. We can look at the motorbike business, which is actually a very strong business for them. They have something like 35 or 40% of global market share. We can add the financing business where they make money from loans and leases on cars. We can add the net cash that is in there, or the industrial business, so in the car making business itself. And then finally we can add the profits if you like from the car maker itself.

Ben Preston:
That gets us to a fair intrinsic value somewhere up there. And if you compare that to what the share price is currently trading, what the stock market says is worth, that’s why we think there’s a big discount on offer. The cycle is a factor. So when one thinks of a stock like Honda, obviously there has been earnings, cyclicality insensitivity in the past and there always will be. This chart here shows Honda’s share price in the black line. Earnings times 10 which is the orange line and then the book value per share, so the net assets. And what you can see is at times in the past where earnings have fallen considerably, whether that’s the global financial crisis or that period in the late-1980s, the share price is not followed the earnings down. Why not? Because the share price has been supported by the asset value.

Ben Preston:
In fact, the first time that Honda traded below its asset value was in the global financial crisis when the whole stock market was on its knees. But such is the fear prevailing of the current time. But once again, the share price is significantly and actually has reached a record low compared to book value without any great particular reason for doing so. So we think this is a really rare opportunity to buy a business of Honda’s quality at such a knockdown price. So that’s Honda.

Ben Preston:
One other one that I wanted to talk about which is related to the auto industry as well, but it’s a slightly different business is a company called Autohome. Autohome is an internet and app company that connects people who want to buy a car with the dealers and manufacturers that want to sell cars. So it’s a little bit like a Google for finding information on how to buy a car. And it’s a way that a lot of the cars in China are bought today, and almost all of the dealerships are subscribers to Autohome. It’s a little bit similar to companies that are in existence in the rest of the world. So something like Auto Trader in the UK and Carsales here in Australia, which connect buyers and sellers of vehicles.

Ben Preston:
Main difference is that because the Chinese market is so large, that the number of vehicles sold in the population of people that Autohome can reach is that much larger. So something like 50 times the population. One of the reasons that car makers like Honda are under an investor cloud, is because car sales in China have been quite weak. Having grown for years, actually, over the last 18 months, car sales in China have been declining. And that’s hit automakers. It’s also hit Autohome, which relies on that car market as well. So we think this is an example of a great company, which has gone through a little bit of a tough period in time, and now can be bought for a significant discount to what it’s truly worth.

Ben Preston:
So if you look at something like Carsales, and Carsales is a perfectly good business. Again, I’m not saying anything negative about Carsales, but that’s priced at 27 times earnings. Even though the car market in somewhere like Australia or the UK is much more mature. In China where you have a lot more growth to come, and also Autohome is really only scratching the surface of the used car market. And yet one could buy the company for a much more reasonable 19 times. Which is to say when we look at shares, it’s not only the classic value stocks that are really priced at a discount to their book value, but really we think about intrinsic value. And that could be a great company that’s just going through tough times or under an investor sentiment cloud for whatever reason.

Ben Preston:
When we look into this sort of simple, massive business like Autohome, last year they had revenue about a billion dollars and they sold 4 million cars to get that. They sell leads so if you’re a user and you go on the app, and you see a car that you’d like perhaps be interested in buying, you can put your name and address and phone number and then the dealership will get that lead from you. And they will call you. And Autohome is paid by the dealer for providing that service. They generate 100 or so million leads a year and the conversion ratio being what it is. About 4 million of those have converted into real car sales.

Ben Preston:
So that means effectively per lead, it’s turned into a successful sale Autohome has earned $250. And if you compare that to the value chain that the dealer or the manufacturer gets from selling that car, you can think about an average car price of about $20,000 and a variable profit margin on that of probably 25%. So on average, the car makers are making $5,000 per car sold. You can see actually advertising on Autohome, partnering with them as a way of getting your leads, you only have to give away a fraction of your profit. So this is a very good value proposition for the dealers and the manufacturers in China who wants to increase their car sales over time.

Ben Preston:
If you think about something like a business like Google, which has been tremendously successful by being an advertiser and helping manufacturers and suppliers find their audience of customers, they’ve become a multiple of the size of the clients that they serve. In China, we think that if you add up all of the profits of the auto manufacturers, you get to something like $20 billion. And yet Autohome is earning only $1 billion in revenue, much less in profit. So we think there’s a long period of growth to come. So again, even within the same industry of autos, you can find real bargains that have been on a fraction of their book value like Honda, and then some good companies that are just trading at a discount to what they’re truly worth more like Autohome.

Ben Preston:
So I’ll wrap up there. Thank you very much. Just to summarise, I would echo what Charlie and Chris have been saying that we believe that a lot of the shares that have attracted the really high multiples on this perception of safety have actually strayed into perhaps dangerous territory. There’s a widespread body of opinion out there that says value investing is dead. That’s been said before. It hasn’t been true before. And if you look at the sort of shares that we’ve bought in our portfolio, relative to what’s out there and the world index, then we’re quite excited about the value that we currently have. So thank you very much.

Chris Inifer:
He was going to be brave enough and actually throw it then but he didn’t. It’s nice to see an Englishman with dental hygiene. Think that’s a wonderful thing. Thanks, Charles and also, thanks to Ben, I’m sure you’ll appreciate they were wonderful presentations giving great insight into the dislocation of markets. And in particular, where we see great value in the portfolio. It is an eclectic mix of stocks in the global equity fund but value is available. Now, it’s been a tough run for the fund in the last 18 months. But hopefully, on the back of hearing Ben and Charles, you can see there’s great opportunity ahead for those that remain invested and look at it as a new opportunity for clients.

Chris Inifer:
At this stage I’m going to introduce Suhas Nayak to you. Suhas has been with the firm since around 2012. He’s a portfolio manager and analyst with Allan Gray on the Australian Equity Business, he also holds a PhD in mathematics. If you’re interested and want to read the paper, I’m sure you’ll happily send it through to you. Suhas over to you.

Suhas Nayak:
I’m going to go with this one, or will try both.

Chris Inifer:
Okay.

Suhas Nayak:
Good afternoon. I’m going to talk about three things today. First off, we’ll cover off on performance. And the message here again is that performance has been weak in the past year or so, and I’ll go through the reasons why that’s been the case as well as talk a little bit about how we’ve positioned the portfolio as a result. Secondly, I wanted to talk a little bit about what contrarian investing means, particularly from an emotional point of view. How it feels when you’re trying to do it, and why it’s difficult to do it consistently. And then thirdly, I was going to talk a little bit about the most contrarian sector that we think is in the market today, at least in the Australian market, and that’s the energy sector. And we’ll talk a little bit about one of the companies in our portfolio today and that’s Oil Search.

Suhas Nayak:
So first off performance. The Allan Gray Australia Equity Fund has had a difficult year. We’ve underperformed the market as a whole. The market’s performance, you can see in grey, and we’ve underperformed by about 3%. Long-term performance has been better, but the recent performance has really been driven by some of the same things that Ben and Charlie talked about, which is the outperformance of defensive names, low volatility names, growth names, and the underperformance of cyclical companies. And as contrarian investors you would expect us to do what we have done, which is to lean into that underperformance and buy more of those cyclical companies. And I’ll go through what we’ve done in particular a little bit later on.

Suhas Nayak:
The Balanced Fund has also had a tough year. So the Balance Fund invests across asset classes, so Australian equities, global equities, as well as fixed income. And across all three of those asset classes, we’ve suffered from underperformance. We’re going to talk about the Australian Equity Fund’s strategy, but the Orbis one we’ve talked about. And fixed income, I think has been difficult in more recent times as a result of declining interest rates across the world. And the Stable Fund, which as a reminder, invests mostly in cash and can invest up to 50% in equities, has done better against its benchmark, which is the RBA cash rate. It’s outperformed that benchmark by a little bit, even as we’ve taken money off the table. As markets have rallied, we’ve reduced our equity exposure in this Fund down below 25%.

Suhas Nayak:
What has caused that difficulty in the equity strategies of each of those funds? Well, it’s mainly been driven by a widening gap between defensive companies, which you see in black, and cyclical companies, which you see in red. Defensive companies are thought to be immune to the economic cycle and they have really been bid up in the last 12 to 18 months. We have done what you would expect us to do, which is tilt into those cyclical companies. And we’ve added new names into the portfolio, like Incitec Pivot and Clydesdale Bank. And we’ve also added to companies that we already owned, like Oil Search.

Suhas Nayak:
How have we done that? Well, we funded that through the winners, which were defensive stocks that were already in our portfolio. And those include things like Ausnet, Aurizon, we’ve taken money off Telstra and Newcrest. So we’ve really tilted the portfolio away from some of these defensive names and into cyclical companies to take advantage of the value that we see. The portfolio now looks even more overweight, particular sectors that we’ve been overweight a little bit for the last couple of years, and that’s energy and materials. And we’re underweight financials. If you narrow down to banks, we’re really quite underweight. We have exposures to National Australia Bank, and ANZ but the market as a whole has much greater exposure. We still have some exposure to what we think is the most hated of the consumer staples, and that’s Metcash.

Suhas Nayak:
Now that we’ve covered off on performance, let me talk to you about what contrarian investing feels like because I think Chris talked about our philosophy a little bit, but I think it’s nice to overlay what emotions go along with that philosophy when you look at a stylised stock chart, like the one you see here in black. So I’ve overlaid some emotions and we certainly feel this as stocks go up, you have a little bit of optimism that builds into excitement. It builds into some thrill and euphoria. And then a wobble happens, maybe the excitement just goes away a little bit. And that euphoria gives a way to a little bit of anxiety at first, a little bit of fear and then when the stock really falls, there’s a great deal of despair. And then the roller coaster starts again, and you get relief, hope, optimism again, coming through.

Suhas Nayak:
The counterintuitive thing here for everyone, I think, including us is that the point of the maximum financial risk is actually that feeling of euphoria. That’s when the stock is priced for perfection. And that’s when you really should be most worried about holding it. On the flip side of that, the point of maximum financial opportunity is exactly when you feel most despondent, most despairing of it. And those are the points that we look for every day is those points of maximum financial opportunity, those points of despair for any particular stock in our portfolio. What does that look like in practice? I’m going to show you a chart of the stock that we’ve owned for a little while, and you can see here in black is the price chart, and we’ve overlaid what we think is some of the emotions that have come along with that, and this stock was riding high a few years ago.

Suhas Nayak:
There was euphoria around it. It was doing really well, producing lots of cash flow and profits and then there were a few wobbles and those feelings of excitement gave way to anxiety and fear and we started buying down at that despondent level when people were starting to give up on the company. And we really started buying when everyone just totally gave up on it. And it stayed like that for a little while. And we built a pretty large position in this company. Then as people got excited about this company, that hope and optimism came into the market, we’ve really backed off and started selling. Can anyone think about what this company is? Can anyone name it? Actually, the Telstra chart would look very similar to this. But this is Newcrest, which is a long standing company in the portfolio, and one that we’ve reduced holdings in more recently.

Suhas Nayak:
Let me tell you why contrarian investing is difficult by starting with a few myths about it, and then a couple of uncomfortable truths. One of the things that people think about when they think about contrarian investing is that we’re just value investors, we look to buy things that are on low price to book low price to earnings. We don’t always do that. We don’t always buy companies that are on low P/E. These two companies that you see here are recent additions to the portfolio. And you can see here that they trade on reasonably rich multiples of earnings, 20 times which is a premium to the market, the markets probably on 17 or 18 times for Nufarm farm. And for Incitec Pivot even richer 40 times and you ask us, “If you’re value investors, why would you do this?”

Suhas Nayak:
Well, the reason we would do this is the E, so the E in P/E, which is earnings has collapsed for both of these companies. Normalised earnings will be much higher than where they are today. And so we’re willing to buy these companies on much richer multiples. So we don’t always just buy companies that are on low P/Es, sometimes we’re willing to buy companies that are on essentially growth multiples because at the bottom of the cycle, most companies are actually growth companies. Another thing that people think about or think that we do is we wait for a catalyst and we wait for an earnings turnaround. But that’s not necessarily the case either.

Suhas Nayak:
In black here you see earnings and what earnings has done in the past and the future projection of earnings again stylised and the market is expecting in this chart the stock to have much lower earnings in the future. Pretty terrible outcome. Now markets are forward looking and so the red line you see is the price chart and the price has already reacted to those market expectations. It’s already dipped. And it’s already reflecting some terrible outcomes in terms of earnings. So what do we need for earnings to do? Well, we just need earnings to be bad. So the terrible earnings just need to be bad. And we can do really quite well as investors in that stock. So we don’t really need an earnings turnaround. That black line, the actual outcome is actually a lot worse than today, the earnings today, but the price has risen because it’s actually better than what people had expected.

Suhas Nayak:
A couple of uncomfortable truths about why contrarian investing is difficult. And one is that things often get a lot worse than you ever expected. This is an example of a company we bought into, WorleyParsons. And early on in the piece in 2011, 2012, it peaked around $31. We didn’t own the stock then. It was riding high as a result of a commodities boom, it was writing a lot of revenue at pretty good margins. And then over the next few years, the commodities boom gave way, may have been a bust even, and all prices declined as well in 2014. And we made our first investment in the company at about $8 a share.

Suhas Nayak:
We thought we were getting a great deal, only to find that for a period of about six or seven months in 2016, 2015, 2016, the price fell pretty much every day by about 1% or 2%. Really tests your thinking, your thesis around the company. I blame this company for about half my hair loss. And we stay true and actually we added to this position throughout that entire period. It took 13 months and from the moment that we thought we had a good deal, it dropped 65%. Unfortunately, even though the stock has bounced back, my hair hasn’t come back. 13 months might sound like a pretty long wait, unfortunately, it can actually be a lot longer.

Suhas Nayak:
This is an example of a company that we owned for quite a while, Pacific Brands. It peaked at about $1.10. And again, we thought we were getting a good deal at about 70 cents. It troughed at 32 cents, which was a whole four years later and after a drop of another 54% from when we first started buying. We were lucky in this case. The patience paid off and again, we were buying through that entire period. The patience paid off when there was a finally a takeover at $1.15. Now, I don’t want you to leave here thinking it always just works out, because sometimes it doesn’t. We get it wrong about 40% of the time. This is an example of one of those instances. This is hopefully a rare example.

Suhas Nayak:
This one went belly up. Most of the things that we get wrong, don’t go belly up. They just underperform the market, but this is an example of a company that we bought into after a capital raising, we invested after we thought that the balance sheet had been fixed only to find about two or three months later that they were insolvent. So it’s a testing process, and sometimes we do get it wrong, but over the long term, we think it adds value. Contrarian investing today in this market is difficult because so many different sectors have had a good run, but there have been sectors that have been left behind and energy is one of them, so I’m going to spend a little bit of time talking about that. And how do we know that it’s out of favour? Well, one way to tell that a sector’s out of favour is to look at its weight in the index as a whole over a period of time.

Suhas Nayak:
This shows you the weight of the energy sector in the S&P 500. And it’s at pretty much 30 year lows, which is surprising to me because in 2016, oil prices got down to about $25, $30. They’re double that now, and yet the energy sector has continued to fall relative to the index as a whole. And it’s not just a global phenomenon, it’s also here locally. The energy sector has underperformed the market as a whole here. And you can see the different sectors in this chart. The performance relative to the market is shown in grey. The energy sector has massively underperformed, while the healthcare sector has done really well.

Suhas Nayak:
Again, as contrarian investors, you would expect us to do what we have done, which is to have a big overweight position in energy and a big underweight position in healthcare. You might think this is by design, we look at it from top down and we come up with a portfolio that is designed to deliver this, but let me assure you, that’s not the case. We look at stocks on a stock by stock basis, and we build up the portfolio that way. And this is how we’ve built up that energy portfolio. We started with Origin, way back in 2012, late 2012. We added Woodside to the portfolio a bit later and then when the oil price fell, we added Worley Parsons. And more recently, we added Oil Search. But we’ve had buys and sells in between as sentiment had ebbed and waned in the sector.

Suhas Nayak:
What is it about energy that makes it so unloved? Well, there are a number of reasons, but I’m going to focus on three of them that people talk about. The first is that electric vehicles are going to kill oil demand. The second is that there is an endless supply of low-cost oil in the world today. And that’s primarily out of the shale basins in the US. And then third is that, well, we don’t have to worry about either of those because they’ve got the energy companies today have essentially obsolete business models and will have to stop what they’re doing because of climate change.

Suhas Nayak:
I’ll go through each of those in turn. Electric vehicles, we don’t think is the end of oil because if you look at oil demand today, only 23% is used in cars. The rest of it is taken up by trucks, aviation and shipping, petrochemicals and other industrial uses, most of which are still growing today and most of which are probably not going to be disrupted by electric vehicles. Even that 23% as that shrinks it’s quite possible that the rest grows. People worry about low cost oil production and one of those reasons is that the endless growth of shale oil in the US. We’ve spent a lot of time looking at the economics of shale oil producers.

Suhas Nayak:
Shale oil is drilled in a very interesting and different way to conventional oil that has been drilled over the last hundred years. Shale oil requires constant reinvestment. People drill multiple wells to make sure that they can keep production flat or growing. And they do that because shale oil wells themselves decline at a really fast rate, much faster than conventional oil. So we think that shale oil producers are probably close to that marginal cost of production of oil. And so we track them pretty carefully.

Suhas Nayak:
Over the last nine courses, we’ve been tracking their free cash flow and I think free cash flow is the thing to track because the profits don’t necessarily indicate the amount of reinvestment that’s required. And because of that high level of reinvestment, you know how you’re doing if you can grow in a free cash flow positive way. Unfortunately, for these companies, they haven’t been able to do that. You can see in grey, the free cash flow break-even oil price. This is the price of oil that’s required to essentially allow the companies to wash their face, to not increase their debt levels. And that oil price is a lot higher than where oil is trading today, which is shown in that dotted grey line.

Suhas Nayak:
Now, of course, there has been some growth and that’s shown in the red. But that growth has only been able to satisfy current oil demand. So we’re not really awash with oil from these companies and they’re not really doing it in a way that sustainable. And I think investors are starting to take notice, which is why if you look at shale oil production today, out of the main basin in Texas, shale oil production has started to slow down or at least that growth has started to slow. We’re not too worried about that either. Oil prices have to go up for these companies to be sustainable businesses. And if they’re not sustainable businesses, they’ll fall over and oil prices will go up because that production will go away.

Suhas Nayak:
One of the things people worry about is what happens to these companies in a world of the Paris accords? And do they have assets that will be stranded? And are they investing in assets that will be stranded in that world? Well, if you look at reserves for various oil companies today, they’re around 12 years. So that’s the amount of time they will be able to produce the assets that they currently have identified. It’s a two edged sword, because it’s not that long. But it does mean that the assets that they have today and that they’re producing are probably going to produce and the good thing today for the energy sector is that many of these companies will pay back much of their capital in that time. We stand to benefit from those cash flows. And we only really have to worry about those future investments because we will get most of our money back.

Suhas Nayak:
Let’s talk about Oil Search, which is a new addition to the portfolio. Oil Search has its major asset in PNG, it’s an LNG producer. And it also has a few, a couple of growth projects, also in Papua New Guinea, as well as an oil asset in Alaska. Now, for the longest period of time, this company has been a darling in the oil sector. It’s been a growth company, everyone was very excited about the growth. And as I said earlier, when people are excited about growth, we tend to stay away, so we hadn’t owned this company for the longest time. More recently, there have been a few wobbles. People have been worried about the delays that Oil Search had experienced in their projects, and also have been worried about the fiscal terms that they might have to agree to for future expansions.

Suhas Nayak:
That’s provided us an opportunity to buy into the company at what we think are decent valuations. So what are those valuations? Well, today looking at their financials, if you look at what they’re worth just producing assets are worth, we’re paying about 11 times the free cash flow of those producing assets. This is relative to a market that’s trading on 14 or 15 times so we think it’s a reasonable discount. Of course, we always look at the downside from here, which is what happens if oil prices fall or if LNG prices fall. And those are the two other scenarios that I show.

Suhas Nayak:
Oil prices around $60, the EV to free cash flow there is about 14 times, still a discount to the market so it’s still not too bad. And of course it gets worse if you stress it further and we won’t do that well in the in the 18 times scenario. But I haven’t shown you the flip side, which is what happens if that growth actually comes to fruition. All these bars show a no-growth scenario. If growth comes that 11 times really drops to mid to high single digits. And we think it’s really good value in that case.

Suhas Nayak:
So, in summary, our portfolio we’ve continued to tilt towards cyclicals as we’ve seen, cyclicals underperformed defensives. We think the energy sector is a really out of favour sector and we see value there today. It’s hurt us in the short term. It’s been a big detractor in terms of performance over the last few years, but we see it as a long term opportunity. And then finally, I think I’d leave you with the message that contrarian investing it’s difficult, it requires some patience, requires restraint at times commitment, maybe loss of hair. But over the long term, we think it does deliver value for our investors. Thank you.

Chris Inifer:
Thanks, Suhas. We might get Ben up here also for the Q&A. We have about 15 minutes of Q&A. Thank you very much to those that have sent through questions. And also via the live streaming. We might go to Suhas as Ben is taking a little while to come up on stage. AMP was the question, Suhas. We’ve built the position, increased the position in recent weakness. Has your view changed from when you last presented to this forum in this group?

Suhas Nayak:
So a few things have changed since that time. They’ve sold the life business since we first invested in the company. They’ve also had a capital raising more recently. From here we think the company is priced for a terrible outcome. And so in that chart that I showed you before, when things are priced for a terrible outcome, the odds are stacked in an investor’s favour because even if the outcome is terrible, we’ll do, okay. And if the outcome is good, we’ll do amazingly well out of our investment. So we think the odds are stacked in our favour. We don’t know how it will go.

Chris Inifer:
So that’s the motivational speech if it’s just bad, we win. Ben, the catalyst … I’m interested in one of the questions has come through about what catalyst has to occur essential, what is the catalyst for a reversion for the portfolio to perform a little bit and perhaps value to start out performing growth? Can you look into the mirror or the crystal ball and let us know?

Ben Preston:
Yeah, the crystal ball is not that accurate, unfortunately. But I think what happens is, share prices get to a level sometimes for any particular company, and sometimes for collections in clusters of sectors or geographies where you actually don’t need the price to go up because you’re going to get paid from the dividends and the earnings and the growth that will come through over time. So our conviction is really that you should focus on what a company’s worth and what it will deliver if you hold it now and never sell it and not worry about … that will take care of itself.

Ben Preston:
If the share price goes up, that’s something that will take care of itself when things go your way. But that’s not the motivating factor. And it’s something you don’t really have to factor in now and having worked with Simon Marais for many years, who obviously sadly passed away a few years ago, but the one thing he taught me, the one thing, one of the many things he taught me was the best catalyst is no catalyst at all because if you can see a catalyst and I can see a catalyst and everybody else can see a catalyst that’s already going to be reflected in the share price.

Ben Preston:
If you really want to buy something for less than it’s worth, then the future has to look very bleak. And that almost by its nature means there’s no catalyst that anyone can see. So a lot of things could happen that would put up before sorry, there was again, if things are already bad we win. There’s a lot of things that could happen that would improve our performance. But honestly, we don’t think about it that way, if that makes sense.

Chris Inifer:
Do you think interest rates have to start going up before…?

Ben Preston:
Yeah, so one of the things that’s been very abnormal is interest rates have come down as much as they have. And I think that’s in large part responsible for why some of the kind of, “safe companies” without volatility and earnings have been so attractive because it says nice, ready alternative to bonds, which don’t yield anything in many parts of the world, they’re negative. So that’s obviously been something that has made life tougher for us. If that reverses, that will be good news for us.

Ben Preston:
On the other hand, I will come back to, we don’t need that to happen. We’ve been investing in Japan for many years, the Japan fund launched in I think 1998, so over 20 years ago. Interest rates went to zero in Japan in 1995, I believe. For the whole history of our period of investing in the Orbis Japan fund, interest rates have not normalised. And yet we’ve had very good Alpha from that fund over time. And I think what happens is when share prices get to a level where the valuations are so wide that you don’t necessarily need things to normalise. The valuation takes care of itself.

Chris Inifer:
Thanks, Ben. Moving to Suhas, just building on the financials discussion a little bit. We’ve increased weight to NAB, we’ve owned ANZ, we’ve looked at a whole range of stocks from IOOF, to Perpetual to Platinum to a whole bunch of things, Challenger. Can you just comment on the financials exposure in the fund heavily underweight banks, but there are other things that we have looked at as well.

Suhas Nayak:
So I guess, the two domestic banks that we own, you would say are probably the two most contrarian of the domestic banks. NAB and ANZ. They’re both priced reasonably for an outcome that doesn’t have a housing disaster in the future. If that happens then all bets are off, but for a normal outcome they’re priced reasonably attractively and they’re in that contrarian space. So we own those. The rest of the financials, we’ve looked at a number of them. And we’ve taken positions in Clydesdale Bank, QBE, AMP, Challenger and Clydesdale Bank and Challenger have been much more recent additions to the fund. There have been idiosyncratic and opportunistic additions to the fund as a result of particular decreases in their valuation.

Chris Inifer:
And I guess a good contrast would be to look at NAB and ANZ in the context of global market. We own Sberbank in the global portfolio. From a valuation perspective, do you often look at them and say, well, they’re cheap relative to offshore banks or more expensive relative to offshore banks and what are your thoughts on that?

Suhas Nayak:
We always look to the offshore names just to see whether we’re getting a good deal here. Domestic banks have rarely presented a good opportunity relative to the offshore banks. Interestingly, Clydesdale Bank is probably one of those opportunities today. And it is an offshore bank that is listed here, and so we have taken a position based on that. But it is one of those things it’s always given us pause without domestic banks, and that’s why we’ve always been underweight for the longest period.

Chris Inifer:
And Ben maybe your comment on global financials from you, particularly the banks, Sberbank many wells before. What have you looked at and what’s interesting?

Ben Preston:
Well, we haven’t owned Australian banks for the exact reason that Suhas has mentioned and one of the advantages of being global and being benchmark unconstrained is we can be very picky. There is about 5,000 shares that we could buy that would fit our sort of size criteria. We build a portfolio of about 50 so we’re looking for the top 1% of stocks out there. So for financials, for instance, we actually said the biggest financial positions that we would have we own banks in Korea, Russia, Brazil, there are times to buy banks. I mean, there was a great time to buy the banks in the US at the bottom of the financial crisis, but it’s often when economies are under a cloud, that we find the best value for financials.

Ben Preston:
And so, it’s a compliment to Australia that the banks have never been cheap enough for us to buy because you guys haven’t been through the sort of economic events that cause the valuations to be as low as they were in somewhere like Russia, Brazil. So we’ve been spoiled for choice of financials because there are countries where those things are priced at a real discount. In Korea, we’re paying less than half of book value for the bank that we own.

Chris Inifer:
I mean, ironically, when you were picking Vodafone, AMP nearly bought Westpac so. 1992 isn’t that long ago, perhaps look a little bit top line I know that we’re bottom up with all the stocks from a bottom up fundamental basis. But if you look top down where are the big exposures in a geographic sense in the fund.

Ben Preston:
We have we’ve got a particularly high exposure to emerging market shares at the current time. That’s not because of any love of emerging markets per se. It’s because we like the valuations that come when sentiment is a weak point. And that’s what we see in emerging markets today. Historically, we have been contrarian, and we continue to be so if you look at when the fund was launched in 1990, before my time, when the Nikkei bubble was raging in Japan, we launched with a zero waiting in Japan, and we were called crazy for doing that because the missing out on Japan, the economy of the future, went full circle in 2012. We were 30% in Japan when everybody else “knew” that it was a basket case.

Ben Preston:
So these things do cycle and it’s not too long ago that I was being asked are there any opportunities to invest left in developed markets because emerging markets were all the rage. And now we’ve cycled full circle from that. When we look at share prices and compare them with our intrinsic value, and look at the discounts that are available in, let’s say, the US versus some markets outside the US, and particularly in emerging markets, that’s where we found bigger discounts. So we’re not there for the economic growth for the…

Ben Preston:
By the way, I should say that many of the shares that we hold in emerging markets, it’s not the Chinese banks and the property companies and these low quality companies that are highly exposed to economic problems. It’s often very high quality companies like Autohome, like NetEase, just that when you compare them against their developed market counterparts or what we think the companies are truly worth, we think we’re getting a bargain.

Chris Inifer:
The portfolio looks a little bit Asia tech dominated. Just a quick comment on US tech, some of the big ones.

Ben Preston:
We’d love to and we have in the past owned Amazon, Microsoft, we still currently own a little bit of Alphabet. We can see some value there. That’s the owner of Google. We’ve never owned Netflix. We’d recognize that some of these companies, some of them are problematic. So you know the recent IPOs of Uber and Lyft. The ride sharing companies, no profits today, no profits on the horizon.

Ben Preston:
That’s not really our thing. But the likes of Google, Microsoft, we would love to own great businesses like that, but at the right price, and we have done in the past. At the moment, we don’t see that the price is attractive enough for many of those. But look, we found other companies that offer just as good growth but might be companies that one hasn’t heard of before.

Chris Inifer:
Last question for Suhas. The comment was specific to RCR Tomlinson. Would the assistance of AI or other things that we might have or could have included in the process by the difference to those types of things? Or do we look at that in a valuation sense?

Suhas Nayak:
No, I don’t think that would have helped because I think the real question was whether the data was available to begin with, and we’re not sure it was. It was a bit of a surprise to everyone. And when they raised capital, there was widespread opinion that that sorted the problems out and just turned out not to be the case.

Chris Inifer:
And your thoughts about including that type of thing in general process of looking at stocks more broadly, incorporating AI into your process?

Suhas Nayak:
I mean, we will always look at ways to improve the process. And if AI is one of them, we’ll look.

Chris Inifer:
Thanks Suhas. And also thanks to Ben, we’re just getting near two o’clock. So we might join in thanking both gentlemen and also to Charles for presenting today. I think all three speakers did a tremendous job. Thanks very much guys. To those questions that we didn’t get to, we’ll try and respond to them at a later date. We actually didn’t filter them, normally I would, but no one lets me so we answered as many as we could. Hopefully it was insightful. Hopefully you enjoyed Ben’s presentation, Charles’ presentation. And also Suhas.

Chris Inifer:
Thanks especially to Ben for coming out from the UK. Sorry to have a crack at your dental hygiene, joke, I won’t do that again. It’s a real privilege to have him out here and to have someone who speaks so intelligently about the portfolio. It is a very different looking portfolio. It’s an enormous opportunity, but we appreciate the numbers are not fantastic over the last 18 months. We are a long-term fundamental contrary manager. What we do is easy to explain difficult to do, but long term we believe that it generates superior results for clients.

Chris Inifer:
On the Allan Gray side, we’d love you to have a look at Solutions. Go and play with the calculator this afternoon. We’d love to get direct feedback and whether it’s helpful, useful, whether the numbers are way off. Whether it’s of any interest to you in any way, shape, or form. The team will no doubt continue to communicate with you on all three fronts: Allan Gray Australia, Orbis and indeed Solutions. Thanks for attending and thanks also for the live streamers that are out there that have joined us. We know in your lives, in your businesses, you’ve got a lot going on at this point in time. So spending some time with us here at the Ivy is wonderful.

Chris Inifer:
I was out walking on George Street this morning and I noticed that you actually got a tram. I’m from Melbourne. So it’s good to see Sydney becoming a little bit more like Melbourne. I think that’s wonderful. Unfortunately, you don’t get Tuesday off and I do so it’s more favourable for me. Thanks once again and we look forward to seeing you soon.