We are ten years on from the GFC, but the recovery has not been balanced. Financials and Resources, hot in 2007, have struggled. Technology has led markets, followed by Healthcare and the Consumer. Geographically there is a huge divide. The US market is up over 300% in ten years, the rest of the world only one-third of that1. That makes a huge difference when comparing Platinum against the benchmark.
Our approach to risk would not allow us to put half a global portfolio on one exchange, yet that is what the MSCI AC World Index shows as a comparison. We are structurally underweight the one market that has driven returns. However, trying to generate capital growth from investing in undervalued companies requires us to avoid the crowd and to explore change. In many ways we think like private owners and assess the return potential of a business over a long holding period. The alternative of trying to outperform the index would instead require us to determine whether we think individual shares will each do better than the opportunity set. We struggle philosophically with how such an approach can work in practice.
There are parallels today with 1999. Expensive stocks are getting more expensive and cheap stocks are getting cheaper. This is hard for a manager who believes price is everything when it comes to making investments. Kerr and Andrew set the business up with the belief that over time, money is made by avoiding the crowd. Over the full cycle we know it works, but, it is not always comfortable; neither for us, for you or for clients.
The numbers bear this out. On a rolling yearly basis, the returns of our flagship fund, the Platinum International Fund, have averaged 10% difference from the market. Over 24 years since inception of the fund, only half the time in fact did we beat the market over a one year period. That is great when the fund is above the market, like it was by some margin in 2017. It is tougher when the fund is below the market, as it is currently. However, what has led to our long-term outperformance of the market is that the positive gaps have been much larger than the negative ones.2
Cast your mind back three years to June 2016. Trump had just been installed as the Republican candidate, US bonds were at what remains all-time lows and the UK was about to vote to leave the EU. We were coming off a stinker of a year and talked about a coiled spring in markets.
Those staying the course were rewarded over the next 18 months, as our 39% returns beat the market’s 26%3. Since then, driven by Chinese reform, trade wars and the impact of rising rates in the US last year, we have effectively treaded water, while the market has gone higher. Most of the recent performance gap comes from us not playing momentum in already expensive sectors such as Technology, Healthcare and Consumer companies, almost all of which are US listed. Our latest monthly factsheet breaks down the last twelve months to show performance step by step.4
In summary, the last few months may have been tough in a relative sense, but over that three year period since Brexit, we are only marginally behind, having carried a fair degree of protection along the way.
The Platinum International Fund has a 55% net invested position. Looking at the history of the Fund since inception in 1995, exposure rarely goes below 50%. So this is a conservative position both in absolute and historical terms.
On the long side, we hold 20% cash and an 80% long invested position, so let’s look at the stocks that make up the 80%5.
We are seeing a growing divergence in valuations between the expensive growth/safety stocks and everything else, and this divergence has really started to accelerate since 2017.
We can see a lot of anecdotal evidence of this in markets:
Sure-thing safety stocks – Paypal 53x, Mastercard 34x, Kikkoman Soy Sauce 34x, Lindt Chocolate 36x, Diageo 27x6.
Wildly priced cloud software stocks (“SaaS”) that we spoke about on our recent roadshow.
The new IPO activity today. A good example is Beyond Meat – it produces meat substitutes (“vege-burgers”). It is almost 7x its IPO price in less than a month and has a market cap of over $10bn despite only having sales of $220m – 46x sales7.
We can also measure the divergence quantitatively:
Over the past 34 years, the only time the valuation difference has been greater than it is today was during the tech bubble.
Growth factor has now outperformed value for nine years – this is the longest period in a dataset back to the 1930s8.
The other side of this is there is some amazing value on offer in the stocks that have been left behind. To put this into perspective, Andrew Clifford has often commented that in his 30+ years of managing money he can’t remember a time when you could buy so many large cap companies, with solid industry positions on single digit P/Es.
The balancing factor is many of these companies are not perfect:
In the short run their businesses are perceived to be economically sensitive.
Or they operate in a geographic region people are worried about, like China.
What we are doing here is trying to prioritise the companies and industries. While they carry some issue in the short-term, they have very clear long-term growth drivers:
Semiconductors – we can’t know what smartphone sales or the DRAM price will be in six months, but we can be pretty sure in the future consumers will want to buy 5G phones, software will continue to move to the cloud and there will be heavy investment into artificial intelligence. These drivers should mean these semi companies are going to be bigger businesses in the future.
It is similar if you look at our holdings in China, which are almost exclusively domestic businesses. With the rise in the middle class, it's highly likely the Chinese will be purchasing more insurance from Ping An Insurance or having more e-commerce parcels delivered by ZTO.
Certainly where we can find growth at a reasonable price we will participate. A good recent example of that is our holding in Booking.com – hotel/travel marketplace on 16x earnings ex-cash9. It benefits from both western consumers increasing travel spend and the wave of Chinese outbound tourism.
For context, roughly 50% of the portfolio is in companies with cyclical exposure to their business - with the other 50% in businesses that exhibit lower cyclicality, or in cash. The average P/E of the portfolio is roughly 10x which, considering we still hold large positions in stocks like Alphabet (Google), Facebook and Roche, which are on higher P/Es, shows how cheap some of the other holdings are10.
In summary, on one hand what we are faced with is extreme valuations and crowding in the high growth and safety stocks, and on the other we have solid companies in industries where there is an imperfection but have valuations so low you simply can’t ignore. As investors we are going to buy into that value, but we realise there are reasons to be cautious on markets and that is why we have chosen to add protection via increasing our shorts.
The Fund’s 25% short position11 is broken into two parts.
10% individual stocks – these are directly going after these very hot areas of the markets like Cloud Software, Biotech, and Consumer Staples. Here we are targeting companies where the fundamentals of their businesses are weak or getting worse, but they have been bid up to wild valuations due to the hype around the sector.
The other 15% of the shorts are index shorts. We put this protection on in the week of 6th May, which was directly after Trump tweeted a trade deal was off. These indices are export nations – HK, Japan and Germany and the tech-sensitive Nasdaq.
From a big picture perspective there were a few factors concerning us:
Economic data is inconclusive. There are signs of weakness that were not there 12 months ago. In both China and Europe there has been a sizeable slowdown in the manufacturing/export parts of that economy. In Europe companies are now firing temp workers; in China you see this in SME’s (small and medium enterprises) reducing ad spending and weaker air travel.
The US yield curve keeps inverting.
The trade war. Forget measuring this. This just means corporates are going to delay investment decisions which is going to slow the economy. This comes through in our discussions with corporates; they’re hesitant to invest, shift capacity etc. because they have no idea what the tariff landscape is going to look like in six months so they wait. And that loss of animal spirit is important.
The US escalating the situation with its moves to destroy Huawei doesn’t bolster our hopes for a quick resolution.
While any one of these factors by themselves would not be important, the fact that you are seeing all three, calls for caution and that is why we have moved quite swiftly to increase protection.
So how should one be invested today:
See what the market is doing – they’re piling into growth and safety at ever higher prices. We don’t think this makes sense from a future returns perspective. Nor do we think it is safe – investors are merely trading the perceived risk of cyclicality and replacing it with valuation risk. For context, if one looks at charts12 of Coke, Walmart, Microsoft, Pfizer starting from the year 2000 – these companies were growing, earnt high returns and had fortress businesses with little competition – so they traded on 30-40x earnings. Sound very similar to today? What happened is these stocks lost money or went sideways for 10-15 years as there P/E derated from 35-15x.
Instead we think buying these businesses that have solid positions, but some near-term issue on P/Es of around 10 or below – whilst carrying protection is an appropriate balance of risk reward going forward.
1 Source: RIMES Technologies. Cumulative returns of the MSCI AC World Net Index and MSCI US Net Index in $A, ten years to 31.5.2019
2 Source: Platinum Investment Management Limited. Average positive deviation from the fund versus the MSCI AC World Net Index in $A is 15%, while average negative deviation is 6%.
3 Source: Platinum Investment Management Limited and RIMES Technologies. C Class Platinum International Fund returns, pre-tax, net of fees and costs and assume the reinvestment of distributions, and MSCI AC World Net Index ($A) returns - 18 months to 31.12.2017.
4 Source: Platinum Investment Management Limited and RIMES Technologies. C Class Platinum International Fund returns, pre-tax, net of fees and costs and assume the reinvestment of distributions and MSCI AC World Net Index ($A) returns.
5 Source: Platinum Investment Management Limited. As at 31 May 2019.
6 Source: Factset. 2019E P/E ratios at 18 June 2019. Paypal adjusted for options expense.
7 Source: Factset. As at 18 June 2019.
8 Source: https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
9 Source: Factset. As at 18 June 2019. P/E adjusted to reflect cash balance.
10 Source: Platinum Investment Management Limited.
11 Source: Platinum Investment Management Limited. As at 31 May 2019.
12 The chart (Source: Factset) below shows Microsoft (green), Coke (orange), Pfizer (blue) and Walmart (yellow) shares indexed to 100 at 31 December 1999, and their progression to mid-2017, at which point, Microsoft, Pfizer and Walmart had only just exceeded their starting levels, while Coke took about ten years to achieve this.
This information has been prepared by Platinum Investment Management Limited ABN 25 063 565 006 AFSL 221935, trading as Platinum Asset Management ("Platinum"). It is general information only and has not been prepared taking into account any particular investor’s investment objectives, financial situation or needs, and should not be used as the basis for making an investment decision. You should obtain professional advice prior to making any investment decision. You should also read the Platinum International Fund product disclosure statement before making any decision to acquire units in the fund, a copy of which is available at www.platinum.com.au. The market commentary reflects Platinum’s views and beliefs at the time of preparation, which are subject to change without notice. Certain information contained in this presentation constitutes "forward-looking statements". Due to various risks and uncertainties, actual events or results, may differ materially from those reflected or contemplated in such forward-looking statements and no undue reliance should be placed on them. No representations or warranties are made by Platinum as to the accuracy or reliability of this information. To the extent permitted by law, no liability is accepted by Platinum or any other company in the Platinum Group®, including any of their directors, officers or employees, for any loss or damage arising as a result of any reliance on this information. Past performance is not a reliable indicator of future returns.