If you have been following our words and deeds since the middle of last year, you would recognise an increasingly strident tone regarding changing patterns within world markets. At half-year, our principal reservation was not about the Euro zone but pertained mostly to the potential of company earnings.
We also had concerns about the level of growth in China which had seemed to slow to about 5% pa and questioned what measures would be taken to reignite growth.
We stated that it was ill-advised to be over-committed to predictable companies which we thought were being used by many investors as a crowded hiding place. We reiterated that both quantitative analysis and our investment philosophy were driving us away from predictable companies and that we were indeed selling some of our highly successful predictable holdings in favour of more cyclical businesses that offered far better value.
We highlighted the extraordinary valuations that were available in more cyclical companies in general, and in whole markets like Japan in particular.
We therefore present this quarterly update to you with a sense of achievement. This has been derived from our recent performance where we have been rewarded for tenaciously following our investment approach and for not caving-in to pressure regarding our strategy, namely the seductive temptation to join the crowds and become a momentum investor.
As we emphasised in the December quarterly report, it strikes us that investment in bonds, which have been a refuge for funk money, will at these levels cause regret should yield rise over the next few years. With governments clearly intervening and propping bond prices and thereby suppressing yields, it is clear that we cannot pick the turning point. We offer you only the observation that to lend government’s money for 10 years as a starting yield of 2% or thereabouts, is being extraordinarily accommodating.
To add a framework to this, we remind you that in the period from the late 1940s to the present, inflation in the US had been around 3.6% pa compound. Importantly, money printing over that 60 year period was relatively modest. We are now in a world where money printing is a fact and we believe this is an important driving force behind markets at present. A rise in bond yields won't necessarily reflect concerns about higher inflation but may simply be caused by a change in risk preferences. In other words, investors are feeling more comfortable to live with more risk in a slow but growing world economy.
As of now, we find several markets and several sectors that are selling below their longer-term fair value. So rather than making a call that there will be a generalised increase in equity markets, or a new bull market, we are arguing that there is scope for us to make good returns from some areas that are still very much out-of-favour.
Within the Platinum International Fund we remain unhedged into the Australian dollar. We believe it is not great value and is causing huge dislocation and hollowing out of parts of the Australian economy. We are also reluctant to own the Australian dollar on the basis that when investors choose to invest abroad, they do not really wish us to hedge back into the Australian dollar. We believe they regard international investment funds as a means of diversifying both their currency and their share risks. There are times when we will own the Australian dollar but only when it is been sold-off in panic, as was the case when we went long the Australian dollar in 2008/09 at 65c to US dollar. Our principal currency exposure at present is the US dollar, followed by the Euro and European currencies. Our Asian currencies are naked while we have hedged out of the Japanese yen into US dollars.
Though we pick individual stocks, we can help you understand the structure of the portfolio by describing some of the overarching themes in the International Fund.
Our strongest view has been the complete neglect of Japan. Here we had the whole market selling at a fraction of replacement cost. With the prospect of a weaker yen, prompted by more Bank of Japan intervention, we could see why earnings could provide significant surprises. We share many of the common concerns that investors have regarding Japan, but, as we often remind ourselves, it is what companies make and sell that really counts. Our Japanese stocks are largely exporters with Toyota (both Toyota Motor Corp and Toyota Industries), for example, being our largest holding a 3.7% of the Fund. We also own financials which benefit from a strong recovery in asset prices.
Returns have been spectacular in the last four months so we have taken profits and reduced our Japanese exposure to around 15% from around 20% more recently.
Information technology is our second largest play through giants like Samsung, Cisco, Microsoft, Google, and Ericsson. They account for nearly 10% of the portfolio and are complemented by smaller US tech names which adds a further 4%.
The next big idea is the pharmaceutical and healthcare sector. These comprise 10% of the portfolio and our advisers will recall that Bianca Ogden laid out our case for this sector in the last quarterly adviser teleconference: it is all about product renewals, changed business practices and exposure to the emerging markets.
We have about 7% in US engineering and oil service companies. This is motivated by the prospect of an investment boom caused by the significant price disparity of hydrocarbons between the US and the rest of the world. As a point of interest, North America produces about 20 million barrels per day of oil and gas equivalents versus world production of some 140 million barrels; yet there have been one million wells sunk in North America versus one million sunk in the rest of the world. This gives you one indication as to why the oil service business should have long legs.
We have also been using price weakness to add to the Chinese Internet plays. This is driven by the logic of their relative price, size and potential to their US peers. These are companies like Sina, a twitter lookalike; Baidu, the Chinese search site; Youku, the principal online video provider and Sohu, a provider of games and a portal.
The other 50% of the portfolio comprises largely stand-alone stock ideas like 3.5% in Bank of America which has nearly doubled in the last 12 months and a smattering of companies across diverse geographic regions from Brazil to India.
DISCLAIMER: The above information is commentary only (i.e. our general thoughts). It is not intended to be, nor should it be construed as, investment advice. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.