The 300 Club

Christine St Anne: I'm at the Morningstar Investment Conference, and today Platinum's Andrew Clifford joins me. Andrew, hello.

Andrew Clifford: Thank you.

St Anne: Andrew, in your presentation, there was an interesting slide about your portfolio exposure, which looks like it's very weighted towards China. What sort of companies are you investing in that country?

Clifford: The sort of companies in China that we have – they're probably three or four distinct groups. One is insurance companies, both life and property and casualty insurance. And China is at an interesting stage in its development where people now accumulated enough wealth that they actually have something to insure. So, whether it's their life and concern about the – if something happens to them, what happens to their family or it’s just that they're accumulating household goods, cars and they want to protect these.

But of course, it comes down also to the nature of these businesses. This industry has consolidated to a small number of players as competition has fallen away, a very profitable, and of course, for us, it's always important, the price we pay. So we're buying, for example, PICC, which is the leading property and casualty insurer on a P/E of about 15 times. And we think that business can grow very nicely. It's very profitable, has underwriting profits and so on.

Another group are the Internet or e-commerce play. So there is a range of them from Baidu, which is like the Google of China, growing at 50 per cent - 56 per cent type growth rates. Its earnings have suppressed a bit because like many of these companies are slowly investing in new ventures, but it's on a P/E of 27 times, but we think earnings can actually outgrow over the next five years that top line growth rate. So we actually think that's a pretty interesting one. There is a range of these companies that are in the portfolio from Youku, which is a bit like a combination of YouTube and Netflix if you like. Qunar, which is a bit like the TripAdvisor of China.

There is another group of consumer companies, one of them, Moutai is the maker of the liquor of the same name, very strong brand name, historically has grown at sort of 15 per cent to 20 per cent growth rate for the last couple of years. With the corruption crack down, it has slowed down. But again, we're buying that on a P/E of 17 or so -- 17, 18 times this year's earnings, which we think for the type of the quality of the business and the growth rate, these are fantastic investment opportunities.

St Anne: Andrew, are you concerned about any of the risks coming out of China?

Clifford: The risks in that – in China, clearly relate to the problems in the property market and the bad debts that are yet to surface for the banks. But having said that, this economy has slowed. I mean property – construction has come to a grinding halt really and yet if we look at variables like parcel deliveries. Last year, they grew by over 50% and in the first quarter they continued to grow.
Other things like overseas travel grew by 20 per cent last year, continues to grow in the first quarter. So it's very clear in whole range of things, movie, the box office at the movies again, 30 per cent type growth rates, we're continuing to see it. So despite whatever has happened in the property market and there will be people who have lost money there, other parts of the economy continue to surge ahead.

St Anne: Andrew, in the presentation, you also mentioned you are underweight US, so aren't you seeing any opportunities in that country or is it about valuations?

Clifford: What the world has done in recent times and investors have done is that they are so focused on avoiding risk, have gone to markets or assets where there is high degrees of certainty. So we see that in the bond markets where people would rather lose money each year on a German bond, then take the risk of investing in something else and that’s flowed through to some equity type assets, where there is a high degree of certainty.
Certainly the US with its focus on many consumer staples names, the Procter & Gambles, and these type of companies, we think we're not going to particularly predict that those stocks fall particularly hard, but we just think that the potential returns are very uninteresting and indeed we do think on a company-by-company basis, they all face particular risks.
So we just think that there are far more exciting and interesting investments to be had, much better valuations to be had in places like China, but also Korea, India, than there are in the US.

St Anne: Finally, Andrew, just a sector question, you mentioned that the energy sector is an interesting place. Can you explain further?

Clifford: Well, it's exactly the sort of thing that we like, areas that have fallen out of favor, the oil prices had a very big fall. Our analysis of that commodity markets, we think that really at current oil prices and you are seeing shutdown of production that will in time provide the balance and we really need an oil price of A$80 or so to get supply back up to meet current levels of demand.
Somewhere like China, it may be growing more slowly than it has, but it will – energy, it will continue to consume. It's going to be a long time to really electric cars any kind of impact. So we think oil really needs to settle at a price above $80 long-term. Many share prices in the energy sector have fallen, so it's an obvious area of investigation. But we haven’t done anything of great substance there as yet.

St Anne: Andrew, thanks for your time.

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Where are the new global opportunities?

Christine St. Anne: The push to seek returns globally has never been stronger. We recently spoke to two Morningstar-medallist global fund managers with strong track records about where they are seeing the opportunities.

Magellan's Nikki Thomas has just returned from overseas and particularly noticed a trend in the cashless economy.

Nikki Thomas: I just went through six different countries with six different countries and not once did I use cash. That’s just amazing, but shows you just how quickly the payments landscape is changing around the world and there are certain companies that we are obviously invested in that have wonderful exposure to that shift away from people using cash in their transactions across the globe, even in emerging markets.

St. Anne: Nikki, also likes opportunities from the e-commerce theme playing out to China and demographic changes in in the US.

Thomas: Most people believe China will have online e-commerce as a bigger part of consumption well before other parts of the developed world. I think in the U.S. the changing consumer landscape is absolutely fascinating. When you think about the shift in demographics, the shift towards millennials and the spending power that they have and the minorities in that market, when you think about the changing and the redefining of convenience, convenience has been redefined by businesses like Amazon and Uber, social media and the impact that’s having on the way information is transported across consumers and that's what they see is important to them are all changing the landscape quite rapidly.

Some companies saw this coming and really adapted their businesses to it or have been a part of the transition business like Uber and Amazon.

St. Anne: PM Capital's Paul Moore has also returned from overseas. In fact, Moore was in Greece as a part of what he calls an investment adventure. He prefers to remain cautious with that part of the volatile world, but he is pleased with the recent investment, a CBA-style stock, but for half the price.

Paul Moore: Bank of Ireland is just the Commonwealth Bank equivalent of Ireland. In fact, its market share is higher and because there is not too much competition their spreads are better. Ireland is now recovering very strongly. So, we think that it's probably going to be in a position to pay 70 per cent payout ratio very, very soon and relative to the Australian banks, it's probably a third to a half cheaper.

St. Anne: Moore also sees value in domestic bank franchises in other parts of the world.

Moore: The domestic banking franchises, which are basically a yield play and a recovery in earnings, so they are basically a replica of what's played out here in Australia over the last 10 years, but they are only just starting. Basically, one of the focuses of our last trip a couple of weeks ago was the Morgan Stanley Conference in London, where all the CEOs of the big banks were presenting and everyone was just focused on dividends, dividends, dividends and they are starting to come through. So that is definitely playing out and that’s probably 20 per cent, 30 per cent of our portfolio.

St. Anne: In a world of virtually zero interest rates Moore has invested in a number of high growth companies.

Moore: Visa and MasterCard is an interesting one and then it's really just, I mean, every quarter they pump out double-digit volume growth, great franchise, just like the Harbor Bridge in terms of the money system. So, they just pick up a little clip, but it's growing double-digit. So you are getting 15 per cent types earnings growth, so just sit and forget.

And then the exchanges again they are sort of monopolies with a big recovery in earnings ahead of them and then starting to see financial market starting to normalize, investment banking activities finally starting to pick up. So that’s a big component of our portfolio. So, if you think about it, I mean, when you got zero interest rates, you either want really good yield relative to zero interest rates, which is the banks or you want good solid organic growth and that’s your payment process as your exchanges, your Googles of the world and the beauty of all those businesses, they got no debt. If you think about picking up zero percent on a Swiss government bond or a German government bond for 10 years, highly indebted Europe versus no debt companies that are growing double-digit, it's kind of pretty interesting arbitrage at the moment.

St. Anne: But like all investors, Thomas and Moore confront a number of challenges. Thomas sees particular hazards when interest rates do eventually rise.

Thomas: Probably the primary challenge, I'd say today is really around this prospect of rising interest rates, particularly in the U.S., but ultimately around the world that the interest rates where they're today probably aren’t sustainable for any lengthy period of time and that means people really need to think how to be better positioned for that change, for that to happen and to allow them to continue to create value in returns they achieve, but also being very mindful of the risks that they are taking in doing that. So the pricing of risk I think doing that sensibly is a real challenge for people in markets today.

St. Anne: For Moore, it's all about keeping that long-term focus.

Moore: I said you got to find the opportunities, when they're presented, be willing to be patient, live through short-term volatility, live through all the questions from the rest of the industry because if you are a genuine contrarian or if you are a genuine investor, you are only going to make money by being contrarian. But it means that you are doing something that the majority aren’t doing. So they are all looking at you saying what's wrong with what you're doing or we don’t like what you are doing. The reality is that, think about it, if you are doing what everyone else is doing, you're not going to make any money.

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Will Australian interest rates trend lower?

Robert Mead: I think, we're actually getting pretty close to the lows. Remember PIMCO came up with the new normal concept a couple of years ago now and part of that concept was a new neutral rate for Australia of around 3 per cent. So, given that we've already moved down all the way to 2 per cent, most of that price action at the front of the yield curve is already behind us.

So, PIMCO is probably not that bearish actually anymore in relation to how low rates can go. And this more recent backup in interest rates is actually great news for investors, for advisors, especially for those in retirement or approaching retirement that we can start to see some real returns being offered again within the bond market, which – and of the lows that we saw in interest rates back in January and February of this year, I don't think we're going to revisit those lows any time over the balance of the year.

Are you as pessimistic about the global economy as other bond investors?

I think, some of the very bearish investors out there, we think they're probably a little bit too bearish. So, our advice is to all investors is stay invested. Don't be scared of markets, don't move back to cash. You can still generate returns from equities, you can still generate returns from bonds, but the key message is that lower for longer remains with us. So to the extent that these low interest rates are justifying higher risk asset prices, we think that remains valid, while we do think the Fed moves off zero in this calendar year. It's going to be very, very measured; very, very gradual in nature. So stay invested. Don't lock yourself into cash rates that are generating negative real returns.

There's still plenty of opportunity out there for investors and our advice would be don't get too bearish. It's very easy to paint the really negative picture. The Australian economy is under pressure. The growth rate potential for us is lower than it was. The transition from mining to non-mining is very, very slow. I think we use the word glacial in some recent PIMCO commentaries and that's still very much the reality, but we need the lows. The RBA may have to move once one more time. Even that's not a given. And we think that 2 per cent cash rate, well below our new neutral rate, will be stimulatory for the economy and now that with this recent bond sell- off, yield curves are steep and expected returns are much better than they were a few months ago.

Are bond returns still healthy?

And the most commonly used words so far in the past few month in the media is this bond rout and so it's a very negative word to suggest we've been through a bond rout. But my view is that a small sell-off in yields is no rout, it's just a reassessment of where fair value should be in interest rate markets, and despite that so-called rout bond returns this year is still healthy. So across all of the sort of various available sort of sources of bond return, they're all in very, very strongly in the positive territory and almost all of them in the positive real return territory.

So I think that's a testament to what bonds do for a portfolio, and that they generate income and they allow for reinvestment if yields do go up. So, by no means, do we think that bond yields will be going up forever, but much more importantly even if they go up a little bit further that doesn't mean we would end up with negative returns. It means that we end up with increasing returns over time and maybe some short term sort of flat lining of return. But it still looks like a very healthy, healthy environment.

The final thing I'd say is that diversifying portfolios is a structural issue. It's not a tactical issue. You don't market time portfolio diversification. Portfolio diversification should be something that we all live and breathe every day of the week and having allocations across the portfolio to different asset classes, asset classes that are not completely correlated with one another, will ensure that investor outcomes over the medium term are much healthier in terms of their risk-adjusted returns.

Will investors shift to riskier assets?

It's a bit disconcerting, I guess, for investors especially those approaching retirement that their assumptions around income in retirement are all being adjusted as real rates come down so far, and unfortunately for the Australian investor base, it's a reality that was used to be something that foreigners had to worry about, but now it's relevant for the Australian investor base as well. Unfortunately, we think that's just something that's with us for the long run.

So you read about - you're going to be reading about 4 per cent or 5 per cent real returns for taking no risk in the history books. You're not going to read about that in the papers anymore. That's something for the past. We know our banking sector is no longer constrained by funding or by deposits. They're now constrained by capital. So their willingness to pay out for term deposits and other things is now a thing of the past. So it's an unfortunate reality that expected returns for investors will be lower, but that doesn't mean you have to take a lot more risk. All that means is you need to be a little bit more conservative in terms of your assumptions. And that's why I said at the start, investors should stay invested. There's no point owning that negative return in a real sense by sitting in cash.

Where do you see the best opportunities over the next 12 months?

The first message would be use the same consistent set of assumptions across your full portfolio. So if, for instance, you're worried about interest rates going up quickly, then apply that to every asset class. Now that's not our view. So, we say stay invested.

Second thing is bonds aren't all about interest rate risk. Bonds have so many different attributes that they bring to the portfolio. Obviously, income generation being the most important one, especially for retirees, but also in terms of allowing you to take other risks in portfolios by providing that anchor that capital stability, that then allows you to take some other risks. You don't have to take outsized risks for your entire portfolio. You can be very selective, knowing that you've got this anchor in the portfolio.

And then finally, there's lots of other ways to generate those returns. So credit spreads, we think, continue to be attractive, investing in all different slivers of the bond market in order to find relative value and find returns that are going to generate expectations well above the inflation rate. So I think it actually looks like a very attractive investment opportunity now that we've had a bit of a backup in yields and at the end of the day steep yield curves are the best friend of a bond investor. And we've gone from having a very flat yield curve in Australia only a month ago to having a relatively steep one right now with cash rate at 2% and many, many attractive investments out there generating 4%, 5%, 6% returns. The benefit of those, the ability to roll down the yield curve, will ensure that investment outcomes in terms of absolute returns are much, much higher than the headline yield would suggest.