Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Contrarian investing in the age of foolishness
Markets are poised for more damage after a remarkable bull run, and Orbis Australia believes now is the time when contrarianism will prove its worth.
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness,” writes Charles Dickens in “A Tale of Two Cities”; a sentiment that Graeme Shaw, director of Allan Gray sister company Orbis Australia, agrees with. The last 40 years have certainly been “the best of times” for investors, with bond returns double the long term averages in real terms, and real stock returns have been 50 per cent higher than the long-term averages.
“Unfortunately, the successes of the past make this the worst of time for investors,” Shaw told the Inside Network’s Equities Symposium on Wednesday (March 30). “They now face very low bond yields, high cyclically-adjusted PEs in the stock market, once again very high house price to income rations, and a rate of inflation that’s a lot higher than we’ve all gotten used to.”
“While it’s fair to say that the stock market has done a great job of protecting investors against inflation over the very long-term, this isn’t always the case.”
The most disappointing periods in stock market history have all been preceded by very strong real equity returns; what goes up a lot inevitably comes down, and those downs can last for a very long time. The NASDAQ has quadrupled wealth over the last ten years, and the S&P has tripled it. That’s “quite concerning for the future”, and while returns have been high, valuations are even higher. 20 per cent of the world’s stocks now trade at highly speculative valuations.
“The last time we saw this sort of exposure in stock markets was in 2000, at the top of the tech bubble, and you all remember how that turned out for investors,” Shaw said. “The dilemma that investors face today is that they can’t really invest in the bond market – yields are really low compared to inflation – but you naturally worry about investing in the stock market.”
Shaw doesn’t believe the dynamic is quite as bad as some have made out. Two thirds of the market has valuations roughly in line with their return history, and the way forward could be to concentrate on that segment simply by buying a value index. Still, that approach has a “number of disadvantages”.
For one, it can’t deviate from the world index weight, and having that much exposure to the world’s most expensive market – the US – likely isn’t sensible right now. It’s also rebalanced only twice a years, meaning investors can lose out on periods when other investors panic “and leave a lot of value on the table”. Shaw believes that a more active approach is required, and that Orbis’ contrarian bent will give it an up in the down market.
“When other people are fearful and panicking – when they let their emotions get in the way of rational evaluation of the value and price, you buy off them,” Shaw said. “Because they’re more likely to make a mistake at that point in the cycle. When they get excited and think the world looks great and the future for the company looks great, you sell to them – because they’re more willing to overpay.”
Orbis’ previous contrarian bets include Toyota, which faced a massive recall after mechanical failings with their cars; Google, which saw its share price plummet during the Global Financial Crisis as investors strayed from advertising-linked stocks at the outset of the recession; and even the mighty Microsoft was cheap when its operating system flopped.
One company that looks “very contrarian” to Shaw today is Global Payments, which operates in about a hundred countries and processes 50 billion payments a year. Payments has a “very high barrier to entry” by virtue of the scale and merchant trust required. It grows with nominal GDP. Global Payments has grown revenue by 13 per cent year on year by taking market share from their competitors.
“You’d think the market would love this stock, and you’d be right. Traditionally, they have loved this company and it’s typically traded at about a 30 per cent premium to the S&P500 – until more recently.” Shaw said. “You can now buy it today at a 30 per cent discount.”
There are a number of reasons for that. Global Payments is heavily exposed to small- and mid-size businesses, which have recovered much more slowly; it’s heavily exposed to credit card payments, which have lost market share to debit cards; shopping habits have changed, with consumers preferring to spend more, less often; and a number of new listings have created the impression of competition in payments.
“We think all of these things will go away. Small businesses will recover as Covid disappears into the rear view mirror,” Shaw said. “Credit cards will regain market share from debit cards after this recession, just as they did after previous recessions. Payment patterns will go back to normal as people return to work and start buying cups of coffee. And once all of those things have happened, people will realise the new listed companies… don’t compete with Global Payments.”
