Discussion Panel: Tony Boyd with three Australian legends of investing

Tony Boyd, Australian Financial Review Hi, my name is Tony Boyd from the Financial Review. I have the privilege today of hosting the Future Generation Investment Forum virtual meeting, with three legends from Australian funds management. Don’t take anything out of this in terms of the way I introduce them; it’s just alphabetical order. We will start with Phil King from Regal, David Paradice from Paradice Investments and Geoff Wilson from Wilson Asset Management. I can’t think of a better group of people to inform us about what’s happening in financial markets. Before I start to ask the questions, I’ll just tell you what came out of a survey of Future Generation investors. They were asked their own attitude to the markets – were they bullish, were they bearish or were they neutral?  Before I ask our panellists their own answer to that question, I’ll just tell you the results. 15% said they were bullish; 32% said they were bearish and 53% were sitting on the fence. I don’t expect our guests to be sitting on the fence. Why don’t we start with you, Phil? What would your answer be to that question?

Phil King, Regal Funds Management I’m more bearish than I normally am. We have seen a bit of a relief rally in the market, but certainly we’re facing one of the deepest economic recessions that we’ve seen for a long, long time. I think it’s tough to see the stock market doing too well in that environment. 

Tony Thank you. That was quite succinct. Para (Paradice), would you like to come in there? I believe you’re sitting in America. You’re in the biggest economy in the world there, which is obviously wonderfully managed by a Republican president. But what’s your answer to the questions?

David Paradice, Paradice Investment Management In March, I felt that things may turn out for the better when the cases started declining in Australia. I felt at about that time that America would be just starting to go up, so I felt that the Aussie market would start moving up and I thought the currency would get stronger. That was when it was the kind of late ‘50s; it’s 64.5, 65 at the moment. I thought the US market would have a significant decline. What’s happened is the Australian market has got stronger and the currency has got stronger, and the US market has also got stronger. There’s a lot of people saying that in Australia, the stimulus after the GFC was about 6% of GDP; this time it’s about 12% of GDP, so there’s this massive stimulus going into the economy, which should help go through.  Everybody is talking about ‘is it V or is it U?’ That’s the question that everybody is trying to work out. I’m a bit like Phil, that I think things have rocketed up way too much. I suppose there’s a whole lot of things.  When you’re thinking about it, you think the lockdown will be thawed out, but then are people really going to go out and start buying? Even though they’ve got this money in the pocket, and that’s the big question that’s human nature. But then of course, people generally are bullish and that’s why you’re seeing this uptick in the equity market and why people are looking through the ‘V’ and thinking it’s only going to be a sharp ‘V’ down and then a sharp uptick. I’m kind of with Phil now. After you’ve seen a big increase in the equity market, now you’ve got valuation and you’ve got interest rates that obviously aren’t going very high; they’re probably close to 0 or 1%. You’ve got that certainty and that’s good for the growth stocks and that kind of stuff. If you look back at the equity market prior to the COVID-19 (outbreak)back in January/February, the equity market was quite expensive; people said it’s quite expensive. Now it’s back up to that level, but you’ve had this massive contraction in the economy, and so it’s probably even more expensive. But the equity market continues to go up. In short, I’m probably where Phil is. I’m a bit bearish.

Tony I noticed in your latest report to your investors, Geoff, you said we’ve just come out of the fastest bear market in history. I think that’s been followed, as Para said, one of the fastest recoveries in history, back to those very expensive Pes (price-to-earnings ratio).  What’s your feeling at the moment? Are you bullish or bearish?

Geoff Wilson, Wilson Asset Management Thank you, Tony. The incredible thing is that we’ve had the longest bull market ever that finished in the early part of this year and, as you said, we’ve had our most severe or most brutal bear market. Obviously, as Phil and David were saying, the incredible liquidity that’s been pumped into the system, both from a fiscal perspective and from a monitory perspective, has allowed valuations to bounce back up. I think if we are all sitting here and the market was 20 to 25% lower, as investors, all of us would be a lot more comfortable. Para is talking about is it a V-shape economic recovery, or is it going to be a U-shape recovery? It could be an L they’re talking about and it could be a W! To me, that’s the great uncertainty. I think obviously valuation has been pushed up because of that liquidity and that does make me nervous. I would be tending on the bearish side.

Tony Thank you. It’s a pretty unanimous group of there being pretty bearish. Let me move to the second question that the investors were asked. Where do you see the best buying opportunities at the moment? Is it Australian equities, and 65% of investors said yes to that, or is it global equities? Only 35% said that. What I find intriguing is that as I go through the performance of your funds over the recent period, the March quarter, for example, I think it’s fair to say that all of your funds that were international that you manage outperformed the indexes or benchmarks, as opposed to your Australian funds, which is an interesting dichotomy there. Maybe if we start with you, Geoff. Is there better opportunity offshore at the moment, or is it actually in Australia? 

Geoff In terms of setting your portfolio, you’ve got to set your portfolio to whether it’s what they call the new normal, or the changed economic conditions we are in. One of the great things about looking at global equities, and Catriona who runs our global fund has been talking it numerously, you can get a lot of these plays. The big changes in the economy, the cashless society, the big growth in ecommerce, telehealth, et cetera, you can get really good direct plays looking globally. You can’t initially get those great direct plays here in Australia, looking for companies to invest to get those type of exposures. To me, you’ve got a lot better selection from a global perspective. In terms of broadly, which economy will do well over the next period, you would have to say Australia is in a fantastic position. In theory, this is what everywhere else in the world would like to be like, at this point in time, in terms of how Australia has been so successful in terms of flattening the curve or getting the virus under control, which will allow us to benefit significantly. Internally, we were talking about the other day, in theory, you’d get a lot of people wanting to come and live in Australia and could there be some big financial benefit from the Australian government by opening it up? Obviously, politically, the problem is they probably won’t do that. I think as an economy, Australia will do reasonably well, the domestic economy over the next period of time. For the US or the UK, it’s going to be a lot tougher over the next little period.

Tony Para, you’re sitting there in America at the moment. Are there better opportunities over there than there are in Australia, do you think?

David I agree with Geoff. I think that the Australian economy should do okay or better. America, as we all know, is taking a long time to address the issues that are happening. It is interesting though that we have an emerging markets fund based out of San Francisco. I think the Australian equity market financial year to date was down 15%, but their benchmark, which is the emerging benchmark, was down 5%.  They’re actually up positive 5%, so they outperformed by 10%.  But they have actually been able to do that because they had investments and China, and obviously China has not affected as much, but there are some areas like Brazil and South Africa, which have been belted. It’s hard to say a blanket ‘Australia is better than that’, but some of those massive stocks in America, the Amazons (NASDAQ: AMZN) and the Googles (NASDAQ: GOOGL) and those kind of things, are benefiting in some respects from this particular COVID-19 crisis. There are good stocks there. I don’t know whether they are good quality or whether they are good value or they’re worth buying or not, but I’m just saying that there are pockets of good stocks around the world and it would seem that even in the emerging markets where our San Francisco guys are investing, they have done a fantastic job finding value there. You can find value; it’s just trying to work out where it is.

Tony Thank you. Phil, I get the feeling there’s a bit of a thematic coming out of our two other guests there, that you really want to find the themes that are going to work and don’t discriminate between offshore and onshore. Am I getting it right? What’s your attitude?

Phil I think that’s exactly right. I think actually sector exposure is much more important at the moment than country exposure. The Australian market underperformed in the bull market and we’ve underperformed this year in the bear market. Sadly, I think we’re probably going to underperform going forward. That’s more about the composition of our market than anything else. The Australian market has a big exposure to stocks that look cheap through leverage, value traps like banks and REITs (Real Estate Investment Trust) and infrastructure. We’ve got a big exposure to some incumbents, like Telstra (ASX: TLS) and supermarkets that are losing shares to newer entrants. Many of the overseas markets have much higher weighting in healthcare and higher weightings in technology. These two sectors are the two sectors that we think will do best in the current environment. They’ve got less exposure to the economy and a lot of the stocks in these sectors have much stronger balance sheets, which is more important than ever before. I think it’s much more important to think about your sector exposures, and we like technology, we like healthcare, and we like gold as well, rather than worrying about country exposures. I think sadly, the Australian market could continue to underperform, just because of that composition that we have in the market. 

Tony Thank you, Phil. Just while I’ve got you, obviously you had a pretty tough March quarter, March and April. It would be just interesting to get your perspective because whenever I’ve asked people about this, and I think the Atlantic Absolute Return Fund was down 58% in March and 32% in February, but if you look at that fund, it was up 82% last year. It’s actually probably still in front! I think since inception, it’s been extraordinary. What have you been saying to your investors as they’ve read that March note you put out?

Phil Yes, the good news is most of our investors have been with us for a long time. We’ve made them a lot of money and we’ve actually seen investors tend to add more, rather than take money away. The Atlantic Fund is a high conviction fund. We use leverage, we invest in small caps, and so when there is a change in direction in the market, it can catch us a little bit unawares. We did probably underestimate the impact of the coronavirus pandemic initially. But then the good news is that we can bounce back. We bounced back strongly after the GFC. We were up 500% in the two years after ’08. Early signs in April and May are very positive. We are having two very strong months. One of the things that hurt us in March was the fact that we do have a lot of small and mid cap exposure. We like the technology sector, we like the pharma sector, but the price, a lot of these stocks that we like in Australia are at the small and mid cap end and as a result, a lot of these stocks got sold off a little bit more than the broader market. Stocks like Telstra and supermarkets obviously had some short-term benefits from the pandemic, but we think will struggle for growth in the longer term. The good news is that a lot of the stocks that got sold off in the sell-off have bounced back very strongly and some of them are back to where they were and some of them are even ahead. Our investors are very loyal and fortunately, they’ve been with us for a long time and they understand what we’re trying to achieve in the Atlantic Fund.

Tony Geoff, if I could turn to you. Your flagship fund of course is WAM Leaders (ASX: WLE), $800 million fund gross assets.

Geoff WAM Capital (ASX: WAM) is the flagship. WAM Leaders is our leaders fund, yes.

Tony You’re right, WAM Capital is a billion dollars. The thing that caught my eye in the WAM Leaders letter that you sent to your investors was when that sell-off happened in February, you moved really fast. You removed the companies with cyclical and leveraged characteristics and then you bought gold stocks, Woolies (ASX: WOW), Coles (ASX: COL), Amcor (ASX: AMC), all of which have done very well. I think a lot of people just buy and hold. Is this something you should leave for the fund managers, or should you yourself follow their lead and be more active in your management of your assets?

Geoff I think when you look at David or Phil or ourselves, in this period of time that we are in, you’ll see the active managers outperforming. I think if in six months’ time you look back, you’ll see all of them do well because unfortunately, the passive play just gives you the index. As Phil said very articulately, you look at the Australian index and it is very exposed to financials, REITs and some sort of old-world companies. Really, in the next six to 12 months, where do you want to be exposed? You obviously want high quality companies, you want liquidities, good balance sheets, and you want companies that can grow. You were talking about WAM Leaders, Matt Haupt, who is the lead PM (Portfolio Manager) there, he’s done a fantastic job of adjusting to the change in environment, and which sort of happened late February. I think for the period, he’s outperformed the market by I think it could be 8 or 9% because of the rotation. In our flagship fund, in WAM Capital, that’s more mids and smalls, because the economic environment had changed from 24 February when it was clear that COVID-19 was impacting the world rather than just China, we realised that it was a risk-off play and that the outlook for the economy was going to be different. We actually went to 43% cash in the mid and small cap funds and we remembered back in the GFC, during these tougher periods you usually find companies raise a lot of equity. I think the equivalent of 12% of the market cap was raised in new equity during the GFC, so we assumed it was going to be 12% plus.  We have used that opportunity in more the mid and small cap funds to a) reposition our portfolios, which I think we all did. The tough thing is, and talking about Phil’s comments or Tony, your comment about Phil, when you get hit with a bear market or a major market drawdown, all fund managers are going to get impacted. The question is how you restructure your portfolio and how you position yourself and really how quickly you make your money back. As Phil pointed out, volatility is just part of investing in equities and it depends which ones you invest in, but it’s really how quickly you make your money back. Phil pointed out that he made it back very quickly after the GFC; you made five times your money by being in that fund. I know from our perspective, after the GFC, it took us a little over two and a bit years to get back to the height again. I think the market took six and a half or something like that. To me, looking at who is a good fund manager or not, it’s really not the fact that you’ll lose the money when there’s major market dislocation, it’s really how quickly you can make that money back – that’s the crux. 

Tony Just a quick follow-up there, Geoff, it would strike me that one of the keys to your success in funds management has been franked dividends and your laser-like focus on making sure you are giving people and distribution that is fully franked. How are you thinking about that at the moment when you’ve got so many companies either deferring or slashing or stopping their dividends because of COVID-19?

Geoff I would initially agree. I know franked dividends have been very topical over the last couple of years because of Labor’s unfortunately illogical, inequitable proposed policy. What we’re trying to do is probably like all fund managers, we are trying to buy undervalued growth companies and buy them when we can see a catalyst that is going to change the valuation. That’s our focus. Our ability to pay fully franked dividends to our shareholders in our LICs is really the function of us making capital and paying tax. Even though there will be lot of companies cutting dividends, how we get most of the dividends we pay is by making money and paying tax and paying the dividend out. The great thing with the listed investment company structure is you can smooth those dividends over time. For us, it’s a function of how much profit reserve we’ve got, how much franking we’ve got and our ability to keep paying those dividends. We think we can continue to pay them and that’s really a function of us making capital profit and paying tax on it, rather than getting dividends from the companies that come in. There is no doubt, what I love is how a lot of the bigger companies are talking about deferring dividends. To me, isn’t that just a polite way of saying, ‘I’m cutting this dividend, you’re not going to get it’; you will just get the other dividend in six months’ time. I’m not sure if they are real deferrals or not, but I like the new verbiage that everyone is using.

Tony That’s the way I looked at it too. Para, Geoff mentioned the amount of capital raisings and potentially the opportunities there. Have you been involved in that? Have you been taking up new equity issues, secondary market issues?

David Yes, we have. We have been taking up some of the issues. I think like we have all touched on, right at the moment it’s pretty important to have a lot of downside protection in the portfolio, to try and buy particular investments or whatever it is where there is limited downside. Of course, it’s hard. Say for example, Flight Centre (ASX: FLT) raised money the other day to allow them to be able to trade for, I can’t remember what the period of time was. But who knows how long? This is the question – how long is this thing going to go for? You have to, as all of our fund managers have done, move the portfolios to a place where there is limited downside protection and not taking on too much risk because you don’t know what the upside is from here. You don’t know how much unemployment is going to be and how things have been structurally changed by this, whether people are going to work more from home and is that going to affect the office market and REITs and all that kind of stuff? It’s a tough time.

Tony The capital raisings, Para, have they actually been good discounts and attractive terms?

David Generally, yes, they have been and the stocks have sometimes traded down to those levels, subsequent to that, after people have taken a stock and then sold it. But I don’t know, Phil and Geoff, do you know what the discounts have been? I don’t know.

Geoff They’re at least 9% discounts. I remember some data a week or two ago that 97% of them you would make money on, because the early ones that were raising were really, as Para said, the Flight Centres, the Webjets (ASX: WEB), the ones that a lot of people thought wouldn’t survive. There was a lot of negative sentiment overlaid on those stocks, so when they raised the money there was quite a strong bounce in terms of those type of companies. 

Phil I think the other thing to add is that most of the companies that have been raising have been raising in a rising market, and so obviously they work a lot better. It’s a lot more difficult to raise money when the market is falling. That’s why we sometimes might need to see wider discounts in a falling market than a rising market.

Tony Gentlemen, we’ve got about ten minutes left. Maybe we can start with you, Phil. It’s always good for the investors to hear about some stocks that you think are going to do well in the current environment. I assume you are going to talk about defensive stocks, but maybe you could tell us a couple of stocks that you think at the moment offer very good opportunities to invest?

Phil We like three sectors at the moment. We like technology, we like healthcare and we like gold. In the tech sector, we like stocks like NextDC (ASX: NXT) and Megaport (ASX: MP1), both involved in data centres. We like Appen (ASX: APX), which has got one of the biggest crowds working from home and it’s got customers that are doing very well in this environment. In the healthcare sector, we like stocks like Opthea (ASX: OPT), which has had some very successful results in the treatment of macular degeneration. That’s a very exciting company and we think eventually that will get taken over by a global healthcare company for two or three times the current share price; that’s Opthea. We also like the gold sector. One of our gold stocks, De Grey (ASX: DEG), has found what we think could be one of the biggest gold discoveries in Australia for many, many decades. That’s at the smaller end of the market. At the larger end of the marker or the mid cap end of the market, we like Red 5 (ASX: RED); we think that’s undervalued. We also like stocks like Saracen (ASX: SAR). Gold, technology and healthcare; they’re the three sectors that we really like at the moment.

Tony Sounds very good. They do tend to be smaller to mid cap stocks, so you’ve got greater leverage?

Phil Greater leverage, yes, and obviously coming with a little bit more risk as well. That’s what we saw in February and March. Certainly, in this Australian market, we don’t see a lot of growth, so I think it’s important to go down the curve a little bit in terms of market cap and try and invest in some of those small and mid caps. 

Tony Maybe that’s a good segue to Para. I think in your latest report, your mid cap and small cap funds both outperformed their benchmarks in the March quarter. What would you tell the audience about the stocks you like at the moment?

David As with Phil, we are quite keen on gold. Gold is an area that we like and as a result, we also are pretty keen on Saracen.  They’ve got fantastic management. We also like Sigma (ASX: SIG) because of their management.  They’ve had a rough trot, but the sales for the last half were up around 30% and they have been benefiting from COVID-19-related stuff. The management there are fantastic and they have had a rough trot of late, but we think they will turn things around.  We think by around 2022, their EBITDA numbers should be much higher than what they are at the moment. Of course, everybody has expensive stock, but everybody loves CSL (ASX: CSL). These three companies are very well managed. CSL is a great business, very well managed, but of course it’s very expensive, a global leader in blood plasma products and also it should be able to assist in vaccine production and things like that. 

Tony Sounds good. I think we are getting a Saracen moment. Geoff, I believe that Saracen is in the WAM Leaders fund. Any other stocks you would name?

Geoff In terms of the companies you want to own coming out of this, it’s well managed, good balance sheets, well positioned. If you are looking more at domestic equities in Australia, more short to medium term, you would probably go for some of the deep cyclicals, only because they’ve been beaten up a lot and also the fact that it appears that Australia is doing exceptionally well and we are coming out of COVID-19. Maybe everyone’s got a bit too negative for that. But in terms of the ones that we like medium/long term, and looking at mid and small companies that have good franchises that can grow, things like Infomedia (ASX: IFM), Bapcor (ASX: BAP), Johns Lyng (ASX: JLG), companies like Objective (ASX: OCL), companies like that, that have some competitive advantage and can prosper in all different types of economic conditions. I know we are all talking about being a bit nervous over the next say three to six months. But I think it’s fair to put it in context and one of the great things about the equity market is it performs over time. You really want to be buying when everyone is a little bit on the nervous side, because you know that at some point in time, everyone will be incredibly bullish again. If you can take that medium term view, and I think David, Phil, myself and yourself would all agree, at some point in time we will look back at this period and it will be like reminiscing as David did about the ’87 crash or reminiscing about the tech wreck or reminiscing about the GFC. Life will go back to normal. Whether it’s the new normal, but it will be a normal and we will be talking about these great bull markets again.

Tony That sounds like a very good note to end the discussion on, seeing we all started being bearish and now we are talking about the next bull market – that’s great! Thank you everybody for participating in the panel. Just before we go, there was one other question that was asked of the investors, and that was, ‘do you still believe mental health is the issue of our time?’ It’s interesting that the answer to that was ‘yes’. 73% of people still believe that. That’s a very good thing, when you think that the whole purpose of the Future Generation concept is to help people who’ve got mental health issues. We appreciate your time in this and your efforts to donate your funds management earnings to this cause.  Thank you.