Great long-term opportunities come in times of uncertainty
Portfolio Manager, Adam Chandler, from Claremont Global, one of Australia’s best performing international funds(1) , discusses opportunities in the current market, which companies they’ve been buying recently, how the fund makes investment decisions and how they think about risk.
How are you navigating the current market environment?
There have certainly been some rough seas in the first quarter of 2022. Between inflation, rising interest rates, soaring oil prices and the tragic Russian invasion of Ukraine, there’s a lot of headline risk. One danger for investors is that they get whipsawed as they attempt to respond to macro and geopolitical risk.
However, we don’t manage from a top-down macro perspective ― instead, we focus on companies and construct the portfolio to reduce exposure to specific risks. It’s a high conviction portfolio of between 10 and 15 companies. All our portfolio companies are listed in developed markets, although typically have geographically diverse revenue.
Over the last few months, we’ve been able to deploy cash and reallocate capital across the portfolio, to take advantage of opportunities where the discount to our estimate of value is greatest. Recent volatility has allowed us to add two new positions to the portfolio – great companies that we’ve been able to buy at depressed levels.
So, you pay no attention to macro?
We’re macro aware and we control our underlying exposures, so that the portfolio can weather a range of macroeconomic conditions.
But we don’t spend time attempting to predict macroeconomic outcomes or left tailed events. In Keynes’ two groups of forecasters, “those who don’t know” and “those who don’t know they don’t know”, we fall in the former category. The list of “unprecedented” events over the last two or three years have been a stark reminder of the limitations of predictions. We are often dealing with uncertainty, not neatly measurable probability.
We think the best long-term protection against downturns is by buying quality companies, run by capable management, with strong balance sheets and not overpaying. The average age of our portfolio companies is more than 80 years – they are battle hardened and have proven resilient across many cycles. Our team has a better chance of developing insight into businesses, than predicting which way many macroeconomic variables may align at a point in time ― and then what market outcome may or may not occur as a result.
You said you’ve seen opportunities in this environment. Can you tell us about those?
In mid-March we were buying a U.S. tech company and a European luxury goods business. Before we had even disclosed the names of the new holdings, an observer commented the positioning changes were “brave” – which they meant not in the flattering U.S. sense of “that’s courageous”, but in the British sense of “are you insane?!”
Of course, they weren’t courageous, nor insane, decisions. We’ve followed both companies for years and have a high degree of confidence in the quality of the businesses and the sustainability of earnings growth over the long-term. We have waited years for the opportunity to invest at the right price.
What were the two positions added?
The luxury goods company is LVMH. The company has an extraordinary portfolio of brands, some hundreds of years old, and are well diversified by product and geography. We’ve owned it before (selling when the price got too far ahead of our valuation) and have always admired the company. So, when LVMH’s share price declined 25% in just over a month, we welcomed the opportunity to invest.
The tech company is Adobe, the dominant platform for the design of digital content. For many creatives, Adobe is as essential as Microsoft Office is for knowledge workers. Adobe has been growing its top line in the high teens, has extremely high incremental margins, approximately 90 per cent subscription revenues and we expect it will continue to grow EPS in the high teens. In the recent sell-off, the Adobe share price was down approximately 40 per cent from its peak, and at an attractive level relative to our assessment of value.
In both cases, while their share prices have declined, the companies continue to perform exceptionally strongly, and tricky markets are usually when the discount to value opens up.
What’s the process for evaluating the purchase of these two companies?
Our process is too detailed to go into here, but at a high level some of the key issues we focus on are:
- Do the companies have dominant market positions, pricing power, attractive organic revenue growth and a capable, trustworthy management team?
- Do we have a high degree of confidence that these companies will be able to withstand a range of economic environments? History is a good starting point, as are non-cyclical revenues, strong and expanding margins and a healthy balance sheet.
- Is there a substantial margin of safety? Even when buying great businesses, price matters. The importance of that consideration was again highlighted last year, as some fantastic companies’ multiples got to nose-bleed levels. It’s important to maintain discipline. We always want to buy companies at a meaningful discount to our estimate of intrinsic value.
How did you get comfortable to make these investments amid such uncertainty?
The first two points are important in their own right for driving returns. However, buying great companies that have proven resilient through prior cycles also serves an important psychological purpose, which is sometimes overlooked. We need confidence in the ability of our companies to deliver on our earnings expectations, and in turn our valuations, to determine how much to pay and to not waiver when the opportunities present.
Without that confidence, we place ourselves in a position where price falls (or rises) alone – rather than facts – are more likely to drive our view of a company’s prospects. By bending to the market’s view, we would be at risk of buying or selling at the wrong point, particularly when there are extreme price moves. Potentially, being our own worst enemy in undermining the power of compounding.
And what if markets continue to decline?
The discount to value may open up further and that’s ok. We typically increase position sizes over time, rather than moving immediately to a full weight.
We’re not trying to pick the bottom; just ensure we earn a very healthy return on capital. That means not buying until there is a sufficient margin of safety. It also means making sure we don’t go weak at the knees, and we do execute when the opportunity is there.
If we do our job well, identifying great businesses and not overpaying, controlling overall portfolio exposure, compounding will take care of the rest over the long-term.
We’ve discussed company risk but practically, how do you manage portfolio risk when you have a bottom-up focus?
Put aside the differential calculus, practically, any sensible portfolio management is an attempt to deal with the two core risks: 1) losing money and 2) missing out.
There’s a spectrum of trade-offs in managing these two risks. Our primary objective is to preserve our clients, and our own, capital (i.e. avoid permanent capital losses); and then position for long-term compounding.
Capital preservation is front of mind, so we prepare for a wide range of outcomes, not just the outcome we think is most likely. What we can control is portfolio exposure. We spend the majority of our time thinking about individual businesses, including their earnings drivers, risks, and likely resilience in a range of scenarios. We then construct the portfolio to limit exposure to specific types of risks.
For example, we don’t want all of our companies to be geared to interest rate rises, and then be wrong-footed if expectations reverse – we want a mix of earnings drivers. In our portfolio today, the earnings of companies such as CME Group, ADP and Aon will be likely beneficiaries of inflation and rate rises. Lowes, Nike and Ross Stores will likely face a headwind from higher interest rates, but that’s OK, we don’t want to get too far to one side of the boat and be hit by the wave no one saw coming.
Claremont Global is a high conviction portfolio of value-creating businesses at reasonable prices. We consider ourselves true stock-pickers and look to avoid owning businesses that depend on a benign or favourable economic environment.
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Adam has more than 20 years’ experience in financial markets,having previously worked as an analyst and Portfolio Manager with UBS’s Fundamental Investment Group and at a London-based, absolute return fund. In the earlier stages of his career,...