A lot can change in 10 years. 10 years ago, the world was on its way out of The Great Recession, Donald Trump was just a wealth reality TV star, PetroChina was the largest company globally, and Facebook was just a website for teenagers. In 2029, the world will undoubtedly look very different from today, which is the topic of this discussion from Livewire Live 2019. It features two of Australia's most accomplished investors; Hamish Douglass, Chief Investment Officer at Magellan Asset Management Limited, and Andrew Clifford, Chief Investment Officer at Platinum Asset Management.
"We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten." - Bill Gates
Watch the full discussion or read my editorialised summary below to hear why we’re in “a new paradigm” of low interest rates, where to find a company on nine times earnings growing at 20% p.a., and in which mega-cap Magellan has recently become top 10 holder.
A new paradigm of low interest rates
Despite acknowledging the danger in such a statement, Douglass said that we face “a new paradigm” in this world of low interest rates. Warren Buffett calls interest rates the gravity of markets – as interest rates go down, stock prices go up, and vice versa. Douglass offers a hypothetical example of a company growing at four percent p.a., which might be worth around 17x free cashflow with interest rates at five percent. This same equity, with rates at three percent, would be worth as much as 33 times free cashflow.
“I do think we’re in a new paradigm, potentially, and that’s always a very dangerous thing to say.” - Douglass
Douglass went on later in the discussion to explain that expectations for long term future interest rates are likely too high. Magellan has two key consultants on the topic of interest rates; Kevin Warsh, a former Federal Reserve member who may serve as the next President of the Fed, and none other than Janet Yellen herself, the previous President of the Fed. He says their advice played a role in him adjusting his views on rates. He now sees three percent as a base case for long term rates, but says that scenarios between zero and two percent shouldn't be ruled out.
Clifford, however, disagreed. He believes central banks are signalling that monetary policy has run its course. With governments in Asia, Europe, and America poised to step up with fiscal stimulus, this simultaneous spending could create significant demand for resources and light a fire under inflation. He sees the 10-year US Treasury back to three to four percent over the next five years.
What ever happened to 'The Asian Century'?
A decade ago, the prevailing wisdom said that the US' era of dominance was over, and China was the place to invest. But as can be seen in the chart above, US markets have significantly outperformed Chinese markets since then. So what happened?
Clifford believes that the thesis still remains in tact, the issue was one of starting valuations. The growth of the Chinese consumer and the ascent of China as a world power is real, but how much were you paying for it 10 years ago? Too much, clearly. The good news for investors, is that valuations are much more attractive today.
"At the beginning of the period, Chinese stocks were insanely expensive. Insanely. Today, they're trading on a fraction of what we would find for similar growth rates in the US." - Clifford
Douglass, however, has a very different take on what's caused the discrepancy. It comes down to an issue he calls "capitalism without capital".
“The businesses that are winning are businesses that are very capital light. A lot of these Asian companies, and a lot of these companies on very low price-earnings multiples are companies that are very capital intensive.” - Douglass
In particular, he singles out banks, of which he says Magellan owns none in their portfolios. He believes capital intensive businesses will continue to struggle, regardless of their undemanding price-earnings ratios.
"We cannot find a bank anywhere on the planet that we want to invest in." - Douglass
One thing that they both agree on though, is that the next 20 years will belong to the Chinese. With low starting valuations, an increasing number of capital-light businesses, and favourable demographics, both 'value' and 'growth' investors should have no problems seeing the appeal.
“At that value end of the market, in some fantastic businesses, high return on capital businesses, there are some extraordinary opportunities to buy. They’re growth businesses irrespective of the global environment.”- Clifford
So what do they like?
Douglass is a big fan of the demographics in China. With more than 600m people still living in rural areas, there's still plenty of room for urbanisation. It's not just those moving from rural to cities though; over the next decade, the middle class is set to double, the affluent middle class is set to quadruple, while the affluent class is set to increase by six times.
"We're making a big rotation into the Chinese consumer." - Douglass
Ali Baba - Douglass disclosed at the event that Magellan is now one of the top 10 shareholders in Ali Baba globally, and easily the largest shareholder in Australia. He said that it's "dirt cheap, and strategically, incredibly well positioned for what's going on."
LVMH - Magellan is also a top 10 shareholder in LVMH (Louis Vuitton Moet Hennessy), one of the world's leading luxury brands. Douglass does not believe that an endemic Chinese brand is capable of becoming a leading luxury brand, going so far as to say that the USA has not produced a luxury brand in its 243 years in existence. Critically, LVMH owns the the world's largest duty free chain, "Duty Free Stores", which includes 420 duty free boutiques at 11 airports globally. Regular visitors to Sydney airport would no doubt be familiar with the stores.
Estee Lauder - Over one third of Estee Lauder's business comes from upper and middle class China, which as mentioned above, is set to grow by multiples in the coming years. (As an aside, Magellan's monetary policy advisor, Kevin Warsh, is married to Jane Lauder, heiress to the Estee Lauder fortune)
Starbucks - Another company where Magellan is a top 10 global shareholder, Douglass says that over 50% of their profit growth in the next decade will come from opening stores in China.
Ping-An Insurance - A leading life insurance business in China, Ping An faces limited competition. The company has grown at 20% p.a. for 20 years, and its growth has shown no signs of slowing down recently. Despite being capital intensive, the returns it receives on that capital are in the mid-20s. Clifford says that if this were a US stock, it'd be on 30 times earnings - but it trades on just nine times.
Ali Baba - "The Amazon of China", but Clifford says it's far more than that. It has positions in payments, video streaming, food delivery, and even ride sharing. Unlike Amazon, it makes money, and trades on just 25 times earnings.
Tencent - This might be called "the Facebook of China", but he says it's more than Facebook could ever hope to be. In fact, he says Facebook are copying it continuously. It also owns the company's leading video game producer. This one is also growing >20% p.a., and can be picked up for around 30 times earnings.
Watch the full video below for more detail on all these points, plus as a bonus, Andrew and Hamish each share their view on Australia's role in the coming decade.
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Great article ....thnx
Hi Patrick, Given the significant interest by large fund managers in the Chinese ADR's such as Alibaba, Tencent, etc why don't you start asking some questions about the corporate structures of these companies. All of these securities are domiciled in the Cayman Islands (which probably should be an immediate red flag for investors). What assets do these Cayman Island companies actually own? What are their legal rights to assets in China? What are the risks involved in their corporate structures? What are the underlying assumptions that the fund managers are making about the long term rule of law in China? Getting straight answers just from these questions would make for an entertaining interview don't you think? Best regards, Rob
Rob, this is a great point, thanks for bringing it up. I'll look for an opportunity to cover this off with one of the global managers who contributes to the platform in future.
MFF Capital Investments owns Bank of America, JP Morgan, Wells Fargo, Lloyds...
Annabelle, MFF Capital isn't managed by Hamish Douglass.