If you’d invested $20k with Platinum Asset Management when the firm opened in 1995 you’d be sitting on around $320k today, a return of ~12.6% per annum*. However, the journey to these returns may have tested your nerves. The active style at Platinum means that periods of exceptional performance are, at times, accompanied by periods underperformance versus the market. Right now, is one of those periods for Andrew Clifford and the team at Platinum.

One of the things you learn with experience is that when you’re feeling uncomfortable, you’re probably right. But it’s not enjoyable.

In this exclusive interview, Clifford takes you inside the investment process at Platinum and applies it to the challenges of today’s volatile environment.

Topics discussed

• Investing at Banker Trust with Kerr Neilson and why it proved to be a breeding ground for many great fund managers.
• Learning from ‘great dramas’ in the 1980s and 1990s and that fear in markets often means it is time to be buying.
• The decision to set up Platinum Asset Management and holding the line when markets moved against the funds.
• Understanding the powerful behavioural biases that test your conviction when stock positions and performance are not working in your favour.
• What Andrew believes is the investment opportunity of a generation and what it would take to change his mind on this view.
• Where he believes the best long and short opportunities exist today in equity markets.
• A cracking statistic that highlights just how few companies can deliver high growth rates for extended periods of time.
• Rising interest rates and what this means for investing in equities.

In my thirty years of investing I’ve never seen stocks priced like that unless they were going bust

*Visit (VIEW LINK) for full details on performance calculations mentioned in this video

Transcript

James Marlay: Well Andrew, from the conversations that I've had with a number of your colleagues in the industry, I know that Bankers Trust, where you started your career was a breeding ground for a lot of investors that have gone on and become quite successful fund managers, running their own boutiques. Can you tell me what was in the water at Bankers Trust? Give me a sense of the environment and what was it about the culture there that helped to make some really great fund managers here in Australia?

Andrew Clifford: Where I came into Bankers Trust was a small team run by Kerr Neilson who was looking after the equity funds there that were relatively new product and so I think I was the fourth member of the team, including Kerr. Over the next few years that team built out, but at the core of what we were trying to do there is we were trying to make investors money. We were really genuinely trying to find those missed opportunities, the undervalued companies in the market and there was a very, very clear understanding of how we would go about doing that and that was this idea of avoiding the crowd. The great ideas are the things that people want to stay away from today and on the other side, whatever is popular, much loved, they are the risky parts of the market.

Today we talk about behavioural finance and all the various cognitive bias that people have and these ideas are much more articulated, but at the core of them this is actually very hard to do. It's actually hard to take a position that is counter to the popular view and the headlines everyday telling you that you're wrong for what you are doing and maybe for many months it will look like you're wrong.

I think that's really that and the other element to that is really understanding that you've got to build a more than superficial, descriptive understanding of a business. You've got to go a little bit deeper on the right issues to understand how things might have evolved differently and that might be as a lay person looking at a semi-conductor stock, not just understanding the market for D-RAM or flash memory but understanding the physics of how you fabricate a chip. Will that really make a difference? Probably 9 times out of 10 it doesn't, but occasionally it's very important that you understand really the processes or the sales team and how it works and whatever so there's a real bizarre area and I think the people there, it was a matter of curiosity. It's what we like doing in our job back then, it’s what we like doing in our job now even if it perhaps on the margin isn't always relevant to the final investment decision.

James Marlay: When you think about your investing journey now, lots of things change, some things don't change quite so much. You talked about those sorts of behavioural characteristics and emotions that investors feel. Could you draw on an event or an investment from your early career that you sort of still carry with you or you've drawn on multiple times that you think really shaped the way that you think and how it did that?

Andrew Clifford: After a year on the Australian market I went off to cover Asia and through that time from ’89, there are a number of different events that occurred, great dramas in the market. The most notable one would be the '89 Tiananmen Square Massacre in China and clearly even though China wasn't quite the focus of markets it was today, for Hong Kong it's an extraordinary traumatic event. The market fell very hard. Stocks were off 30, 40, 50% and you know, it's easy at that point to now start imagining all sorts of very bad outcomes flowing out from this, but in reality because everyone was already doing that, the stocks were already pricing in those really negative events, and so it was with all of that fear around you had to be buying. Two years later in Indonesia, which was a newly opened market back then, they had a big issue with inflation. Interests rates went to 20% and the market collapsed and you're going, "How does this end?"

Of course, at that point the economy slowed, interest rates came down, things recovered, but it's when everyone is on one side of the boat and tilting it over that way, I think the lesson is that all of the stories start to come to match that and we can do that in individual companies as well. All of the sudden Facebook has issues with government regulations and indeed it does, and this is seen as terrible, but it might possibly be to their extraordinary advantage in that they can deal with it, but how about all the up and comers? Can all the potential competitors for their eyeballs deal with it.

There's always another side to the argument and you need to be looking for that when everyone is gone one way.

James Marlay: Interesting. We are going to talk about some of your views on markets today but going out and starting your own firm and you did it in partnership with Kerr and the first boutique in the global space, a really pioneering move. What was that decision like? You were still quite young. It's a pretty bold move. What was that experience like in the early days?

Andrew Clifford: It's interesting. I think for those who sort of left, there was not any real decision. It was just sort of yes, this is ... we enjoyed working with Kerr and we were still part of a small team at Bankers Trust and we wanted to do this. That was so easy. I think I was sort of in my later 20s at the time and you're not so focused on the risks and the downside and the difficulties of doing it. Having done it, I'd never do it again and there are a lot of things that you don't consider as a young person about the risk of doing that, walking away from a very, very good job and a very well paid one at that time and at my age, but I never really thought about it. You can look back and go “that was a bit careless”, but anyway.

James Marlay: Was there a point where you thought it might not come off or did you move, and things went more or less to plan?

Andrew Clifford: They went pretty much to plan for a couple of years and then we hit one the periods we go through where we were not particularly ... the funds weren't performing well so we would start in early in '94, and '94 and '95 had been pretty good and in going through from about middle of '96 it was a period where the great growth stocks at the time, Coca Cola, Procter & Gamble, went from PEs of 20 to 50 and they were all the things that you wanted to own and of course that's not what we owned and we really struggled in those years. And it feels like at any time that you're going through those periods of underperformance, you think I don't know what I'm doing or we're never going to catch this up.

You go through those moments so yeah, I think at that point we weren't fully established as a business. I think we probably brought in a billion dollars or so, the way I remember it, but you know that was difficult, but we then came through that with some pretty extraordinary performance through the back half of the '90s and established ourselves once and for all.

James Marlay: I know you don't measure yourselves against an index. Your proposition to investors is absolutely returns and your performance does deviate quite differently from the index on the up end and downside. I'm sure you have an eye for it because you know it and people ask you about it. Tell me how do you and your team, what things have you developed to help you deal with periods of time when you're feeling uncomfortable and out of favour? How do you stop yourself from wanting to change course?

Andrew Clifford: I think there's a few elements to that. One is that it's probably ... you do have to keep an open mind. You have bought a particular stock and it's not working, and you have to keep re-examining the case. It's one of those things when things aren't going your way, you keep trying to take yourself back to the underlying facts of the case and why you're invested where you are in the first place.

You do go through that but it's also, one of the things that you learn with experience is that when you're feeling uncomfortable you're probably right. It's not enjoyable and so one of the things I talk about more with the idea of, with respect of new ideas is that when someone comes up with a new idea and your initial reaction is almost revulsion like, "Are you kidding me? I'm not going to buy that." An example that I did that with was one of our team brought up the possibility of buying coal, thermal coal stocks in early 2016 and I was like, "Are you kidding me? Everything is stacked up against these things. Coal price is at $40. It's never going up." When you catch yourself with that reaction, then you sort of know actually that's the ... they're all your cognitive biases hard at work, that intuitive response. When you find yourself doing it, you have to go back and go, "Hang on a second. Let's actually look at this." In that case we didn't and we should of because we would of made a lot of money from that point.

It's that same when you're in a position, yeah, sometimes you do have to go back and go, "Well, the case isn't working out the way I expected. I was wrong about various facts," and you have to sell and move on, but it's that combination of knowing that good decisions are uncomfortable and then just continuing to re-examine the case and looking at how it's unfolding.

James Marlay: When I was doing some background reading to prepare for our chat today, I think back as far as 2014 I was finding articles and videos of you talking about how that you felt the opportunity in China was and even in the June quarterly report, you talked about how you still believe that it's the opportunity of a generation I think were the words that you used.

Andrew Clifford: I have used those words.

James Marlay: What is it that makes you so excited about China?

Andrew Clifford: China went through a very significant obviously investment boom. The commodities, we all experienced that and really this was coming to an end in 2013 and by 2014 you had had a very substantial investment slow down and the economy was really struggling and you know we had a whole lot of issues out there with potential bad debt in the banking system and whatever. What it meant though was that it brought down a whole lot of stocks to extraordinarily attractive valuations. Some of the companies we were buying back then, Tencent which is now relatively well know company, had been around for quite a while, but we would of been buying that back then on mid 20s earnings multiples, growing very, very fast, 30, 40, 50%, and an extraordinary role in China's social infrastructure.

These opportunities were being given to you because of that fear around China. Other companies that ... and clearly Tencent has been a great stock and now it's having its new rollover at the moment in various issues and we've owned it and sold it and still held a bit at the very top. Or Ping An Insurance, which is this extraordinary life insurance business, private company, leads the market, great position in general insurance, the lending fintech in the country. It's got a long term record of growing at 25% and you know you were buying that on PE of 10 or so and the business just keeps growing so there are some quite extraordinary businesses and I think sometimes people might think about China as a bit of the wild west and what have you, but if you go and meet the companies there and talk to these good private companies, they are as good as companies anywhere in the world.

Even in industries like cars where people thought they would never come up the quality to where the foreign companies produce cars, today all of the independent studies show that they are very, very close and you have a company like Geely, which we don't have in our international fund at the moment, but they bought Volvo. We can talk about IP theft, but actually the Chinese are just buying intellectual property like anyone would these days.

These companies become very sophisticated and we're paying very, very little for them. Now since 2014 when we first started talking about that, we've had some good markets in China. We had the run on the currency in 2015, which brought everything back down from which point the market was pretty good and now we've had a new episode today where really starting with the financial reforms in China earlier this year have created a great deal of uncertainty in the economy and then of course, President Trump has thrown his trade war in on top of that.

The interesting thing is that with a company like Ping An that we've owned all the way through, you know it did have a good setback in June, July, came down about 25% so a good bounce, but it remains substantially above where, it's probably a double from 2014 and it's still extraordinarily cheap and still continues to grow very, very nicely.

I think if you were to look at any of the companies that we're buying in China, they're demonstrably better very much so in terms of growth. Certainly they are equal of their US or European peers in terms of quality in many cases or if not catching up and we're often paying fractions of the valuations.

James Marlay: It doesn't sound like the conviction has waned at all in China, but you mentioned earlier that you do, when things are going against you, when you're standing up against the market, you do need to go and test your thesis. Have you thought about a scenario that would force you or what would it take for you to change your views on China as an attractive investment destination?

Andrew Clifford: I think the way we see it is that there are a number of risks that could really mean that you do great damage to that economy and I think the one thing I'd focus very clearly on is the fact that the exchange rate isn't freely floating and what that means is that they can't control monetary policy. They have to try and maintain these capital controls. The long history of economics is that ultimately is an unsustainable position. They have a very easy solution, float the currency. It's pretty clearly not in their intention. You never know. One day you might be surprised. If it happens, I think it would be the most bullish thing for the country even if the currency fell 10, 15%, you're taking away a fundamental risk that they can't really freely manage their monetary policy or that they can get errors like the run on the capital account back in 2015.

We keep looking back at the banking system and again, one of the problems with a country like China is that all the statistics that we would take for granted and there are many statistics, many of them are probably perfectly reasonably compiled, but we haven't got the same comprehensive view of the financial system for example and who's spending the money and what have you and so we keep studying that and looking for the flaws in the system and if we really felt that we would find one, we would certainly have to adjust our thinking.

James Marlay: Positioning and views, yep. I know on the flip side and the numbers may have changed since I read this report, but effectively a net exposure of zero to the US?

Andrew Clifford: Yes.

James Marlay: And your funds overall exposure is relatively low. I think 60 or 70 number was the last one I saw?

Andrew Clifford: Yeah, 70 is approximately it.

James Marlay: But there's not a reflection of ... You said it doesn't mean that we don't think there's opportunity out there, it's not a broad market view. Can you just take me inside that positioning and sort of break it down a little bit for me?

Andrew Clifford: Sure. I think what we have is globally a huge disparity in valuations and it really comes down to this issue where there are three big picture issues that are driving uncertainty in markets. The idea that China is potentially slowing down as a result of financial reforms and there is certainly some evidence of that, but there's other evidence that it's not that traumatic, but certainly it's a concern. Then you have the trade war coming in on top of that and then you have rising US rates and when does that come to have an impact?

The result of that uncertainty has seen people ... and we've had a general level of greater risk aversion around over the last decade. People since '08 have not really wanted to take huge risk and the way this is playing out in equities is that everyone wants to own companies that are immune to these issues and what are those companies in the market's mind at the moment? It's anything that's fast growing so it's the new age software, software as a service stocks. It's eCommerce so Amazon, Netflix if you want to put them in that category. It is bio-tech, payment systems. These are all the rage and are attracting huge valuations and valuations, the comparability perhaps isn't completely there, but compared with 2000, 2000 is the only period where we have seen higher valuations so we aren't quite in that category, but everyone is crowding into this select group of stocks and they are driving the indices higher because they have quite a substantial part of the market today, at least in the US.

Meanwhile everyone wants to avoid anything that's go any uncertainty relating to this. Obviously China is out. Things like many of the commodities are not getting a lot of attention and certainly things like copper and nickel, which are actually in short supply at the moment and the inventories are falling, their commodity prices are coming down, the stocks coming down with them. Semi-conductors, at least the traditional semi-conductor stocks like the memory chips and many of the analogue chip makers, these companies are seen to be cyclically exposed, if the economy is weaker they'll be hit and so they're down hard. Auto stocks are ... have many things that people worry about, but you can throw the economy on top of that as well.

There's a bunch of companies, Samsung Electronics, six times earnings, global leader, its business is making semi-conductors, predominantly in memory chips and yes, it's cyclical and yes, earnings might be down, almost certainly will be down in the next couple of years, but that's an extraordinary starting valuation for an industry that is significantly consolidated and on top of that, around a quarter of its balance sheet is in cash. Now in my 30 years, I've never seen stocks priced like that unless they were going bust or you were about to have a massive collapse in a commodity cycle.

That's one, but I can tell you about Ping An... Well, it's gone from 10 to 12 times because it's had a good rally or a Glencore in mining on eight times and growing and that's at not high commodity prices other than perhaps coal. There's this huge array of value out there. BMW on seven times. It's got no debt when you take out its financing book. Valeo in France which is the big auto parts company that are enabling the autonomous revolution and the electric vehicle revolution, nine times.

There are some pretty interesting companies out there trading at very, very attractive valuations and that's the exciting part of it and that's our 85% or so that we're invested long predominantly in all of the companies that are very, very interesting valuation. We still have a bit of Alphabet and a bit of Tencent that we've owned for a very long time that haven't quite got out of before they roll over, but those newer stocks in the portfolio I think are an extraordinary value, but we have to live through some of this uncertainty and potentially a bit of a slowdown in the US, probably a couple of years out yet and China has its issues for the moment, but like all of these things, they will work through them.

James Marlay: You mentioned the concept of starting valuation and your descriptions there. How important, what role do starting valuation play for you in terms of stock selection and building portfolio?

Andrew Clifford: It's pretty critical, but it's got to be always in the context of how this company is going to grow. We have no problem with buying a company that's on a PE of 50 or 60 or has no earnings. I mean we've done it many, many times. The issue is though that you still ultimately need to think about the return on investment you're going to make and there are some very simple numbers that we use at the moment and we say, Well, if you're ...Think about this like a private owner. You buy a company that is on a PE of seven so you're getting an earnings' yield, so just flipping that over, the inverse of that of 14%, okay? That's not bad when your bonds are two and a half, three. If you think of this as a private owner, I'm going to hold that hope. I'm going to buy that entire company. I'm going to bank those earnings for the next decade. It's not growing. I'm just going to keep getting that 14%.

If I compare that with the alternative, I could buy a company on 25 or an earnings' yield of four percent at the start, to bank the same dollars, so without thinking about interest earned or anything like that. It's a very simple example, not at all theoretically correct, I need that company to grow at greater than 25% per annum for a decade to bank about the same amount of funds. How many companies starting with half a billion dollars in revenue in history have ever done that? The answer is about two percent so we certainly would think that buying a company on 25 times, growing in the 20s is a perfectly buyable thing because you can quickly see within three to four years that you're going to be getting a decent ongoing support from its earnings, but you still need to think about that and the likelihood of this company doing it.

Our concern when we go back to these expensive stocks in the market, the software companies trading on 15 times sales and above, some of them will justify. There are some really extraordinary companies out there. We do think about it. We do go and visit them and look at them, but many will fail and that's just history because growing that quickly, companies hit impediments as they go from 15 people to 50 people to 250 people. These are just some of the issues that companies have to deal with and some will do it well, but the majority of them won't, so not everyone will become Amazon or Netflix. There are plenty who die along the way and if you think you can identify the one that is the next one, we'd do it, we would buy it.

James Marlay: You have a bit of trouble doing that?

Andrew Clifford: I think sometimes you think now this really is a pretty interesting and yeah, so ... but at the moment, the other side of it and why they're not so attractive to have a go at is that there are all these other companies elsewhere that you can buy, which are far easier to own, and I think that also ... and this is where rising rates probably is important because in a valuation sense, that is the anchor of which we value everything and if you're banking on earnings 10 years out as part of that valuation, the pure mathematics of that is much greater. They may be immune from a revenue growth point of view to higher rates, but they certainly are not from a discounted cash flow sense. It clearly, I think, part of the last couple of weeks, four weeks or so, as US Treasuries have gone higher and they look like they are going higher still perhaps, I think it's about the valuation impact of well, now I can 3.2 versus 1 or 2 in some of these very high growth stocks.

James Marlay: Are you concerned or is your team concerned at all about that rising rate environment in the US? Is it a healthy thing or do you feel like it does have the potential to be really disruptive?

Andrew Clifford: Interest rates are the anchor on which everything works, both the real economy and markets, so it is one of those things that you need to be thinking about, but the long history of it is that as rates rise it's a function of the fact that the economy is in good shape and so I think as Ed Hyman of ISI who will always say, "Well, the economy doesn't roll over and the market doesn't roll over until after the last rate rise." Now he says that because he believes it's going to be another two or three this year, but I always think that's not very helpful because what if the last one was the last one?

James Marlay: Which one?

Andrew Clifford: Who's telling me when it's the last one? But I think other rules of thumb which are well known, the yield curve flatten and you then look like you've got another one to three years typically before. Of course, every cycle can be a little bit different. Certainly you need to be thinking about the differences here, but I suspect that the US probably is a fair way away from that sort of recession that people fear, but I do think interest rates will continue to go up and how ... trying to judge how the market reacts to that is always problematic so for us we watch that, but we come back to the stocks and go if Samsung is on six times, but the US economy is slowing, how important is that for that and how do we adjust earnings and think about that.

James Marlay: You talked about cycles and each cycle being a little bit different, one of the ways people talk about cycles is the different factors that drive share prices growth and value and there's been a lot of conversation about the fact that value has been deeply out of favour for an extended period of time.

Andrew Clifford: Yes.

James Marlay: Leading some commentators to say this time it is different.

Andrew Clifford: Yeah.

James Marlay: Your thoughts?

Andrew Clifford: You know it's funny, this thing about that we study history and yet every cycle is slightly different and the factors that come bare art are different, but I think certain things are like gravity, so over time there are factors in markets that will drive valuations over a longer period of time. Ultimately that's going to be M&A if nothing else, so I don't worry about that so much, but what I would say is one of I think the truths about investing is that one of the reasons you want to avoid where the crowd is even in ... if everyone is investing in software for example today in the listed market, that's a function of fact that capital is going there in huge amounts in the unlisted market and where capital goes is where you want to stay away. It eventually destroys-

James Marlay: Too much capital gets allocated.

Andrew Clifford: 2012, that was the oil patch. That was Shell. 2007, 8, that was iron ore and steel plants in China, 2009, 2010, so money goes around the world looking for places to invest and we get these manias and eventually that weight of real money going into real projects is what pulls it apart so we will get a crisis in Turkey because you know they attracted capital because of their economic policies, but ultimately it destroyed it as well. You had a current account, unsustainable current account position. We sometimes see it in debt building up in housing obviously in the lead up to the GFC, not just in the US, but in Spain and Ireland and other places so you want to ... I think the sort of underlying principal, the thing that doesn't change is wherever that money is going in the real world, in the listed world, eventually it will catch up with it. Is that October 2018 or is we need another year or two or three? Don't know, but then you're investing. You're getting into past the parcel and some people do that well, but we don't.

James Marlay: Andrew, thank you very much for sitting down with us today. It's been a pleasure to meet you and appreciate you sharing your views and telling us a bit about how you invest at Platinum.

Andrew Clifford: Thanks for your time.