Fund Manager Q&A

Nick Kirrage admits he was never a gifted athlete but nevertheless last year completed the ‘Marathon Des Sables’, a 254km ultra-marathon across the Sahara Desert. A career specialising in value investing, which also needs extreme discipline, focus and patience, may indeed have been ideal preparation for this remarkable feat.

When we recently chatted with Nick, who is Portfolio Manager at Schroder Global Recovery Fund, we discussed the race, the chart he’s following most closely today and why he describes himself as 'the person buying the stocks that will make you feel marginally sick'. 

We also looked at his large position in South 32, which stood out given he is a UK-based global manager, and his ongoing bullish view on the unloved financial sector. Read on for an edited transcript of this entertaining and insightful discussion. 

Q: How would you describe your role if you were talking to someone at a dinner party?

I would say I'm an investor who does what others don't, won't or can't. I'm the person buying the stocks that will make you feel marginally sick. 

For our income funds, you should look at them and feel a little bit uncomfortable. For our recovery funds, you should feel really queasy. If I'm not doing that, I'm not making you money.

I have a number of clients who explicitly say to me, "Nick, I want you to go and buy the stocks that I can't buy directly for my clients because they would feel so uncomfortable but I know that buying these cheap investments is the way to make them returns over the next 10 years. It's in their best interest but I can't do it for them directly, so do it for me."

People are fascinated by behavioural psychology and how they do things. Whenever I tell anyone, it's the classic 70% of all people think they're an above-average driver. Everyone chortles because of course, they think, "But I probably am an above-average driver." 

On average it's really, really tough for fund managers, after fees, to show they are beating the benchmark and yet I would say the percentage of fund managers who think they're above the benchmark and better than average, it's more than 70.

I think this applies to lots of things and I love to talk about biases and heuristics and behaviours, this kind of trying to explore the psychology of what we do. You get lots of people saying lots of different things and the technical explanation we give is this: the cheapest 20% on whatever valuation metric you want to pick. 

But I always say that it's much more simple than that. Psychologically, value investing is doing the thing that sucks.

Q: You recently participated in the ‘Marathon Des Sables, a 254km ultra-marathon across the Sahara Desert’. What have you carried from this experience to your working life? 

The Marathon Des Sables as a concept has been something that had been in the back of my head for a number of years and I was just slightly fascinated by it. It just seemed so remote, so different to anything that I'd ever done before, so far beyond anything I could do. What you come to understand is that the human body can do amazing things.

I am in no way a gifted athlete. Anyone who's ever seen me kick a ball around can tell that I do not have those skills! But you can learn how to kind of commit yourself to something, how to kind of overcome the mental and the physical discomfort. It's just about plodding along, and it's the camaraderie, also, the desert was perhaps one of the most beautiful places I've ever been to. 

It wasn't just Lawrence of Arabia sand dunes, there were these jebels, these mountains, and running along these rocky ridgeways and down into these enormous dried riverbeds and skipping down the sides of these sands dunes that were 400 metres high, you're kind of dancing down it.

 It was a mind-blowing experience and I think I'm not doing these things to prove anything to anyone else but in my own mind it was probably something that proved to me that if I can do that, I don't have to fear anything, I don't think either mentally or physically. I would urge more people to push themselves, not to kind of show off or to convince anyone else of anything, just simply because it's amazing what you're capable of, even if you're listening to this going, "No, no, no, I couldn't!" I was there myself 10 years ago. So do look into it.

Q: Although you are a UK-based global manager, one of your top 3 positions is in South 32, indeed it appears you have been growing your position in recent months. Could you please outline the value proposition you are seeing here?

We look at all basic materials businesses through the same framework. It's a big cycle, basic materials, and people tend to chase it around in a circle. So when things are very low, people get very depressed. When things are very high, people are very optimistic and they're talking about the super-cycle and how it's different this time.

We think about those businesses through exactly the same lens, which is when you look at long term commodity prices, no matter whether the current narrative is about "it's different this time" or the cost curve or whatever people say, the truth is that in real terms, there's very, very little inflation in commodity prices. We've been running out of oil every year since I was born, I've been told that story, and yet we never seem to run out of oil because we get better at finding it and digging it out in places that previously would've been impossible to dig it out. 

Through that lens when we look at commodity businesses we say, "Actually, we could probably take the last 20 years' worth of average commodity price for most commodities and apply them to businesses" and the average profit margin digging things out of the ground. That gives us quite a static framework for what we think for the long term profits these businesses can make.

And in some cases that can diverge hugely from the levels of profits they're currently making. South32 and Anglo-American are businesses where we think the level of earnings that they can make are higher than the ones that they currently make. 

But I think the other thing that attracts us to basic materials, and this is also true of banking, is that they're two sectors which frankly went through near-death experiences in the last 10 years. I think if you're the kind of person who looks at nine years into a bull market, with debt issuance at an all-time high and cov-light loans all around the place, actually what I really want to invest in that environment is a cheap valuation. 

I also want the kind of business that is worried too. Businesses that are worried about dying are the ones that nearly died last time. They're not the ones that flew through the GFC. And commodities and banks fit that bill.

Q: In terms of sectors, Financials are nearly a quarter of the portfolio. You were bullish on this sector when we spoke around 15 months ago. The global financial index has not moved convincingly yet, however, so what are your expectations from here?

I’ve been talking positively about financials for quite some while now and they’ve not done a lot, but I think they’ve been storing up value from my perspective. 

Let’s talk first about the safety piece. The capital side, there are very few businesses and industries that have been de-risking continuously since the GFC. There just aren’t. Part of that’s management being once bitten, twice shy. The second thing is regulators forcing it on them.

But either way, it’s capital safety for shareholders. That’s a pretty good thing. I think if you look at the level of returns they’re making now, a lot of the impediments that have stood in the way of making money out of them over the last five years are starting to ease, so headwinds from regulatory pressure and fines, the bad debt impairments and the reducing of the non-care books on some of these businesses, a lot of that is drifting off now, and we’re starting to see, certainly from global, European banks and US banks, dividends coming back, book values starting to grow, all of that will force investors to have a look at these businesses because they’re getting cheaper as they actually grow their profit, something they haven’t done previously.

There’s a lot of talk about this relative to the banks in Australia that have been under a lot of pressure and perhaps some value is starting to emerge. There are some interesting ideas, but from my perspective one of the great things about being a global investor is I don’t have to look at it through the lens of a single country or sector. I can say, “Well, look, perhaps some of these Australian banks do look interesting but I can buy European banks where we’ve already gone through a housing downturn, we’ve already gone through all the fines and the royal commissions, we’ve had all of that, and they’re trading at probably half the valuation of Australian banks still.” You’re probably further through that process with great capital and I can just say maybe they’re both great investments but over here I consider these banks to be the better investment today.

Q: Which chart are you following most closely right now? 

One that we've been talking about for a while, which is one for our clients that looks at the percentage of global equity fund managers that are investing in value or growth companies. When you look at Morningstar at the entire universe of global equity fund managers listed anywhere in the world, so over a trillion dollars of AUM, you can see that 92% of them have a majority bias to growth or more growth-investment style. Only 8% of them have a majority bias to a value style, which I think tells you something about how out-of-favour the market is. 

We know that value has had a very, very tough 10 years. We also all know, Investing 101, that we should buy low and sell high, that's the idea. So in theory when something's suffering it should be an opportunity but right now 90% of people are still sticking with their growth investments despite that.

And it feels a bit like this elastic is stretching out in a very, very aggressive and potentially unsustainable way. I think this is something that, to my mind, still really resonates and every client I put it in front of says, "Wow" or "I didn't realise that." 

Investors today know to diversify: Look overseas, put it in bonds, put it in other assets, put it in mid-cap, put it in small-cap, put it in large-cap, emerging and developed, everything is diversified. But when it comes to value versus growth, the market is 'all in' on growth... and half of us don't realise it.

Q: What was the last book that really stunned you? 

I tend to try and read one investment book and one non-investment book after another. 

On the investment side, I read 'Superforecasters', which is written by Philip Tetlock and Dan Gardner and it's an extraordinary book. For those who haven't read it, the science behaviourally around how you are able to put together and think about future outcomes and the probabilities around that, and the kind of people and the kind of traits and attributes they have, and the way they think that enables them to be radically better - and as teams as well. 

So this is something that's obviously pretty prescient if you think about it, most investors aren't just an island, they work as part of teams, how do you get the best out of teams without getting the worst out of teams, the worst behavioural aspects of teams, the crowding and herding and stuff. Superforecasters is a wonderful book. It's been out a couple of years now but I would recommend it to everyone.

And on the non-investment side, I read A Brief History of Germany, that's an amazing book. I think we all, in the same way when it comes to investing, we think about the world in the last five years. That was a book that highlighted to me how Germany was a radically different country just 120 years ago and Europe looked completely different and it made me feel, thinking a bit about the Brexit piece, which I know everyone thinks is absolutely transformational, but made me understand that that is pretty much a speck in the annals of history and that we will, in terms of how we're evolving, and these democracies and these countries, we've got a long way to go and it's worth always, as an investor, standing back and trying to think a bit about the bigger picture.

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Nick seeks to identify stocks which trade at a substantial discount to their fair or intrinsic value and where profits growth will surpass expectations. To be the first to read his latest insights, follow his profile here. For more information on the Schroder Global Recovery Fund click 'contact' below, or visit the Schroders Australia website.



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