A cat among funds management pigeons

PORTFOLIO POINT: Allan Gray Australia's Simon Marais is part of a new breed of activist fund managers making money in a difficult market.

In a challenging market, the very notion of a fund manager is suddenly being challenged by many retail investors who are investigating everything from bonds to alternative investments in the quest for better-than-cash returns. Within the market, it is 'active’ fund managers who are getting the most ferocious criticism, as the traditional pattern of 'index-hugging’ means sub-par performance, often for years on end.

But inside the 'active fund’ sector, a new breed is rising – you might call it 'activist’ and it’s typified by Simon Marais, a South African fund manager who came to Australia less than a decade ago and now leads the Allan Gray group (created from the recently renamed Orbis Group).

You may not have heard of Marais and his team, but they certainly have been performing – ranking first among their peers over one, three and five years. According to consultants Mercer, the flagship 'Orbis Australia Equity Fund' was up 0.8% over one year and an impressive 20% per annum over three years. This performance has to be put against a median for local equity managers of 8.9%.

Of course, in a flat market that does not mean Marais and his funds have been raking in the profits, but over a three-year period Allan Gray Australia can boast an annualised return of 14% per annum on its flagship $2.5 billion Australian equities fund (and at a time when many super funds are on target to report losses for two of the last three years).

How does Marais do it? Well you might call him a cat among the pigeons. Operating in a very different manner from his peers, Marais takes high conviction positions with his small fund – stakes of 10% or higher – and then directly intervenes in the management of the company to seek better outcomes.

Among the biggest holdings Marais controls just now are Hastings Diversified Utilities Fund, SP AusNet and Fairfax (where he has been offering a sceptical view on having Gina Rinehart as a potential board member). It’s a tough business, where the risks and returns are higher than normal, but Marais is clearly making a name for himself – most recently at Spotless, where behind-the-scenes diplomacy and advocacy created a successful takeover, which made money for shareholders. – James Kirby, Eureka Report managing editor.

I’m just trying to put your style in perspective. In theory, all active managers are the same; they’re all active, but some are activist. Is that a conscious approach from you or has it evolved?

I think it’s more evolved. I do think when people give us money, we take the [custodianship] of that money very seriously and I think it includes trying to make sure that the people who manage the company that you’re investing in [on their behalf] do the right thing, because there are huge conflicts sometimes.

I think the big difference between us and most other managers is that we take a very long-term view when we invest; we tend to keep stocks for long periods of time, which probably means we tend to know the companies we invest in better. We try and get a really good understanding of it, and secondly it’s probably worth our while to do it. If you’re going to have a stock and you expect to sell it in seven months, which is the average length of the stock market, there really is no need to be activist, just bide your time.

This ability to influence change '¦ can you assess that in advance?

No, it’s very difficult. I’d say nine times out of 10 we get sucked into it, because we make an investment in a company, and as time goes on, the company for some reason takes a turn which we didn’t anticipate, or something happens which we just think is not in the best interests of shareholders. That’s often when we really think 'Look, we have to speak up now, because if we don’t speak up, who will?’, and it’s far better for us. But I think when you reach that point, I’d say 9/10 of other fund managers say “We’ve reached that point, we’ll just sell the share, regardless of price”. We think at that point normally it’s in the share price, and actually you lose all the upside, and it’s far better for us to say “Let’s rather try and recoup the upside here by actually engaging with management and saying 'Look, what you’re doing is really detrimental to shareholders’”.

So what would be the best example of that approach paying off in recent times?

At Spotless, they got a bid which we thought valued the company fairly. Management said “Well, we’re not going to entertain the bid because we think we can turn the company around”. We looked at it and said “management may well be right”, but they have no money at risk here; there’s still a 30% chance of this huge downside. We’ve just had one with ING Living Fund, where I think we were very vocal in saying '¦ their management of the fund has not been good, and it doesn’t make sense to have the fund externally managed; management must be internalised, and really the shareholder shouldn’t pay for that privilege. I think we can do quite an amicable agreement with ING in the end. To ING’s credit, I think they did listen and they could have told us, “Look, that’s the contract, stuff you”, as some other banks around town have done from time-to-time when internalising.

Do you think Australian companies say “No” too quickly to takeover offers?

I think they do, and to me the big thing is just there is a conflict sometimes between management and the board, and shareholders, in the sense that often a takeover does mean that management will lose their jobs, the directors will probably lose their positions. As long as this recognises this conflict, then I think in the end, credit to the Spotless board, I think when they’ve decided to change at least they got a bit of a higher price and they squeezed a few extra cents out of private equity.

You did actually mediate between the private equity bidder PEP and the target Spotless?

Yes, we did. Look, we never had the two of them in the same room with us, but you’re right, I’d phone one and then we’d speak to the other one, and say “What about this, what about that?” I think as a big, long-term shareholder, that is where we see the value we can bring.

Can this approach backfire?

Look, there are times when you’re just not successful, where you really try and get management to do something and they just won’t listen to you and you have very little ability to do things.

Some might say it backfired at salmon company Tassal – didn’t three directors leave?

Yes, well, I don’t see that as a downside at all. I think it was a good thing for the company.

Right, but at the time you said you were “gobsmacked”.

Yes, look I think our surprise was that the directors wanted to resign because the shareholder, which is a big shareholder with the support of another very big shareholder says “We want one external director [which] is not linked to us, but this is the person we put forward, and you want to resign because of that, good riddance to you”. But that’s a crazy thing to do. I think it’s probably because most of them wanted to go anyway.

Do you have a list of people you have in mind; a sort of a stand-by squad of board directors?

We have recognised that the hardest thing to do in Australia is to get good quality directors; a lot of clever, good people just don’t want to go on boards, because there’s a lot of risk for very little upside for them. So we have started to pull up a list '¦ often when a CEO of a company resigns and it’s someone we think has done a good job, we will often ask them if they would be interested in considering board positions.

Have you any sense whether where you are working is causing ripples or is confronting to some people?

I think it is confronting to some people, but having said that, I think we have very good relationships with a lot of our managers. I think people also appreciate that '¦ we tend to stick around for a long time; we don’t just grab the share and want them to push short-term things and then dump the company.

Would it be fair to say, Simon, that when you’re in a down cycle – and we’re in a pretty bad patch of the market at the moment – these opportunities to turn around companies are more obvious, so on that basis, will this style you have be appropriate in five years’ time?

I think it’s always appropriate. It’s like good management – never out of fashion.

But are the rewards as good when stocks are strong?

I don’t know. It’s funny, often to turn around a company is easier when markets are a bit more buoyant than they are now. The problem now is, if you have a difficult company like the ones we get involved in, often you can push for change, but change is incredibly difficult because the market itself is so difficult.

Is there a company you’re thinking of that you’ve tried to push all the buttons?

I think a company such as PaperlinX, for example, is a classic, where you just look at it and the markets are just terrible. It does make the turnaround much harder than it would otherwise have been. But also '¦ a lot of times I think management can act very suboptimally and it’s not apparent when things are buoyant. Look at the commodity market until very recently; you had to be a real idiot not to do well in that market.

But you kept away from miners and energy stocks '¦ do you still?

Look, we tend to be deeply contrarian in what we do. We like to invest in things where expectations are really low, and where things have been tough for a long time, and I tend to shy away form things where you have had very good five or 10-year periods.

You have a significant holding in Thakral, the hotel company – have you made a commitment either way to assess that offer?

No, no, we won’t accept the offer.

So you have rejected the offer, have you?

Well we haven’t rejected the offer, but I think we’re unlikely to accept. If the worst comes to worst, you can always break the company up yourself and realise the assets. They tell us that the assets are worth 96 cents and I have no reason to doubt them. Even if it costs you 10% to realise the assets, you still get well into the 80 cents, which is a lot more '¦

What’s the bid at?

Seventy cents.

OK.

So, I can see why if the thing doesn’t have an '8’ in front of it, you’re better off breaking the company up and they will do it. I think management and the board are committed to doing it.

Do you have anything new on your register that you’ve become a significant shareholder in this year?

I think Collins Food, which we very recently bought – the old listing of the KFC franchises in Queensland, which have been an absolute disaster for shareholders. A company we’ve very recently become involved in – it was in a trading halt at the time – is Matrix Composites. It’s manufacturing specific drilling equipment in Perth.

Have you a significant stake in these two?

Yes.

Five per cent plus?

One we’ve got 10% and one we’ve got 18% – Collins Food, I think we’re 18%.

So will Collins Food be getting your attention in the near future?

Look, I think that company is well run, and there you have a CEO that owns '¦ a big chunk of his wealth is tied up in the shares and the franchise, so I don’t think it’s one where we’ll have problems. '¦ I think it came to the market at a ridiculously high price of $2.50, but now you buy it at just over a dollar; it’s not even a year later. It’s a very stable business, and it varies a little with ups and downs, but Kentucky franchises are great money spinners; great cash cows. They should just be managed well, and you have good management; the same management you’ve had for a long time, so I think that should work well.

Among brokers, the general consensus is still that this year we might see the ASX certainly up above 4500; somewhere between 4500 and 5000. What do you think?

Look, consensus forecasting the stockmarket is absolutely nothing; the brokers don’t know either, and neither do we. Markets are just volatile; in fact your best time to buy in the stockmarket is when everybody as consensus says it will go down. That’s at the core of what we do – contrarian. So, the only thing that makes me worried '¦ I think it’s good that the stockmarket is down, it gives you much better opportunities to buy better value. The only thing that makes me worried is that everybody still thinks it will go up. Once they’ve all capitulated, that’s when you really should mortgage the house and buy stocks. But I think that it’s reasonable now; I don’t think the market is overcooked.

Will you continue to stay away from banks and miners?

Mining companies I will probably stay away from for the moment. Not forever, but one must recognise the problem with a mining company – your costs generally go up, because every year you dig a little deeper, and your grade tends to go lower. It’s a declining asset, unlike a business such as brewing businesses or CSL or something, which can increase in value over time. Secondly, I think the current prices are very high. Returns are just outrageously high. The fact that you go to Perth and pay $4-5 for cup of coffee – it’s probably $6 by now! I haven’t been there for a while. That is just silly. That’s classic boom-time stuff and normally that’s not a good time to invest in anything.

What about financial services stocks?

I think financial services are OK. The only thing that’s probably holding them back a little bit is just that our banks in Australia are so expensive relative to banks elsewhere in the world. So I think if you’re going to invest, you look at what you pay for UK banks or US banks, and what you pay, and just because we think our banks have done a lot better, will they continue to do better in the future?