An income fund aimed at retirees

This week’s fund manager interview is with Jason Teh, the Founder and Chief Investment Officer of Vertium Asset Management. They started in May 2017, and their fund is called the Vertium Equity Income Fund. It’s an income fund aimed at retirees and as I say it’s been going since May 2017. It’s been going all right; Jason’s an interesting character and it’s interesting to listen to him on the subject of getting income and having a low volatility fund which is what he’s aiming to achieve. 

Here’s Jason Teh, the Founder and Chief Investment Officer of Vertium Asset Management.

Listen to the podcast or read the full transript below:

Jason, perhaps we could just start with a bit of a profile of your fund.  It’s a retail fund, is it not, focussed on income?

Yes, it’s a retail.  The strategy is open for institutional investors as well.  It is an income fund but the way I sort of see it, people who want income generally tend to want low risk equity exposures as well.  Our target clients tend to be retirees and the retiree has spent 40 years saving the nest egg, the last thing they want is to have a high risk equity exposure when they retire.  They want income and they want low risk equities and that’s a strategy that we provide.

And the minimum investment, $50,000?

Yes, at the retail level, that’s correct. 

You’ve been going I think for a couple of years?

Yeah, getting close to a couple of years now, that’s right.  We’re not quite there yet, but we’re getting there.

How much have you got in the fund now?

The strategy is about $55 million.

What’s your fee?

The fee is just under 1%, 0.97%.

No performance fee, just straight out 0.97%?

No performance.  Yeah, that’s right.

You also seem to have a spread between application price and withdrawal price, 0.9505 to 0.9457, as well?

Yes.  I just can’t remember exactly what the spread was, but thanks for reminding me.  That spread obviously just typically represents transaction costs when we have to, the opportunity you have to sell, or if you get the application we have to buy.  The spread normally reflects transaction costs.

Right, okay.  Just looking at your performance, it seems to me the problem that you have in a way is that since inception you’ve delivered a distribution of 4.73%, this is according to your website – 4.73% distribution which is kind of roughly the same as I think the average yield of the market.  But your growth has been -4.3% which is not great, so you’ve actually delivered an average yield with a negative growth?

Yeah that is the outcome of actually a pretty tough market.  You are correct.  Just taking a step back we have three objectives.  Our strategy is, actually the only fund in Australia that actually offers three objectives.  One is high income, lower risk as defined as standard deviation versus the market and outperform.  When I say outperform, not every single year, but give us five years so that we can show our true stock picking skills over a market cycle.  For the last close to two years, we’ve delivered a higher income versus the market.  Not by a huge margin, but still outperform.  Importantly that low risk equity exposure, our standard deviation has been 40% lower than the market and as a value buyers’ fund manager we struggle in a bull market.  Prior to that September sell off we were lagging because we were not participating in that extraordinary bubble that we experienced, you know, before that bust. 

When you look at the full numbers over that time frame it actually captures, a good portion of that is a bull market and then you’ve got the last three months that really, you know, reset everything again.

Yes. No, that’s fair enough and we’ll get into what you were saying about the bubble and so on in a minute because it is very interesting.  When you talk about standard deviation, you mean volatility?

Volatility, yeah. 

The volatility of your unit price has been 40% less than that of the market, is that right?

That’s correct, yes.

Well, that’s something isn’t it.  How have you achieved that?  Is it simply the stocks you’ve picked?

Yeah pretty much.  We have a slightly more flexible cash limit than our peers.  We can go to 50% maximum cash.  Cash does help to lower your risk profile but beyond that, the way we’re picking stocks is actually lowering the risk profile even more.  So of course, investments in Transurban is not going to move around as much compared to investments in Rio, because they’re two different type of companies.  If our bias is towards, especially of late, defensive stocks then that would be the outcome.

Now obviously we’re not going hold to defensive stocks forever if they’re expensive we’ll be selling them because expensive defensive can still fall in capital, or in share price.  Yeah, it’s just the process that lowers the risk profile.

Just take us through some, say your five favourite stocks that you’ve got?

One, for example, is Vicinity Centres.  It’s trading at a discount to NTA.  Themes that the market sometimes gravitate towards – oh, retail’s tough – let’s not hold any retail or REITs.  Oh interest rates are rising, let’s not hold REITs.  But because of the story you can get the stock at a discount, so discount to NTA.  They’re aggressively selling assets in the portfolio to actually bring their gearing down.  After the asset sales their net debt to EBITDA will drop to three times, versus the sector at six times, so it’s got half the debt levels.

From a valuation point of view buying discount to NTA.  That’s one.  You’ve got other defensives.  This cycle is actually, when I think about defensives I always think about interest rates because that’s how you should price them.  Funnily enough, when people think about, ‘oh right the interest rate’, well guess what’s happened to the Aussie bond it will virtually collapse.  Right, so over the last three months it’s fallen.

Normally when you see falling interest rates you see defensive stocks outperform because the markets trying to mark to market to the risk-free rates.  This cycle we haven’t seen so much of it.  Ausnet Services is one that we hold in the portfolio.  It still has a 6.5% yield, except that the share price has actually tracked sideways for the whole year while the risk-free rate in Australia has actually fallen.  It’s actually very – the way it’s behaving – and there’s nothing wrong with the company, so therein lies the value opportunity as a defensive stock.

Now by saying that, even though the portfolio currently is quite defensive the share market correction over the last three months has substantially widened our universe because prior to September our investment pool was actually quite narrow because the market was just too expensive.  Like if you want to stick to the value discipline or capitulate at the wrong time you get washed out or if you stick to the value discipline you have to wear that pain when the market’s riding up.

Now that a lot of stocks are a lot cheaper, the universe stocks have widened and we can now cherry-pick where we want to have decent exposures elsewhere in the market than just holding defensives.  I guess overall when I look at some of the stocks in the portfolio some stocks offer still reasonable value, some of the defensives, but I think there’s potentially more opportunity elsewhere in the market and that’s our job especially during this reporting season because it’s so timely.  The correction happened from September to December, we’re now getting a few companies confessing before reporting season and you can see the gap down.  You know, Costa Group the other day say, “Sorry guys, we’re going to have flat profit growth” and you pull 30%.

Companies don’t have to have negative earnings growth, it’s just the disappointment associated with the expectations and the market will be very quick to a shift in expectations.  And Costa, by the way, prior to the downgrade, was trading on 24 times PE and now it’s trading on 18 times PE, on lower earnings.

I suppose the interesting point, Jason, is 24 times PE is not that excessive.  It’s obviously higher than the market but it’s not like 50 times, like some of the stocks have been trading at.

Yeah, that’s right, or Afterpay, it doesn’t really have a PE of 100. 

That’s right.

Yeah, so look, it’s not ridiculous, but I guess the key is whether expectations can be met.  There were expectations for companies like Costa to have earnings growth and they confessed to say ‘sorry it’s just flat earnings growth’.

How do you avoid those traps?

This is where I think the market has sometimes confused structural growth with cyclical growth, right?  It’s very easy for fund managers to go we have this over-exposure in tech, because we’ve got to have growth.  That’s all fine, like I said, Costa is not reporting negative growth, all it is reporting a pause in earnings growth.  The trouble with the narrative of growth is that sometimes people forget that there are cyclical elements associated with that growth, especially when the economies are slowly, right?  Costa is not a tech company, so maybe people are buying less avocados and buying – well, my theory is maybe people are buying less smashed avocados for $25 at your local café because the Australian economy is weak.  There are cyclical elements associated with some of these growth stories.

When the earnings get revised down to a lower level, you get a massive PE de-rate.  This story or people getting caught off-guard with these growth stories is just really the cyclical element playing out and it’s largely linked to the economy.  We’re beginning to see that in the US market.  You can see so many global companies like Apple, Caterpillar, even NVidia, they’re still reporting profit growth, it’s just slower.

Interestingly, your December quarter report that you put on your website introduced me to an interesting term called ‘the narrative trap’.  You talked about the global growth narrative trap and the rising interest rate narrative trap.  Take us through what you’re talking about because I haven’t heard that term before and I think it’s quite interesting.

Yeah.  As I said, the stock market loves stories and our job is to figure out which story is correct, right?  That’s the difficult bit because there’s a thousand stories out there.  Last year coming off 2017, to be clear, 2017 was synchronised global growth.  Everything was on fire – China, Europe and the US.  But in 2018 some things began to appear where we could already see China beginning to slow.  And in fact, they started to – and the reason why we know is because they started to stimulate.  They cut the Reserve requirements for their banks quite early last year.  Then Europe began to slow a little bit later and then finally the US caught up.  But the market hung on to that growth story, right?  Even though globally you could see signs of a slowdown.

Because of this disconnect and hanging on to that growth story, the market was paying higher and higher multiples on what I call, people think of it as structural growth stories, forgetting the fact that there are cyclical elements associated with the earnings.  I think in that December quarterly I tried to show the PE history of Apple where look at the last 10 years, when things are bullish it hits a PE of 15, when things are bearish it hits a PE of 10.  Then something unusual happened for Apple, it just spiked up to another level in the middle of 2018.  It went to a PE, I think from memory, of 17.  Without earnings going up to the same extent, right, and the PE is diverging away, that’s a sign of a bubble to me.  The question is whether investors will capitulate and get caught out.  Holding on to that old story and the facts were changing through time, the facts were actually global growth was slowing but the PEs were getting higher, and eventually, like I also mentioned in the article, economic gravity always wins because PEs always sort of come back to economic fundamentals and eventually the US economy caught up with the rest of the world.

Now, everybody recognises that the US economy is slowing.  There is nowhere else in the world that’s showing growth.  China is still slowing, Europe is slowing and in fact, I think Germany just missed a technical recession and the US is finally showing signs of a slowdown.  All the global growth cheer squad last year pretty much got wiped out in the last quarter of 2018 because they weren’t aware – or they weren’t willing to look at counterfactuals and those counterfactuals were growing throughout that year.

Part of that global growth story was also the rising interest rate story.  If you really bought into the global growth story, of course you’re going to say interest rates have to rise, because that’s what interest rates normally do:  interest rates rise when economies do well.  Just like how if people forget cyclical elements with growth, interest rates also fall when global growth slows.  You can get the double whammy where you get stocks like Transurban now approaching one year highs, everybody is like, ‘oh yeah, interest rates’.  Rising interest rates, of course, I know rising interest rates should affect Transurban’s share price, but guess what, interest rates did fall.  People are getting caught out with things that had some growth but earnings are getting revised down and they’re getting caught out.

Do you think that it’s now a buy the dip situation?

Buying the dips works perfectly fine when economic growth is robust, right?  Because if you think about economic gravity, as long as your fundamentals are fine, when valuation looks cheap, keep on buying the dips because the chances are at stock having an earnings downgrade is actually quite low because the whole economy is humming.  We have already witnessed, especially in Australia, and even in the US, you miss earnings expectations – like Challenger the other day.  Challenger even before the downgrade, looked reasonably cheap.  It wasn’t that expensive, but a downgrade is a downgrade, it fell 16% on one day.

Buying the dips is dangerous if you’re not very clear on the earnings trajectory.  If you think the earnings are closest to its lows, that’s fine and this is where I guess real stock pickers stand out.  But if you’re simply buying the dips because things look cheap, whether you’re an expensive stock or a more expensive stock, let’s say a stock is trading on a 20 times multiple like Costa, got de-rated.  Or even cheap stocks, earnings collapse, the stocks are going to fall.  Late last year in November, Lendlease collapsed, they lost 30% and that wasn’t an expensive stock.  Clydesdale Bank, that collapsed, and again, that’s another not so expensive – in fact, it’s even cheaper now, it’s got a PE of 7.  It’s the earnings trap that can really get people off-guard who are just wanting to buy the dip.

That’s interesting though, you mentioned Clydesdale Bank that’s CYBG, it’s on a PE of 7.  That’s a fantastic yield now too, are you buying that at a PE of 7?

Yeah, so this is sort of related to buying the dips.  I’ve got to have some sort of element of certainty of the earnings.  Obviously, Clydesdale Bank being exposed to the UK market and I know the UK housing market is slowing.  Obviously, you’ve got the Brexit overlay.  But it’s one we’re definitely watching and it’s on our hitlist I suppose, if you could sort of say that.  Trying not to actually expose our unitholder to too much downside if we move to early on some of these stocks, yeah.  But it looks cheap on the headline, but cheapness does not protect you if you continue to have earnings downgrades.

No, that’s right.  What’s your outlook then for 2019?  As you say the global growth story hasn’t panned out as it’s turned out, where do you think we stand now as we start 2019?

I presume that’s a question on the market, right?

Yes, of course, but related to growth as well, of course.

Okay.  First of all, the entire world is in a global synchronised slowdown.  Just like how the entire world was in a global synchronised growth in 2017.  There’s no doubt about that.  2018 we saw some divergences and the beginning of 2019 most major economies are in synch, we’re in a slowdown.  Like I mentioned before, Europe or especially Germany just missed a technical recession the other day.  Those are the type of numbers, it’s not that rosy.

The economic momentum will continue to slow.  Typically, what happens in these types of environments, the central banks normally step in and the question is, how much?  From a stock market participant, you want to move ahead and try to price in some sort of stimulus that eventually the central banks they have to do something to actually stop the slide economic momentum.  China was very early at the beginning of 2017 where they started small measures in terms of stimulating the economy.  They’re still stimulating today.  They haven’t come out with a big bang policy yet.  That’s one thing investors should keep an eye out.

Europe, finally Mario Draghi has recognised that there’s low economic growth, I think he had a speech the other day, because prior to that he didn’t recognise it.  ECB, they still want to normalise interest rates, I don’t know how you normalise interest rates when the economies are slowing.  Obviously, the Fed, Jerome Powell, some time in December, he’s already recognised this slowdown.  The rhetoric is changing.  The only country I see stimulating is China but the rhetoric, the tone has changed for both the ECB and the Fed.  But I haven’t seen proper stimulus measures. Rhetoric is one thing but actions is another.  You need to see the actions follow through to stop the economic momentum slowing further.

From a stock market perspective, obviously the stock market is trying to front run, because it’s forward looking and that’s possibly why you saw this massive bounce since December, is because it’s recognising that the tone associated with the Fed has changed.  That the Fed put, potentially may come in some time this year to actually put a floor under the slowdown.  Because in economic slowdown you see massive earnings downgrades, and we’re seeing it right now, it just comes with a lag.  That’s I guess the situation where active managers have to navigate is do we jump right back in the market when valuations are cheaper without any confirmation that the central banks, even though they’ve changed the rhetoric, but without the central banks actually doing anything.

What do you make of the overlay, you mentioned Brexit overlay, but the other overlay is the rivalry or conflict between America and China which has up to now been a trade war situation?  But now we’ve got the criminal charges against Huawei which takes it to another level.  Do you think that this is getting to the point now where it’s getting serious and it might cause an investment manager like yourself to go into his or her shell?

Yeah, so it’s going to be very specific.  Like especially Australia, when you look at the stock market, resources are linked to China.  I don’t think that will have any effect on – whether Huawei is positive or negative, it will not have any effect on iron ore prices or oil, let’s say, but basically this rift between the US and China, I can’t see it going away.  Like sure there’ll be a trade deal, but I suspect it’s a band-aid solution to what is the real issue.  The theft of IP between these two countries.  Again, it’s a question of whether it’s a true narrative or not, whether investors should gravitate towards, like I said, irrespective of whether Huawei turns out to be positive or negative, I think it has little impact on iron ore prices or oil will be dictated by demand and supply and which obviously are largely linked to the demand profile of China.

Are you saying we don’t need in Australia to worry too much about what’s going on because it won’t affect the iron ore price?

No, not really.  It won’t affect our commodity prices.

But what if it affects the Chinese economy?

Okay, so you’ve got to think about, so right now, obviously the Chinese economy is slowing.  Actually, and it’s interesting, every other slowdown in history we’ve seen the iron ore price come off. This cycle iron ore for whatever reason is actually up, so something else is happening and it’s obviously not linked to Huawei.  Let’s say, okay, things get really antagonistic hypothetically between the US and China, and Huawei is one example, there could be other examples coming up in the future and because of that trade between the two countries stops or slowdown further.  You’ve got to think about how much trade influences the Chinese economy from a demand perspective and if you put that into context versus infrastructure spending or domestic consumption, trade is actually not – it’s still a component of total GDP but it’s not a huge component of GDP.

Trade in South Korea, it’s like 50% of GDP.  But trade in China it’s nowhere near to that extent.  Sure, it will hurt but it’s not going to have a huge impact.  If you think about the biggest delta in terms of what’s going to move economic activity is going policies announced, infrastructure spending or policies around housing.  That will have a bigger impact around let’s say steel and iron ore compared to what’s going on in trade.  But by saying that, because the economy is slowing, any incremental negatives such as a trade issues, compounds a slowing economy.

Yes, that’s very interesting, Jason, we’ll have to leave it there.  It’s been great talking to you, thanks.

Okay, you’re welcome.

That was Jason Teh, the Chief Investment Officer and Founder of Vertium Asset Management.