Don't Be Suckered

South African-born Kerr Neilson is one of the local market's outstanding fund managers. His Platinum Asset Management group now manages more than $18 billion in equities markets around the world. The bulk of Platinum's funds are in unlisted unit trusts, but the group also has an ASX-based listed investment company, Platinum Capital.

Apart from being one of the best fund managers, Neilson is also one of the most frank commentators on both the domestic and international markets. He is clearly outranked by larger rivals such as Macquarie Bank, but Neilson is not slow to openly criticise a range of 'leveraged' products that he believes are unsuited to many private investors.

Neilson even queries why investors would bother to buy stock in his own listed funds management company when they can buy units in his unlisted funds at net asset value.

With that sort of direct approach about his own products, it's hardly surprising that Neilson, a former Bankers Trust executive is especially fortright about "alternative" investments including infrastructure, hedge funds, private equity and emerging markets.

In today's interview, Neilson also discusses the details of Platinum's recent unfortunate investment in the controversial Japanese dot-com "Livedoor" and why he's become a little more selective about investing in China. (This article also includes a transcript of the video interview broadcast on Friday, Febuary 17).

Michael Pascoe: You’re not a fan of private equity funds and hedge funds, to quote your December quarterly report, you said that unsustainable earnings are being manufactured, leveraged and sold to the public in listed vehicles. How serious a problem is it?

Kerr Neilson: There’s this issue called "risk love" as it’s called in the trade '” just this desire to take big risks in the belief that interest rates or debt is not a long-term obligation and that, with it being quite cheap, it’s well worth taking a punt. And that’s what worries us most.

If you look at one of the great bells of a change in market sentiment, it is when money is almost free. There are two great bells: one is the cost of money and the other is price inflation. One of the driving forces in Japan '¦ why it’s in a bull market '¦ is you no longer have deflation, so that’s the bell for the bull market. But the bell for our bear market in the Anglo Saxon countries is [that] there is perhaps some evidence of a little more inflation and it is a fact that the cost of money is going up.

Certainly in the United States inflation is going up and will go up a little higher perhaps, and it is holding quite high up here in Australia and it is coming through and starting to hurt consumption.

There's this idea that everything can be securitised, sliced and diced into infinitely small pieces and there’s always some sucker at the end of the game to take it up. Well, what we highlighted in our quarterly was that it is highly dependent on there always being a sucker and when the music stops that there’s always going to be a seat available. Well, we’re not clear about that.

So the big infrastructure deals that are packaged up and sold off by the time they get to the retail level: you don’t want to know about them?

No I wouldn’t, because if you look at the motivation of the promoters, they’re not necessarily aligned as long-term holders. What I like to do when investing is buy businesses where I have an alignment with countries that are longer-term focus because there is a creep towards short-termism. If I can find people who are really serious about developing businesses long term, I know they’re going to thrash the living daylights out of those who are short termers.

I’m not trying to lecture but there is a lot of effort that goes into systematically creating wealth and to do so by simply following the herd we think is a very difficult game.

At the riskier end of the business there are the emerging markets. What do you like there?

Not so much because the feature of the emerging markets is that post-1998 they started to improve, then we had this massive fall in the yield on bonds and everyone went pouring into the emerging markets. So they’ve been the best markets by far. The trouble is now that if we are in a period where bonds start creeping up, the alternative becomes slightly more attractive.

The risk premium, we think, will start going up. Not to say they’re over, but I think the very high ratings that they’ve recently been given really has removed a lot of the political risk that hitherto was the concern and we think there is still plenty of institutional risk in those markets. Every now and again you see the institutions failing. There’s graft in government, money gets washed out to the wrong place and so on, and we’d be a bit wary that now is not the time to be doubling up on the emerging markets. They’ve been massive and great fun but it’s not the time now if you are a risk-averse person. Certainly not.

Which one country do you prefer in the present?

I think it’s a bit unfair that Korea’s classified as emerging market, but is actually a small industrial power. So that’s the one we’ve put money in and we still have money in India, but we have been taking money off that table there from the top position to around 7; it’s now halved.

And China?

China’s great but, you know, I think with a little more doubt about growth. You want to be selective. We think because of the yuan, which will probably gradually creep up and be revalued this year or certainly next, money will wash into the property market. So there’s some good opportunities there but the trouble is with all the very cheap money they’ve been getting, they too have oversupplied the market with production kits so they can make anything in vast quantities.

You’ve seen them washing into the steel market now, the export steel market, so our concern there is you need to be pretty selective and there are parts of that economy that are grossly oversupplied. And profits are the factor that is going to drive the next leg of the bull market for some of those stocks and they’re not going to have very good profits for a while, some of them. We think it will be a consumer-driven market from here.

You’re just back from Japan, one of the major places you invest in. What’s the state of Nippon?

Good. The bull market is clearly in force now. We think it’s been in force for 40 months or thereabouts '¦ sort of 35, perhaps '¦ and I think the big insight we got was that the next driver from here on is really just the escaping from the bond market. So people who think in terms of flows as in foreign flows or domestics coming back as buyers, but we think the real driver from here is going to be people escaping from these very low yielding JGBs '” Japanese Government bonds '” which are now yielding, say, 1.4%, having come up from having a yield of about 60 basis points. They're leaving that space and coming to equities and other assets. So we think that’s going to be the next big driver.

The [forward] market’s already running pretty hot. Could that be dangerous?

The Japanese market has more than doubled from its base, which was probably in April 2003, so I think it will hesitate here. I don’t think it needs to immediately go higher. At 16,000 I think you’ve got a fair amount of congestion and the foreigners have definitely been driving it, but what we’ve seen in places like India and now Korea is the domestics come in quite late. We've seen it before: Indian private investors got a thrashing in 1994. We couldn’t believe valuations when we saw them when we went back in 2003 and it was just that they had been completely gutted. The same thing for the Koreans; since the International Monetary Fund crisis of 1998 they’ve stayed well away and are now coming back in. We think we’ll see the same thing in Japan.

You are famously contrarian as an investor. Japan now seems to be a consensus bull. Does that mean you’re getting out? You have increased your shorting activity there?

We’ve reduced our position and we’ve introduced a small short and we’ve also been short in Japanese Government bonds. What I think might happen right now is we might have some concerns about growth in China, that China is not going to grow at 9–10% and maybe it will come down a lower growth rate. So I think with that we’ll see commodities also having a bit of a rest, the Aussie dollar having a bit of a rest. And so we’re just putting in place some protection.

Japan is still your biggest single holding?

We’d have about 30% there, about 20% in Europe; about 15% North America and then about 7% in Korea, 3.5% in India. And some cash.

Which is a very different weighting to the standard international portfolio. Why?

They’ve defined their world versus an index. We’ve tried to define our world in absolute returns. So if we were simply following the index it would be easier to manage '” it’s an easier job. But you wouldn’t get the rewards. This is a brag, but if you put money with us 22 years ago, you’d have about 40 times what you started with. If you’d been with the index you’d have about five times. You know, it’s night and day.

You’ve just copped a few headlines for investing at the edge '” Livedoor in Japan, which is in all sorts of trouble for overstating profits and other matters. Does that concern you?

No. We regret losing the money but we will always make errors and we make plenty, but then in this game that we’re in we hardly celebrate when we have a stock that goes up multiple times.

So you’ve still got your Livedoor shares? You haven’t sold?

We’ve still got them. And they may be suspended. You know, the cash on the balance sheet is greater than the current share price. There is a business there. In fact, when we were in Tokyo we met a couple of sniffers: people who were really trying to break [LiveDoor] up into its component parts, so they were quite interesting in terms of what they thought was worth doing.

But there’s plenty of risk?

You know if it gets delisted people gets a bit sort of itchy. But the business carries on.

What’s unfashionable now. What do you like that nobody else has done?

We think the paper industry is the one standout. It’s the one commodity play almost in the universe that has not moved for a whole lot of quite interesting reasons, and it’s not so easy to make a bull case but we’ve found a way of doing so. We think the agricultural area remains most prospective as well. Things like agricultural companies could be interesting. Fertiliser companies could be interesting. And we’ve got one in each.

Forecasting currencies is one of the all-time dangerous occupations. Are you doing to at the moment?

We’ve decided to keep batting and our sense is that we’ll get a bit of loss of enthusiasm for commodities, and with that the Aussie and the Canadian [dollars] perhaps will have a bit of a rest and a bit of a pull back perhaps, but no one’s too eager to own the US dollar. The yen I think is the easy one to own.

Australian shares have outperformed and it's argued that they’ll continue to outperform. Philosophically, how do international shares compare with domestic?

If you’re an individual investor I don’t think you have necessarily a greater advantage here. I’m talking about a person who plays the stockmarket, that whether you play in this market or internationally you can play in both. Your information flow is now with the internet and every other medium, it does not put you at a big disadvantage.

So I would say to everyone they should play in the broader field other than where they really have specialist knowledge. So if you’re a specialist on retailing, really you stick to that and maybe try to do that internationally as well.

The greatest problem we find with private investors, those who do it less than full time, is they haven’t, in many cases, identified what is their area of speciality: what is their special feature they can bring that gives them some edge against the field, and that’s the biggest problem with private investors.

For investors who want to put money with Platinum there are different routes. If you were outside and wanted to put money with you how would you do it?

Well I wouldn’t necessarily encourage them to do it in the first place. Why not? Because as we get bigger we will have greater difficulty producing remarkable results as we have in the past. That is a thing we are trying to work on and find ways of obviating: that we do not lose our strong history of performance or our strong culture of performance. So we’re quite happy to just grow the business with our existing unit holders and look after them, and if you come along so be it, but we’re certainly not trying to get a lot bigger. If we do what we have done before, we have to get bigger and that’s big enough. So we’re not really after developing an incredibly large business like some you see.

But in terms of ways to invest without paying too much in fees, what’s the most cost-effective way to get in?

You can pull down a prospectus from the web. What is now called an offer document. Look it over. Make sure you understand our investment approach and if you’re happy with that and you’re patient and you think you understand what we offer, you then maybe you’d like to put money with us, but you must be clear about what you’re buying and we try to spell that out pretty well in our prospectus.

And the fees on that route?

It’s 1.54% per annum, and then there’s a dealing fee, which is a buy/sell spread of half a percent. That’s the full extent of your fees.