Getting to know David Bryant

Ranking number one or two in the league tables in equities, microcaps and fixed interest year after year is no mean feat, but for Australian Unity Investment’s chief investment officer, David Bryant, it's the day job. Few investors are likely to have heard of Bryant, but he's rapidly emerging as one of the most successful fund managers in Australia.

As a professional investor with responsibility across equities and fixed interest, Bryant has some key principles that he explains in today's interview. Among them: Don't bother trying to match indexes and never buy something you don't understand (especially in the bond market).

Bryant joined Australian Unity three years ago from Perpetual. During that time, he has managed to stitch up three main external funds management deals that have catapulted Australian Unity into one of the best-performing financial investors.

Among those ventures was a deal to take a 50% stake in Platypus Asset Management, which has almost $1 billion in funds under management and is the best performer in Australian equities over one, three and five years, according to fund management ratings house Intech. It is a similar story, on a shorter time frame, for its 50% stake in microcap fund manager Acorn Capital, which ranks number one over three months and number four over a year; and fixed-interest manager Vianova Asset Management, which is the number-one performer over three months and number two over 12 months. Not bad, given that the Vianova fund has only been going for 15 months.

Platypus, the equities fund, is growing at a rapid rate: it had about $125 million in funds under management when Australian Unity took a 50% stake less than two years ago.

Bryant says being adaptable, understanding the areas the funds are operating in and not following the indexes is the secret to success, not just in the shares portfolio but fixed-interest funds as well. Today, he explains how he makes money to Eureka Report.

The interview

Adele Ferguson: Tell me about the funds? How much do you have under management? How many funds?

David Bryant: The three funds have about $2.6 billion in funds under management.

What stake does Australian Unity have?

We have 50% in each one.

Your performance is exceptional. What are you doing differently?

Absolute return focus. We don’t believe that benchmarks provide any basis for reasonable investing. You have to make decisions day by day on your whole portfolio. You can’t invest 80% according to the benchmark and then just try and skew the other 20%; you have to make conscious decisions about all of it as that is what you get paid for.

Acorn specialises in microcaps and always has. Why is that? What is the attraction of micro-stocks?

Initially, microcaps traded at a heavy discount to larger-cap stocks. We felt this was excessive given what they are. Some of that discount has disappeared, but it is still there and if you can research and choose a portfolio of microcaps well you can more than offset the lower liquidity that you find in smaller stocks. Also, in microcaps, there is a dearth of research and if you know how to find the right information you can pick up stocks that others don’t look at. You can’t out-research the big guys in the big stocks so the best thing is to look where they are not looking.

What areas are you most keen on for microcaps?

We are keen on emerging areas such as biotech, computer sciences and technology and mining. There are always a plethora of new opportunities. You just have to know how to work through them.

What have been some of your best performers?

The Reject Shop has been a great performer, Equinox Minerals, MacMahon Holdings, Sphere Investments, Oakton and Blue Chip Financial have also been star performers for us. Our biggest holding is in Equinox; we hold about 6.2% of the company. Our next biggest exposure is to MacMahon Holdings.

To be honest, the miners and mining-related stocks have been the biggest winners for us in the past year. We are very bullish on them. Equinox shares have gone up more than 120% in the past year and contributed about 3% of our overall performance to June 30. It has a large copper mine and production is about to commence shortly. The market has re-valued the stock based on expected production levels.

Another winner for us is Sphere Investments. It has had a dazzling performance in the past year, up nearly 200%, due to its large iron-ore reserves in South Africa and strong global demand for iron ore has increased the value of the company.

Monadelphous Group has been another winner for us. It went up nearly 130%, so has been great for us to have in the portfolio. It is an engineering company that supports the mining sector via equipment hire, maintenance and engineering consulting. The company has done very well off the back of the recent mining boom.

You hold 80 stocks, but you always make your money on the top 20. Explain how it works?

The rule of thumb is about 45% of the stocks lose money, and the stars carry the rest of the portfolio. Our portfolio analysis shows that the potential to add value increases as the capitalisation decreases. For instance, five-year returns in the large caps stock was 12.9%, in small caps 13.1%, and in microcap 14.2%.

What about liquidity in microcaps?

The maximum position size is 10% and that is a reason why we limit the funds under management to $1 billion, which is less than 1% of the microcap universe. In the short time Acorn has been in operation, the microcap space has gone from $29 billion to $100 billion. That gives you an idea how lucrative the space is.

As for liquidity, we don’t see it as an issue. In the top part of the market you have many investors and a certain herd-like mentality. Look what happens when a stock issues an earnings downgrade, the stock gets hammered. You have less volume at the lower end, but you don’t have the waves of money moving around on short-term news all the time, so if liquidity is about being part of the herd ... well, it's not the be all and end all.

In microcaps, are you overweight in one sector?

We are sector-neutral because we don’t think in that space that you can choose one sector over the other.

You have a 50% stake in Vianova, the fixed-interest fund, and it has been a top performer in a tough market. (Vianova beat the industry benchmark but failed to beat the cash rate.) Why is Vianova performing well?

The fixed-interest market has really changed in the past 10 years. Almost half the index is now corporate debt and other non-government debt, whereas it used to be mainly government debt, and so you would rely on the federal and state governments to pay you back. Now, you can’t just look at the interest rate you also have to look at who will give you your money back and whether they will still be there in the end.

Being able to avoid things you don’t understand is the key to our success. In this space, it is about not following the index that keeps you out of trouble. For instance, Fanny May in the US has had to go back and re-state the last few years’ earnings and it has had hundreds of consultants working on it. They can’t figure it out. If Fanny May can’t work its own business out, why would you buy any paper they are issuing just because they happen to be part of the index?

The other thing to watch is that there are a lot of global players with local issuers of paper, so sometimes you can’t work out who the parent of the issue is or what capital position it is or what guarantees you have. It may look good, but our view is a lot of credit stuff is a mess, so we take the view if we can’t understand it, don’t buy it.

What is your outlook for the fixed-interest sector?

At the beginning of this year, when assessing the risks to our investment strategy, we were most concerned about the prospect of a housing-induced consumption slowdown in the US. We were also closely observing developments in the sub-prime lending sector of the US economy, as a large number of lenders were becoming distressed in quick succession.

We perceived the risks to our strategy centred on a short-term cyclical-based economic slowdown in the US driving yields down in most Western economies. While mindful of this short-term risk to our strategy, we believed that structural global risks to bond yields supported our short duration position over the medium to longer term.

To recap, these structural issues include structural US deficits, structural global imbalances, re-regulation and a long-wave bull phase in commodities.

We are surprised at the extent of recent cyclical strength emerging in the US and elsewhere at this stage of the economic cycle. To have both cyclical and structural conditions aligned against global bond markets would create a new set of circumstances on global liquidity and investment conditions. Although equity markets appear buttressed against incremental rises in bond yields, we believe increases in volatility indices from very low levels will adversely impact leveraged investors across all asset classes in addition to a higher-yield environment.

Any sustained combination of structural and cyclical pressure on bond markets would be unambiguously dangerous for bond investors over the next six to 12 months. This is a situation we felt possible but not probable at the beginning of the year. This now appears more probable, and would increase risk premiums across all financial markets. Accordingly, we remain of a short portfolio duration and continue to avoid risky credit exposures.

So, to put it simply, the market has been on a hair trigger for last year. We found short-dated securities and long-dated securities have been relatively good value and everything in the middle has been an area to avoid.

Why are the short-dated and long-dated securities a good buy?

Short term (for example, one year) is not subject to capital loss when interest rates fluctuate as they are short in duration. The 10-year are a good buy as the yield curve has been inverted (for example, long rates are lower than short rates) and the economic prosperity, easy money and excess liquidity can’t and won’t last, so why would they be cheaper? We also avoid following what the index is suggesting.

What is the investment philosophy at your 50% held fund Platypus?

We try to invest in companies and trusts listed or soon-to-be-listed on the ASX that offer opportunity for above-average investment returns through their growth potential. Typically, the portfolio consists of 25 to 35 stocks, with a substantial portion of the portfolio in relatively large and liquid companies.

Platypus is a high-conviction, concentrated Australian equity manager. We focus on long-term growth stocks with a track record of consistent earnings and dividend growth. We hold shares in relatively few companies – usually 35 or less – which we believe have been undervalued by the stockmarket. Having said that, we have not been a fan of Coles because we haven’t had a lot of faith in management decisions. Woolworths has outperformed it and it has done that for a reason: a strong board and management team.

We like Wesfarmers. It has one of the best management teams around and we have been a strong supporter of the financial discipline of paying out all the profits to the extent that you can frank the dividends. I think the Coles deal is a good one for them.

What do you see as the outstanding themes for investors in the year ahead?

I think this year will continue to be a good year for equities and so will 2008. There will be a few hiccups on the way, but I think conditions are still looking pretty good and the resources sector is still under-valued.

I think there will be a lot more takeovers. I don’t see it being the end of private equity, but with a few of them listing overseas, I see it getting toppy, and I think shareholders will continue to become more aggressive in taking action when their companies aren’t doing the right thing.

Do you think resources will remain an outstanding theme?

Most definitely, yes. We have a heavy weighting in BHP and RIO (more than 20% of the portfolio combined) and we believe it should perform well over the next six months. We would be comfortable adding to the resources exposure if an opportunity presents itself.

What is your medium to long-term view of these?

We have a strong outlook for the resources sector.

What stocks have been standouts?

Queensland Gas Corp has been held by the Trust since inception (April 2006), and has been the best-performing investment to date, tripling in just over a year. In May, the stock rose 37% as part of a general re-rating of coal bed methane (CBM) stocks. A year ago, CBM companies were seen as little more than explorers with potential to be minor players in the domestic gas market. Today, following the demise of the PNG gas pipeline, a contested bid for QGC and the realisation that domestic gas prices are likely to rise in coming years, the stocks are being valued more like utilities than explorers.

Rio Tinto is another favourite. It rose by 15% during May, the re-rating triggered by takeover speculation, but supported by upgrades to commodity prices, particularly in iron ore and coal.

Another standout for us has been Babcock & Brown, which just keeps going up in price. It had another big kick up when it raised its earnings guidance at the AGM.

I really like Reverse Corp, the telecommunication company, which also has been outperforming the market.

What have been poor performers for you?

We have sold three small-cap positions in the past few weeks – Aquarius Platinum, HFA and Centrebet, primarily for risk-control purposes. HFA was sold off following an announcement late in April that its 40% shareholder (MFS) was looking to divest half of its shareholding prior to the end of the escrow period. The stake was sold in the first week of May at $2 per share, approximately 20% below where it had been trading prior to the announcement. As this was unfolding, we reassessed our investment in HFA and concluded that we could no longer ignore the delays to the mooted tie-up with Lighthouse (their product supplier), and the insider selling (first the founder, then the major shareholder). We sold out of our position on the 7th of May.

Any concerns with the portfolio?

The major risk in the portfolio is the investment-banking position (Allco, Babcock and Brown and Macquarie Bank), which we can neutralise in less than three days’ trading if required.

What are your retail fees?

Platypus 0.95% plus performance fee, Vianova Strategic Fixed-Interest Trust is 0.7% and Acorn is 1.35%

Just to recap, could you summarise how have you performed against your peers?

According to Intech Investment Consultants, Platypus is the number one performer over one, three, and five years. Out of a universe of 25 bond funds, Intech ranks Vianova’s performance number one over three months and number two over 12 months. Remember, the Vianova fund has only been going for 15 months, so we are very pleased with its performance. According to Morningstar, Acorn Microcap Trust Fund ranked number one over three months, and number four over 12 months.