Hunter Hall and the human factor

PORTFOLIO POINT: Ethical investment pioneer Peter Hall says judgments of people play a big part in his investment choices.

In a world of superstar fund managers, Peter Hall is unique: he is the driving force behind a value-driven funds management company with an ethical screen; the BRW Rich 200 member who gives away 25% of his wealth every year; and the owner of homes in Sydney and London, who protests against Japanese whaling.

Established in 1993, Hunter Hall created a template for ethical investment long before it was fashionable. It created a “negative screen” to rule out stocks that derived earnings from weapons, tobacco, gambling, animal testing, human rights violations, uranium mining or unremediated destruction of the environment.

And investors have responded strongly. Today Hunter Hall has $2 billion in funds under management.

While it’s nice to know there’s a market for this sort of thing, it’s better to know that it pays. The flagship Hunter Hall Value Growth Trust returned investors 35.5% for the 12 months to October 31, outperforming the MSCI benchmark by 49% and the All Ordinaries index by 13%.

Since its inception in 1994, the trust’s outperformance has been no less impressive, beating the MSCI by 11.2% and the All Ordinaries index by 5.5%.

Despite such strong results, Hall is not slowing down, as evidenced by the launch of his Global Deep Green Trust in October 2007. This was the first Hunter Hall fund to use a “positive screen”, to invest in companies deemed to have a positive impact on the wellbeing of people, animals and the environment.

It is these ethical and sustainable funds that have bounced back the sharpest from the global financial crisis. Outperformance of the sustainable option of many industry funds was a key theme of 2008-09 reporting period.

Despite being launched at the top of the market, the Global Deep Green Value Trust has returned investors more than 2% while most indices remain down by roughly half. In the year to October 31, the fund beat the benchmark by 43.5%.

Some of the positions held by Hunter Hall aren’t the kind you would immediately associate with the ethical investment set. He is very excited about the outlook for a small Italian gas producer named Po Valley Energy. He also holds a considerable amount of gold in the Perth Mint.

In today’s interview, Hall talks about the opportunities for investors post-Copenhagen. He names wind and wave power as the most serious contenders on the carbon neutral front and tips a number of emerging Australian biotechnology companies as his favourite plays on the ASX.

The interview

James Frost: Peter, you’re based in London but you’re here for a few days so I expect you’ve seen some of the political horse trading that has been going on in Australia. What do you make of it?

Peter Hall: I think Kevin Rudd is a politician who has tried to negotiate an agreement that most people can agree to and live with, rather than striking into bold new territory, which is what we really need to do. Waiting for the whole world to come to an agreement on cutting carbon emissions is a mistake. What individual countries need to do is make exemplary statements of intent, and I’ve just seen that Obama has done something of this nature in the US.

There is considerable focus on making the switch from coal to gas from a carbon emissions standpoint. Is this going far enough?

We should be looking to go further, but gas is a good interim solution for baseload power. Our funds invest in gas but we’re also investors in renewables further down the chain. Po Valley Energy (PVE) is a company we’ve held for about five or six years, which claimed a lot of gas production and exploration areas after the industry was deregulated in Italy.

It took them five years to get approval and they’ve only begun to start producing gas in the past month or so. They’ve got a very substantial portfolio of developments coming up over the next few years and they should start generating very good cash flow. We got into it at $1 [it was $1.51 intraday today] and the in-ground gas is worth $8 a share, and as they start producing the share price should start moving as well.

The chief executive, Michael Masterman, is what I call a lucky general. Napoleon was once asked if a general was good or bad, and he said, 'I don’t care if he’s good or bad, just as long as he’s lucky’. Michael is guy with great character and great intellectual capability and a great concept. And he might also be able to turn all those things into a really substantial and successful business.

Coal seam gas has attracted a lot of attention in Australia and offshore. Have you invested in any of these companies?

No, we don’t have investments in coal seam gas. Not because of our ethical screen but just on a valuation basis.

How about geothermal? It’s often promoted as a potential solution. Do you hold anything in this space?

We’ve looked at geothermal and we couldn’t justify the prices that were being asked. We’ve seen the problems that have happened at Geodynamics but we still think that would be a great area to invest in given the right investment opportunity. We just haven’t found it yet.

What do you think the “great white hope” for carbon neutral energy could be?

I think wave power is very interesting and that might be the long-term ultimate solution. We have an investment in a very interesting wind technology company based in Canada called Catch the Wind, which has made some improvements in the efficiency of wind turbines and really changes the economics of wind turbines; it could ultimately make offshore wind turbines more economically viable. Wind and wave are probably two of the really serious alternatives to geothermal and the renewables area is a very interesting space.

What opportunities do you see in the Australian stockmarket for investors with an ethical mindset?

I obviously like the medical technology companies that we hold. Sirtex (SRX) develops drugs for liver cancer and that’s one that I think has a tremendous future. Australia has a lot of these little niche medical science businesses that are very interesting. We’ve got another little biotechnology company called Fluorotechnics (FLS), which is trying to commercialise an analysis tool for scientific developments, and we’ve also got a stake in Biota (BTA).

Sirtex has had a remarkable improvement in the past year, when it went from NPAT of $1.2 million to $18.2 million and EPS rose from 2.2¢ to 26¢ over the same period. It’s the now the largest position in three out of your four funds. When did you get involved with this company?

We have been involved for about seven or eight years '¦ a long, long time, and it’s an example of long-term investing with your eyes on a really big prize at the end. You’ve got to go through the valley before you can get to the mountain. We’re still not earning the sort of return on that investment that would justify the investment holding period. It’s really got to go up by a factor of three or four for us to get there, but it’s doing very well and the business is doing very well.

Biota is a company that has had its share of ups and downs. Has this been part of the portfolio for a long time?

We’ve held Biota for about two-and-a-half years but I have followed them for about 20 years off and on. The biggest returns in this business go to people who are willing to take on the problems that other people are not willing to take on. We get paid to accept illiquidity in our investments. We get paid very well to take on difficult problem companies, to persevere and solve problems with them. So that’s where we find mispriced opportunities: in the front page disasters, the difficult situations, the outliers of the market.

Some of these companies that you hold and have bought into over the years have been nowhere near turning a profit. Putting good management to one side, what else do you look for in these kinds of opportunities?

You have to look at what the end market, whether that market is a big enough market to generate significant profits and whether the management and the product and the strategy are there to take advantage of that opportunity. That’s a matter of judgment and that’s why our type of investing really is more of an art than a science. The human factor is so terribly important, as it is in all things to do with life and you just start making judgments about people and the competence of people.

Gold is also a big part of your strategy, accounting for 4.2% of the Hunter Hall Global Ethical Trust and 2.1% of the flagship Hunter Hall Value Growth Trust.

About a year ago we began to think there was a very good chance that inflation will break out because of the huge stimulus that’s been applied and it’s a hedge against that. It’s a theme that we think might play out over the next two to three years.

How do you hold the gold?

We’ve opened a Gold Ounce Account with the Perth Mint, which holds gold on our account in its vaults. The mint is owned by the WA government, which guarantees its obligation. Not only has this removed our gold holdings from financial intermediary risk and the risk of expropriation by a foreign government, but it’s also reduced our holding cost to zero, because they do gold lending.

We are talking about tens of millions of dollars worth of gold here. Why would you choose to buy the physical form over say an exchange-traded fund?

Well the ETF is London-based and Jack Lowenstein, our deputy chief investment officer, thought that there was a possibility that the British government might fall to pieces and expropriate the gold. So we chose gold deposits at the Perth Mint instead '¦ very much a belt and braces approach [laughs].

What’s your outlook for companies with an ethical or sustainable view post-Copenhagen.

Clearly, this is the issue of our lifetimes. It is a big problem and we’ve got to deal with it. No doubt the pressures will force the world to be changing its behaviour and ethical and sustainable funds are well-placed to profit from those changes in behaviour, so I think the future is bright.

The problem is that many investors are not particularly interested or sensitive to the problems '¦ but they will be once icebergs start floating past Sydney Harbour, rather than just New Zealand! Then there will be a great switch of interest; the only problem is that it might be too late because these problems do take an enormous amount of time and effort to change.