Invest like Ashok Jacob

If you’re interested in diversifying your portfolio into international equities, here’s an opportunity to consider: Ellerston Global Investments, a high-conviction actively managed portfolio led by Ashok Jacob, the former chief executive of James Packer’s private company, Consolidated Press Holdings. Jacob and his team are significant investors in the fund.

Although the fund is new and has a long-term focus, it has outperformed its benchmark so far. The portfolio returned 14 per cent over the five months from November 1, 2014, compared to a 7 per cent rise in the fund’s benchmark, the MSCI World Index (Local). This performance is despite the fund only being 50 per cent invested at the end of its second month, and around 75-80 per cent invested now, with plans to raise its equity exposure slightly over the next few weeks.

EGI raised $75 million before listing in October last year, and Ellerston has $3 billion in funds under management across several funds. Jacob says international markets offer a superior risk/reward profile, and his team looks for temporarily misunderstood companies around the world.

Looking offshore

Jacob says in his experience, Australian investors don’t yet feel positively about the idea of investing offshore. “Australia is one of the few countries in the world which has not had a recession for 20 years,” he says, adding there has been a non-stop bull market, except for the “great reset” of the Global Financial Crisis. “If you take out that one year [2008], if you think about it, if you’ve ever sold Australian shares, you’ve done the wrong thing.”

But he says among retail investors, there is little awareness of currency risk. After the hollowing out of the manufacturing industry, there is no part of the market that is benefiting dramatically from the lower Australian dollar, he says. But he takes the view that investing in the right currency can help drive excess returns.

Another issue in the Australian market is the risks facing bank stocks, Jacob says. Talk of changes to dividend imputation, increased capital requirements and changes to superannuation mean that financial stocks now face headwinds rather than tailwinds. “The financials here are trading at around twice the valuation of global financials, so our banks would be trading at north of two and a half times book, the rest of the world would be trading at somewhere between half and one and a half times book, in terms of much larger banks, better funded banks, more diversified banks, better income streams.”

Speaking before the recent sharp sell-off, Jacob pointed out that Australian banks had swollen to an unprecedented portion of the index. “If you want a better risk/reward profile you’ve got to be in overseas markets.”

Jacob emphasises the importance of portfolio diversification throughout cycles, but says that with the Australian market trading on a relatively high price-earnings ratio and facing a number of headwinds, he expects inferior returns from the Australian market compared to global markets.

Finding bright spots

At the moment, the market with the biggest tailwind is Japan, Jacob says: profitability is rising and the market is the best from a valuation perspective. He says Prime Minister Shinzo Abe’s reform program – including quantitative easing, new government spending and regulatory reform to boost competitiveness – is taking hold.

He also singles out Europe, particularly Spain, which he says has a lot of high quality assets for reasonable prices. Low interest rates are also offering Europe companies the opportunity to take on or refinance debt very cheaply.

“Our fundamental thesis is you want to be invested in markets where there’s a tailwind,” Jacob says. But he adds that as the US normalises its monetary policy, stock picking will become more important. “If you go back over the last three or four years, you haven’t been paid to think,” he says. “You just wanted to be long high quality shares, because the Fed prints, the BOJ prints, the EU prints and the money leaks its way into the top 50 equities in every market.” He says that as US interest rates start to rise, equity markets will normalise with “enormous bumpiness”.

“What you want is to build a portfolio based on momentum that can survive the bumpiness that’s there in front of us in the road at some point,” he says. “What we are trying to do with this portfolio, other than being a boring, global vanilla equity fund, is to have an angle around everything.”

Looking for angles

The fund looks for opportunities such as corporate restructures, spin-offs, fallen angels, companies that are emerging from bankruptcy, or new CEOs. EGI is a high-conviction portfolio of up to 25 securities, with each stock making up between 2 and 6 per cent of the portfolio.

One spin-off that EGI has invested in is Synchrony Financial, which was previously wholly owned by GE Capital.  The business provides private label credit cards for companies including Walmart, Amazon and GAP, as well as financing for large consumer purchases such as furniture, appliances and electronics, and financing for elective healthcare procedures. EGI notes the business’ access to data on consumers’ purchase patterns and pursuit of mobile opportunities.

In terms of looking for opportunities when companies change management, EGI has invested in UK-based supermarket chain Tesco. The company has faced struggles in its attempts at international expansion, while in the UK its share price has fallen as it loses market share to discounters Aldi and Lidl, leaving some wondering if its woes are a warning to Australian retailers (see No longer unstoppable? Coles and Woolworths brace for battle, October 15, 2014). But EGI was drawn to the installation of new chief executive Dave Lewis, nicknamed “Drastic Dave” due to his earlier work at Unilever. Lewis’ steps to streamline the company have included closing stores, cutting the group’s dividend, reducing the number of products available in stores and closing its defined-benefit pension scheme. “If a turnaround can be successfully implemented, the stock could be re-rated dramatically,” says EGI’s December quarter investment report. Tesco’s share price is up 24 per cent since Lewis started in the job on October 1, 2014.

EGI has taken a stake in newly listed French hospitality outsourcing firm Elis, which was previously private equity-owned. The group rents and launders linen for hotels and restaurants, and also provides toiletries for hotel bathrooms, dust mats, work uniforms and pest control. Elis has a 47 per cent market share in France, a 30 per cent market share in Portugal and 16 per cent in Switzerland. EGI says Elis will benefit from both the outsourcing trend and its ability to cross-sell a range of services to clients.

In the UK, EGI was previously interested in Barclays Bank (see Kohler’s Week, September 27, 2014), but Jacob says the team never got comfortable enough with the scandal-plagued bank and decided to invest in Lloyds instead, given its greater progress in restructuring.

The LIC also has positions in television broadcaster Tribune Media, and in Vivendi, owner of Universal Music.

Comparing dividends and growth

EGI charges a management fee of 0.75 per cent per annum plus GST, plus a performance fee of 15 per cent plus GST of the outperformance compared to the MSCI World Index (Local).

EGI’s prospectus says the company intends to pay half-yearly dividends but warns it may not pay out in some periods. Jacob explains that the stocks in the fund are largely dividend payers, and that the group wants to pay out the maximum possible dividend, considering the tax implications of investing in foreign shares. “We’d be happy to pay a two or three per cent dividend as long as we could make sure the taxation of that is not unfair to shareholders,” Jacob says.

But he points out that shareholders in EGI have made a 15 per cent capital return on paper since its October listing.

Of course, many investors will be searching for yields higher than two to three per cent. But for investors who are keen to diversify, concerned about the Australian market’s headwinds and sold on the manager’s experience, EGI is worth a look.