PORTFOLIO POINT: Where will Kerr Neilson be looking to invest in 2012? What are his views on the dollar, China, the US and Europe? Read on '¦
Legendary Australian fund manager Kerr Neilson is often contrarian and perhaps he is more than ever an independent thinker on markets now that he has reached a level most of his peers can only aspire to.
Neilson, the managing director of ASX-listed Platinum Asset Management, masterminded the rise of the Platinum brand over the past two decades and made more than $1 billion from the flotation of the group three years ago.
Today, as he contends with a battered share price and sliding level of funds under management, he presents the same inscrutable academic demeanour that has attracted thousands of small investors and some notable big names, such as George Soros, who provided some of the seed capital when he launched the group in 1994.
One reason for Neilson’s success is that he has always kept an eye on the longer game, which is why his revealing interview with Eureka Report offers exceptional insights for the private investor.
As the markets fear deflation, Kerr is pencilling in inflation. As the wary shy away from “highly priced” stocks such as Google and Apple, he sees them as inexpensive.
As always, Neilson will never fall neatly into one category; forget about tagging him as a bull or a bear, though it’s worth noting he and his fund are no longer “generic shorters”, rather they are moving in on exceptional situations and shorting where there is outstanding mispricing. He cites the example of “90 times earnings in nonsense such as cloud computing”.
And while he understands the reduced enthusiasm among private investors for equities, he also has a keen grasp of history and recalls in comparable “bear” phases, such as the 1970s when retail punters fled the market, the buyers were replaced by sovereign funds at that time run by Arab nations but in our own time more likely to be run by China.
Neilson is sparing in his public interviews; we last talked to him in April 2007 when his group was preparing to float (what exquisite timing! '¦ we now know the market reached a peak in November 2007). Neilson is without doubt Australia’s greatest offshore investor. To find out more on his singular views of the dollar, the EU, China and global markets '¦ read on.
We are underestimating inflation
James Kirby, managing editor: One of the issues preoccupying investors is that earnings and forecasts are being made in the context of very unstable credit markets. Do you think that earnings are at risk going forward?
Kerr Neilson, managing director Platinum Asset Management: Everywhere including Japan, you have higher profits than you’ve ever had before. At the same time we’ve had corporate tax generally going down and after tax an even greater share has gone to the corporates.
Now, in this period when governments have stepped in to make up for the retrenchment by the individual in terms of borrowing, you just sense that there’s going to be more pulling back of some of those benefits that have been granted to the corporate sector. There’s no talk of it yet, but that’s surely going to happen over the next five years. It would be astonishing to me if it didn’t.
Simultaneously, you’ll probably have a labour effect in some industries where I think social inflation can actually be a little higher than the general belief that we have no real inflation impulses. And you get it in strange ways. If you look at the British economy it’s happening.
You’ll see inflation in medical services whether we like it or not because of ageing and because of people not being prepared to do that work and because of migration limitations and so on.
Is this inflation factor a global concern?
Yes. I think so, but in addition you need to understand the deflationary pulse of manufacturing outsourcing '¦ I think that’s come to an end. That was a big driver for most of this last 10 years and I think that’s gone
So, is there an inflation projection that you would work with for 2012 that would be higher than you would see consensus working with?
I don’t know where consensus lies, but I think we’re talking normally about 2–2.5% and I think it’s more like 3% or something, but while it’s an interesting question, it’s not the interesting issue for us right now. The issue is what’s going to happen to expectations. Of course, at the same time the banks in Europe are shrinking and this is, by the way, the biggest argument against inflation at the moment.
Earnings forecasts are too high
Inflation aside, are you expecting a period in the near future where our price/earnings (P/E) multiples will be the same or lower than today?
I think the P/Es optically look fine, but I suspect what actually happens is you don’t have the earnings to the same degree as the P/Es are projecting, so you have to be highly selective. The short answer to your question is that I think in some areas you’re going to have prices going up, causing some compression of margins and then the P/Es we put on those earnings, because of uncertainty, brings us to a closer focus point than normal '¦ this results in markets being pretty flat at best.
Many investors are retreating from equities to cash, bonds and, in our local market, hybrids. They’re also looking to hedge funds and emerging markets. Do you think that is a justified reaction?
That’s the question we ask ourselves and we don’t know the answer because we do feel that there’s been a love affair with equities and now we’re now living in a world of retrenchments and uncertainty and then there’s a bit of change in age profiles. In the United States you’re starting to eat into your 401K [retirement plan] rather than adding to it.
But there are also new buyers in the form of these sovereign funds, so it’s a sort of interesting question there. What I’d rather share with you is the idea that the individual is more reluctant to own equities. But if you’re a sovereign fund owner, you’ve got some pretty nasty choices. You saw this in the 1974 oil crisis where, you know, the Kuwaitis ended up holding stakes in these German mega companies like Daimler Benz and, I think, some of the steel makers and so on because it was a way of compensating for their lack of heavy industrial exposure, if you like.
So, we can’t know how that works and the Chinese are certainly going to be redirecting towards equities, in my view.
There are two reasons why you don’t want to be too miserable on equities. One is that they are real assets of a description and governments need those enterprises to create jobs. And second, that while not perfect inflation hedges, depending on the type of business they can be quite a good inflation hedge.
US blue-chips are 'bewilderingly cheap’
You’ve built your reputation on overseas equities. Are US blue-chips undervalued?
I think so called blue-chip stocks globally now compared with their history are really quite cheap. If you look at all the measures – you know, in terms of price to book, adjusting for what I would say is a period of lower profitability – they’re not expensive and that’s what gives us some encouragement because some wonderful companies are bewilderingly cheap and you sort of wonder '¦ you’re looking around corners trying to find out what’s so wrong with their businesses.
You look at some of these drug companies, which are on about 7.5–8 times earnings, and the way I look at it 7.5 for anything but a really poor company is interesting.
Google is cheap
Meanwhile, there are companies on seriously high valuations such as Apple and Google '¦ Are you prepared to purchase at the levels that they are trading at?
I don’t think they are particularly expensive. And Google is probably a bit cheap. But, you know, we’re reluctant to chase the market leaders because it’s just not how we invest, but I wouldn’t stand on ceremony and say no one should buy them, because everyone knows they’re great companies '¦ they’re being priced as if they are OK companies, not great companies. I have some reservations about Apple. I think it might make you a little money from here, but then at some stage they are a toy maker – a sophisticated toy maker – that has given away its economies of scale to subcontractors.
European brand names are worth holding
In terms of commitment to Europe, what do you hold now ?
It’s some brand names like PPR which is the owner of Gucci. We have Adidas. We have things like that and then we’ve got BMW and Siemens and Daimler Benz. These are aspirational brands, certainly Daimler and BMW are.
We don’t hold banks in Europe. Our financials are principally in Asia. Our biggest bank holding is Bangkok Bank in Thailand.
The Australian dollar will not rise much further
Now, looking at 2012, when you look at the Australian dollar it probably has been a key factor I imagine in colouring your returns in the past year, perhaps the speed at which it rose caught your team by surprise?
No. We were caught by stubbornness.
That you didn’t believe it would be so high? Is that it?
In a world which is pulling in credit, and we are heavily borrowed abroad, we felt that the Australian dollar would show less strength than it did. Furthermore, we had the view that China would start to reveal evidence of slowing, which it’s now doing. The Australian dollar was a pleasant choice against bad choices, so it was a relative choice, not an ideal choice.
And so that’s been, and remains, one of the issues for the Australian dollar. But even so, I think it is in a period of some withdrawal now and the amount of recycling that’s been going on in sovereign funds and foreign exchange reserves of these nations: that’s been an additional driver.
Now some of these pressures will come off and they’ll come off from less trade, fewer trade imbalances and perhaps the demand for the currency being satiated, in near terms, simply because the big drivers are starting to diminish and demand for our materials and the costs of our materials supplied to China for example. But I would have thought the currency won’t go far from here and intermittently drops down into early 90s.
China cannot stimulate indefinitely
Can you tell me your view of China? Are you of the view that they will manage as well as they have always managed in terms of conditioning their growth?
Probably not as well as some would believe, but we can’t get a good read on this. There are some hedge managers in the United States, you know, [hedge fund manager] Jim Chanos and people like that who’ve got a really miserable view of China and maybe an extreme view.
But what frightens me about that is there’s a whole lot of financing going on that is all predicated on perfection and not on concern of downturns.
It’s not just going to be turning on the tap again and off we go. It’s going to be more of a lumbering re-engagement of the gearbox. It’s not simply the switch is on; we’re off again, in my view.
The outlook for 2012
Do you feel more or less optimistic than you did this time last year looking at the year ahead?
About the same. We’ve got lots of problems. And what is better now is that compared with December last year the values are sort of OK. But then on the other hand – there’s always the other hand –you’ve got better values but your profits are quite evidently unlikely to improve by anything like as much as we were hoping last year. We didn’t see it and that’s why we were wrongly positioned.
Today you have to say confidence is at low ebb. [There is a view which suggests] the European fix will be all right; we’ve got fiscal rectitude, not guaranteed but highly probable, we then see the ECB working in cahoots with the IMF getting some sort of support, firstly guaranteeing the banking system and then secondly supporting the bond markets, and then suddenly everything starts turning on its head and we start thinking that our life’s not great, but at least we’ve no longer got a liquidity crisis. We still have a solvency issue, we still have a de-gearing issue, but we don’t have these solvency issues that will affect anyone of significance.
Obviously your unit price on the big fund is down a bit from the start of the year and your funds under management are down as well. What can you do to improve that in the next 12 months?
Well, as I’m sort of hinting, we’ve been too negative on both the Aussie and the world and we were running shorts that cost us a lot of money, particularly at the second half of last year from August on. We’ve now moved away from generic shorting and moved to specific shorting of stocks. We’re starting to make some headway with those. Either they’re called cloud computing or other rubbish, and on 90 times or something.
We’ll make a bit of money on that. In terms of flow of funds, there’s not much we can do. Because we feel a bit bad about our performance, we’re surprised how there are quite a few institutions looking for serious long term managers and so we are doing our work on developing those channels and that is showing some progress.