Monaco Mover

Richard Farleigh is the rarest of treasures: an exceptionally successful Australian investor who's willing to explain his investment strategies. For many Eureka Report subscribers, Farleigh has a lifestyle every investor must occasionally dream about: he lives entirely from his investment proceeds. Moreover, he lives extremely well from his investments; he's valued at $160 million on the BRW Rich 200.

Based in Monaco '” living in an apartment overlooking Monaco's only beach '” Farleigh divides his time between the Riviera and London.

But if you think this former RBA official might be way too complex to follow, think again. Farleigh is direct, often blunt, and his investing style is almost obsessively based on economic fundamentals. Don't call him a trader; in fact Farleigh says day trading is nonsense. "The idea of buying something in the morning and selling it in the afternoon is ludicrous."

Maybe that bluntness comes from his roots in rural Victoria, the youngest of 11 children born to an itinerant family. Later taken into care and eventually adopted by a local family in Kyabram, the first sign of Farleigh's exceptional abilities was when be became a local chess champion. However, these formative years have clearly moulded his investment style; he has an abiding determination not to lose money.

A graduate of the legendary Banker's Trust trading desk in the 1980s, which also housed market figures such as Chris Corrigan of Patrick and Jillian Broadbent of the RBA, Farleigh left Australia in the early 1990s to run a hedge fund out of Bermuda.

He is a “top-down” investor who truly believes the dictum "the trend is your friend". His key interest is in deep economic trends and how forces such as inflation, commodity prices and currency movements affect prices across all investment markets. Once he is convinced of a trend in the markets, he's clearly willing to take very big position because he believes markets don't overreact, rather they underreact. By this he means that deep trends such as rising commodity prices regularly last longer than many people expect.

For Australian equity investors, Farleigh’s main message is that there will always be value in the areas of the market that are less examined by brokers and analysts. On the ASX this means small-cap equities, along with technology and even biotechnology stocks.

Six main points define Farleigh's investment style:

• There are always patterns and anomalies in any market '” this is why small caps can offer very good value.
• Markets are slow to react to structural influences such as the changing influence of Chinese demand on commodity prices.
• Small companies offer more opportunities. Farleigh has increasingly become involved in start-up equity.
• Markets go further than generally expected, such as the ASX between 2005 and today.
• Markets move in underlying trends. The decline of the Japanese banking system was deeper than forecasters believed.
• A view on the fundamentals can be combined with price movements to manage trading positions.

Farleigh's most pragmatic advice to investors is to know how much you could afford to lose if the markets move against you. You should be able to withstand such a loss if necessary.

Eureka Report caught up with Farleigh just as he is becoming better known in the UK market after volunteering to join the panel of a popular BBC2 television show called Dragon's Den, where a panel of venture capitalists are asked to review new ideas or products from budding entrepreneurs.

James Kirby: You are a firm believer in what you call “trend investing” rather than short-term investing, typified by day trading. Could you name a deep trend that's running at the moment.

Richard Farleigh: Absolutely. Take the commodities market, for instance. If you get a situation where all the factors are bullish and all the key indicators are going in the right direction, then you should believe it. The market will invariably surprise you just how far prices will go, even if they might seem giddy at the time

Do you see sectors where the opposite is happening, where the trend is deeply negative?

Well, I have not been examining either of these sectors closely but the international telecommunications sector looks poor. I'd say you could short just about every telco stock in the world for the next few years and you'd be doing well.

In Australia, I suppose the asset that comes to mind is residential property, which is at the end of an upward trend. I'd just say that it's a tough time to hold a view on Australian property.

Talking about residential property, you became quite well known in investment circles at Banker’s Trust when it became known you'd sold your home in Sydney and put the proceeds into deutschemarks. Is that true?

Yes, it's true, but you have to see that in perspective. You know I was just 28, I had very few responsibilities. It was not my plan to publicise it, but because I was working in a trading room in Sydney. I had to make the disclosure and then it got out into the market. It was a very successful trade at the time, but you know I had a stop/loss in mind of about 20%.

Could you imagine doing something like that now?

(Laughs) No, I couldn't.

So tell us what you can about your investment approach now, as a wealthy 45-year-old with plenty of money to lose?

One of my key principles is that you'll have one bad year in five and in that year you have to be prepared to lose at least 20% on any of your positions. In fact, for myself I make the figure 50%. I'm not saying this happens every five years, but I prepare for it. It's all about having appropriate expectations.

And you have this notion of “staying the game”. What do you mean by that?

One thing investors need to remember all the time is “don't get wiped out”. It' sounds simple, but it's important. You should never be too confident. From that principle there are certain observations. For example, you should not be too wedded to one idea. Something I often tell people is that you don't have to have a risk position all the time; you don't need to be over-confident

Obviously, diversification is sensible for any investor. I think one of the key diversifications that is regularly underestimated is cash; you should not underestimate cash. Personally, I'm not interested in diversification for diversification’s sake '” putting money into bonds or whatever '” a lot of the time I have positions and then I have cash as my diversification.

I suppose in many ways, you're an investor writ large. You're what many people might dream about if all their investment plans worked out and they were able to live entirely off investing. I'm wondering what you can tell retail investors that's directly relevant to their position in the markets.

There are several things I'd like to point out. They are criticisms, mainly, but I think they are worth considering. First, I am very sceptical, actually I'm dismissive, about chartists and technical analysis. I just reject that whole scene completely. As somebody who trained in maths and econometrics, I can't take them seriously.

The chartists that I've met have no mathematical grounding whatever. I don't know what they base their theories on. I reject all those theories, including the Elliot Wave.

I believe in fundamentals, which always come first. Charts are occasionally useful to identify simple price trends but not for any more obscure patterns.

So do you reject the idea of any patterns at all in the market. Are there no recurring trends?

The way I look at it there is 90% fundamentals and 10% price action '” and there is no reason why markets should follow any pattern apart from simple price trends '” I have established firm reasons for the existence of trends but I do not believe there are solid arguments for any other patterns.

Notwithstanding ... I've never seen a trend that I am sure could recur.

Even though you are now loosely involved in the media yourself, (in BBC2’s Dragon's Den) you've been pretty scathing about financial media commentators, especially market pundits. What's wrong with us?

(Laughs) Where do you want me to start?

Well, start where it hurts least.

OK, my main objection is that a lot of people in financial media make it all sound too easy. You know you get these breezy generalisations '” oil is going up, buy oil, something like that. It's not so easy.

Private investors get this message from media that the markets can be understood easily, that they are inefficient. They are not inefficient, I've learnt that the hard way. You know the market price is the market price, I can't put it any other way. The media experts will say it's a bull market for X, or a bear market for Y '” you know its fiction '” it depends on how many bulls or bears you call on the phone.

People in the media make careers out of giving strong views and they have no track record. I'd say I have a record but I'm very reluctant to give a strong view!.

So, have we any redeeming features at all?

Oh yes, there are useful aspects, I think, when the financial media does work that is educational, when it communicates investor education that's good. I mean it can occasionally be useful to tell investors what has happened in the past, especially if they are not familiar with past.

I know you spend your time now between London and Monaco and you have a lot of investments in unlisted companies. What are your views on the Australian investment markets?

I look at the ASX '¦ it's been so strong, and I know it must be a nervous time when you are in a period of historic highs, but I think the fundamentals are still bullish. I know people will be taking profits on the ASX, but I would be buying more in that market.

Investors are getting worried about some key indicators that suggest over-confidence. Average price/earnings (P/E) multiples for the market (at 18 times historic for the ASX) are trading ahead of leading US equity indices such as the Dow. This is new territory for Australian investors. Should we be worried?

I look at fundamentals. I don't get hung up on market ratios such as P/E numbers. Markets are always changing; what made sense in the past may not make sense in the future. I'd say to Australian investors: I'm a consensus investor, the consensus is right a lot of the time. As I said, when the fundamentals are strong, prices can go a long way '” further than generally expected.

So what are you worried about?

Looking at the bigger picture, I am quite happy that higher oil prices have not affected inflation. The bigger picture worry at the moment is Iran.

In your new book Taming the Lion (Wright Books), you only mentioned brokerage fees once. At Eureka Report we have been alarmed at the level of fees creamed off in the markets, especially in managed funds. Does it concern you at all?

Yes, it does. I always try to keep all my fees to a minimum. More importantly, if you are not managing you money and investments yourself, you have to be very careful to whom you hand over that responsibility. I worked in the Sydney market for years, and I look at it now and, you know, some of the people who were making the coffee are managing money now. There's a lot of people managing money who simply do not have the skills to do so, whatever fees they might be charging.

So, you started in the Australian markets, then you ran a hedge fund out of Bermuda. More recently you've been named as one of the top “business angels” (financiers of start-up companies) in Europe. What are you interested in these days?

I'm terribly interested in new technology and science investing. I'm really interested in what is coming out of the universities. I really think it is a great way to diversify your investments. I know in Australia there are some real limitations '” in terms of the depth of these markets, especially the lack of depth in the technology markets '” but I 'd still say to people there will be investment potential in these sectors.