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Investment Europe: Four stocks able to withstand escalating economic risks?

The US Federal Reserve began the process of shrinking its balance sheet at the end of 2017 and will continue on this path until December. So, despite the recent dovish language of the Fed and other central banks, balance sheets have contracted 3% over the last year. Liquidity is being sucked out of the system and this is being led by the Fed.

Pairing this with recent soft manufacturing and industrial production data coming out of the US, are conditions already too tight and is the Fed making a policy error?

In addition to monetary policy, we also remain troubled about the broad deterioration of corporate credit. While the stock of outstanding debt is high in an absolute sense, the growth in non-investment-grade credit is the particular concern. Worryingly, the growth in lower quality debt has occurred in weaker businesses that are increasingly under the threat of disruption. Companies have used a low interest rate environment to take on debt, buy back stock and pay dividends, rather than invest for the future.

So, while global stocks have rallied about 20% from the December 2018 lows, we see many risks building. On top of tightening and credit excesses, we still have to contend with trade war fears, European political instability and a bubble in growth stocks.

As humans, we misjudge the likelihood and impact of rare events. Like a Jenga tower, while we may not be able to pinpoint the precise moment of collapse, we can observe building instability. The price action in the fourth quarter of 2018 is a reminder of what can happen when such risks come back to the fore.

Despite heightened risks, we continue take advantage of the market’s tendency for irrational extrapolation. We seek investments offering a high margin of safety and multiple ways of winning.

Facebook

We added Facebook to the portfolio last December, when the market became very concerned about regulation and a slowdown in advertising rates. Due to the work we had already done on Facebook, we observed this slowdown would be temporary, as advertisers were shifting from the ‘news feed’ to the ‘stories’ format. In addition to this, we also believe regulation is lifting barriers to entry and is providing a moat to Facebook’s business. We believe Facebook has a long runway to monetise its platforms, via both advertising and e-commerce opportunities. Facebook was added to our portfolio at less than 20x earnings – a very attractive price for the growth and quality it displays.

Siemens

As the market herds into growth stocks, cyclical names have become incredibly cheap – even pricing in recessionary outcomes. Therefore, we have selectively added cyclicals to our portfolio – in companies displaying a structural growth story. Siemens is a good example of this. The market views Siemens as a giant messy conglomerate, but the company is slimming down its portfolio, with almost half of its earnings set to come from its digital factory business. The digital factory is the next wave of industrial evolution, incorporating both hardware and software to fully digitise the production process – from concept through to mass production. Siemens is the only company able to provide a complete end-to-end integrated solution, but it trades at a significant discount to the pure-play companies, as all the market can see is a chaotic conglomerate.

SAP

We also added to our software incumbent cluster through SAP. Via its own product development and acquisitions, SAP has transitioned itself from just a back-office enterprise resource planning system to a software stack. It offers customers many insights, from the design of products right through to feedback of the user experience. It then feeds back this user experience and data. SAP’s portfolio allows the complete digitisation of the enterprise. Just like Microsoft and Cisco, SAP is the incumbent, allowing the advantage of scale and customer lock.

Sony

Technology conglomerate Sony is another recent addition to the portfolio, which we bought at 9x earnings. Sony is the number one player in high-end image sensors for cameras, which is another structural growth story with very high technological barriers to entry. The image requirements for camera handsets are going up, which translates into more image sensors per camera. Samsung, the number two in image sensors, only uses Sony sensors in its high-end handsets. Secondly, Sony’s music business is now growing, thanks to the likes of Spotify and Apple Music. For every $10 spent on Spotify, $7 must go back to the music label and Sony is one of three labels at the forefront of this. Finally, Sony has the dominant gaming console, with the largest online streaming service. Sony has over 40 million subscribers paying a monthly fee, while it also takes a 30% cut of in-game downloads.

Jacob Mitchell, portfolio manager and CIO of Antipodes Partners

To read this article on Investment Europe, click here.

How populism heightens portfolio risk

Around the world, political leaders are finding success selling deceptively simple answers to difficult questions, using the failings of free trade and mass migration as a convenient whipping boy for rising inequality.

Giving a voice to people’s frustration is one thing, but addressing the cumulative long-term effects of privatisation, de-regulation, corruption and technological change that have silently eroded the economic rights of the individual is another. Investors need to be aware of this.

A global economy flush with cheap capital has not helped, generating asset price inflation to the glee of the wealthy and accelerating a boom in skill-biased technological innovation. Arguably, it is the failure of policy makers to equip their labour forces with the skills of the future that has been the most profound contributor to the growing angst around wealth differentials.

Equal opportunity and unequal reward

The real question for policy makers is how to return opportunity to the people, with the societies that prove more resilient being the ones that can afford to balance the need for equal opportunity with unequal reward.

What matters for investors is that populist policies almost always result in looser fiscal policy, often at the expense of productivity-enhancing structural reform with negative short-term social consequences.

The euro area is a case in point. Following the European sovereign crisis, the European Central Bank embarked on an asset purchasing programme to create a more favourable environment for unleashing market mechanisms in Europe’s rigid economies and bloated welfare systems. It was a precondition for steady and balanced growth. The short-term impact of fiscal austerity, for example, created socio-political problems of rising unemployment and falling state revenues. It created a policy outcome no euro area government had a mandate for. Witness the social turmoil and political changes in Greece, France, Italy, Spain and Portugal as these countries experienced a powerful pushback to labour reform and austerity.

The rise of populism across Europe has also been accompanied by a surge in tensions between autonomists and centralisers, with the potential to further exacerbate fiscal risks. Interestingly, this trend is not a reaction to economic woes, being most pronounced in Europe’s most successful regions. Northern Italy, the wealthiest part of the country, has long flirted with the idea of floating off to form a country called Padania. Catalonia, the most productive part of Spain, has been fighting for independence to cut its payments to poorer Andalusians. The continent’s integration was meant to solve such questions, but they are surfacing once more to the angst of Europe’s leaders.

Not even the United Kingdom, where the House of Commons plays the role of one of the oldest representative institutions on Earth, has been immune to the spread of populism. Britain has succumbed to the populist wave because it decided to apply the most powerful tool in the populist toolbox – the referendum – to the most profound question regarding its relationship with its main political and economic partner. While the visible result has been the re-shaping of British politics by ‘Brexiteers’ claiming that the people have spoken, the less visible result has been a constitutional revolution. Before the referendum, Parliament reflected the best interests of the sovereign. Now, for the first time in Britain’s parliamentary history, MP’s feel obliged to give in to a populist revolution.

Recent events in Italy are a timely reminder that populism, fiscal policies, bank balance sheets and lending to the private sector are inextricably linked.

Through rising yields, bond markets sanction any perception of unsound fiscal policies likely to aggravate budget deficits and public debt, or in the case of the euro area, violate commitments to deficit and debt targets. Rising bond yields shrink the value of bank assets which consist of large holdings of government bonds, in turn making banks more risk averse and less inclined to extend credit to the private sector.

With Trump’s populist policies seeking to widen US fiscal deficits to levels last seen in times of war or recession, markets may soon begin to discount the US government’s EM like sovereign risk profile and increasingly limited fiscal firepower.

With the populist locomotive now set in motion, increasing political risks have the potential to stress nations that have rapidly accumulated both public and private debt, reliant on external capital despite weaker institutional frameworks.

Set against the backdrop of tighter global monetary liquidity and the potential for slower growth and higher inflation, the financial and political tail risks are elevated.

Recent overindulgence

A decade of overindulgence has led to another set of risks. As generationally-low interest rates and QE-induced yield curve flattening has throttled excess capital towards increasingly risky financial assets, investors have been willing to pay a premium for the illusion of durability in an uncertain world.

The bubble in ‘structural’ growth is perhaps the most poignant example. Technology products and their suppliers have changed the world, making up a higher proportion of global market capitalisation than ever before (globalisation has been a conduit for even greater industry concentration and risk).

Tending to dominate their early niches, businesses such as the FAANNGM’s (an ever-expanding acronym), Alibaba and Tencent have generated tremendous value protected by deep competitive moats.

In search for further growth, investors are investing in their competitors. Whether it’s Amazon and Netflix competing on content streaming or Amazon’s Alexa threatening Google’s core search business with its voice search capabilities, the titans are bumping heads.

For competing software and internet businesses, barriers to entry are being eroded. The ability to deploy, then effortlessly scale their technology on platforms offered by Amazon Web Services, Microsoft Azure and Google Cloud reduces up-front capital expenditure. Combined with large addressable markets and a boom in cheap venture capital funding, particularly in the US and China, the seeds for intensifying competition have been sown. The next frontier of technological disruption won’t be so easily won.

Preparing for uncertainty

The challenge with the current environment is the number of low probability, but potentially material, events that are difficult to build a portfolio around.

Accordingly, over the long-term, we believe that a holistic framework for managing uncertainty is likely to prevail. At the position level, we seek to own attractively priced businesses with a margin of safety and investment resilience, characterised by multiple ways of winning.

Looking beyond the more simplistic model of regional or sector diversification, our investments are grouped into clusters that share overlapping sentiment, idiosyncratic, end-market and macro sensitivities. As stocks within clusters are likely to exhibit a higher correlation to each other, we limit cluster sizes to no more than 15% of the portfolio while attempting to minimise the correlation between clusters. In this sense we aim to control, to a higher degree, concentration risk within the portfolio and mitigate the impact of the unknown unknowns. We also employ multiple levers, such as longs, shorts, active currency and cash management, to offset building portfolio risk.

To read this article on Cuffelinks, click here.

AFR: Antipodes says disruptors distract from main tech game

Investors should not get become distracted by “disruptor” technology stocks, says Jacob Mitchell, Founder and Chief Investment Officer at Antipodes Partners, who believes that incumbents remain the strongest investment options. 

Speaking at the Pinnacle Investment Forum on Tuesday, Mr Mitchell said more established technology stocks, including companies such as SAP, Microsoft and Cisco, had a market advantage over newer companies.
“You know what these businesses are. They have significant pricing power and each of them, whether it’s Cisco and Microsoft, are basically using that lock to add additional features to their offering,” he said.

“We think you are better off, in the bubble of growth that we’re currently living in, finding an incumbent that is actually getting stronger.”

There was more value to be found in some of the older stocks too, he added.

“We’ve looked at the valuation across the top 10 enterprise software companies in the world and they’re trading on 21 times free cashflow. Our stocks on average are below that, they’re even cheaper and we’re taking the best out of the group.”

While newer companies such as Dropbox could offer a single service like cloud storage, the scale of a company like Microsoft meant it could offer the same service within its broader product suite, as it did with cloud storage service OneDrive, a situation Mr Mitchell believes investors should be wary of.

“Does Dropbox really have a purpose if you can use OneDrive in the cloud with Microsoft?” he said. “Can it survive and can they actually charge for that when effectively it’s being given away for free by Microsoft?”
The scale of investment in research and development by the larger companies also means they will continue to innovate, pushing smaller players out of the market, he said.

“The R&D of incumbent platforms is almost double the sales of the disruptors,” Mr Mitchell said.

“The big companies are rumbling past. They’re taking six times as much revenue as disruptors and, while some of these disruptors are growing fast, they may hit the wall when one of the platforms decides to seriously compete in the segment they’re in.”

Mr Mitchell said disruptors also had the potential to push each other out of the market, citing the increasing saturation of the ride-share and taxi market as an example.

“You see all of these Uber copycats, but we don’t think any of these companies will survive,” he said. “Really, I think it will come down to Uber plus maybe one other, potentially a duopoly. But it’s going to be a bitter fight to the death.”

His inclination towards larger players is also seen in his wider sector preferences, believing globally focused stocks are a stronger investment than US companies with a more domestic focus.

“It’s not because we are fundamentally biased against the US. We think some of the best companies in the world exist in that market and we’d like to buy them when they get cheap,” he said.

“The problem is, the US domestics have had tailwinds. Arguably it’s as good as it gets and you are starting to see fairly broad cost pressures. We think the worst is to come in the US domestic stocks.”

Mr Mitchell said the incumbent multinationals were making trading conditions tough for the locally focused businesses.

“The companies leading the disruption are Amazon and Microsoft, these big multinationals. There’s significant, competitive pressures building.

“If you found a strong incumbent retailer that had an answer to Amazon, Antipodes would have no problem buying it. We think Walmart is in a very strong position to compete with Amazon, but they’re the exception.”

To read this article on the AFR, click here.

Morningstar: Korean telco leads value plays across Asia

Asian powerhouses Japan, South Korea and China offer opportunities across the board, particularly in the realm of telecommunications where Korea Telecom has the infrastructure edge to make it a world leader, say portfolio managers from Antipodes Global Investment Partners.

Speaking at a roundtable in Sydney yesterday to launch the company’s latest global ETF, Antipodes portfolio manager Graham Hay said investors risked overlooking KT Corp despite its past as a former state-owned monopoly and provider of superior telecom infrastructure, with healthy real estate assets to boot.

KT is Korea’s incumbent fixed-line telecom operator in Korea. It is also the largest broadband provider and second-largest wireless telecommunications operator. It has a growing television business and is entering into other businesses, including cloud computing and payment processing.

Korea nightlife Seoul KT Telecom article

‘South Korea is a cheap, global market with great, global-facing businesses’

And while Australia was still grappling with delays and cost blowouts in its bid to roll out the national broadband network, KT was well advanced on this front and other services such as its 5G network, Hay said.

“As we here in Australia have embarked on the NBN journey, KT has an NBN built inside it already,” he said.

“The anomaly though is the valuation, in our mind. When you look at the infrastructure these guys have – and remember this infrastructure is the beating heart of the digital economy – this infrastructure is where most telcos around the world would like to be. Korea have largely already done it.

“They’ve spent the capital and we think they’ll harvest that investment over the next few years through 5G and other new services that are laid on to the network. When we benchmark it against even regional peers it’s a world-class asset but it trades at less than a third of the valuation of its regional peers on a range of metrics.”

Antipodes is a top 10 shareholder in KT, which is among the top 10 holdings in Antipodes’ new ETF, the Antipodes Global Shares (Quoted Managed Fund) (ASX: AGX1).

Other Asian companies in the AGX1’s top holdings include Japanese oil company Inpex, Korean financial services provider KB Financial, and from China, Ping An Insurance, China Mobile, and multinational tech and online services giant Baidu.

“We’re seeing opportunities across the board in Asia,” Hay said. “And the rough breakdown for us is Japan, Korea and China. But each of these countries has slightly different angles to them.

“Japan is very much about corporate rehabilitation; Korea is a cross-section of companies both domestic and export-led, and then in China it’s really a focus on the transition from urbanisation-industrialisation to a consumption-led and service-related economy.”

Antipodes also has an eye on the potential for investment in North Korea. Portfolio manager Andrew Baud noted the company had extended its exposure to South Korean construction companies in the event Seoul reunifies with the hermit kingdom to the north.

“These companies would be huge beneficiaries of spending that would take place if reunification happens,” Baud said. “But we haven’t taken it too much beyond that point. The attraction is more South Korea, which is a cheap global market with great, global-facing businesses.”

As for KT, it remains good value after posting solid third-quarter results, according to Morningstar US analyst Dan Baker.

He has set a fair value estimate of $18 for KT, which is currently trading at $14.24.
China Mobile, the largest telecom operator in the world, is also undervalued in Morningstar’s eyes. It has a fair value estimate of $10.63 and is currently trading at $9.12.

In China it has 916 million subscribers and has 61 per cent of the country’s 4G telecom market and 60 per cent of the total wireless market.

Ping An Insurance, China’s second-largest life and P&C insurer, is significantly undervalued. Its fair value estimate is $23.89. It is trading at $20.40.

French utility Electricite de France, and US software giants Cisco Systems, Microsoft and Qualcomm are some of the other top 10 holdings in the new 30-stock Antipodes ETF.

Antipodes Partners says its new fund seeks to generate absolute returns above the MSCI All Country World Index by identifying underappreciated companies in the midst of structural change.

“ETFs are coming of age,” Antipodes Partners managing director Andrew Findlay said, noting that the number of global ETFs and active ETFs on the ASX had grown at a compounded annual growth rate of 23 per cent as at July this year.

This article was written for and originally published in Morningstar.

What might 2018 bring?

The world of 2018 is an exciting place – but will a quantitative easing hangover from the global financial crisis be a blight on the horizon? Jacob Mitchell explains.
During the global financial crisis central banks prescribed an antibiotic, known as quantitative easing (QE), to an ailing global economy. Today, the global economy is in good health, with the antibiotic now creating dangerous distortions in global asset markets.

One of the biggest distortions is within fixed income, with European junk bonds at 2 per cent, absurdly (at least to us) yielding less than 10-year US treasuries at 2.4 per cent. Read more

Antipodes awarded 2017 Fund Manager of the Year

Antipodes Partners has been named Australia’s Fund Manager of the Year, at the Professional Planner | Zenith Fund Awards which took place on Friday 6 October, 2017.

Antipodes Partners also won awards in the two international equities categories; ‘International Equities – Global’ and ‘International Equities – Alternative Strategies (Long/Short Global)’.

The Zenith judges praised Antipodes’ strong returns in both its long-short and long-only strategies since establishment in 2015.

The other top award, ‘Distributor of the Year’, was awarded to Pinnacle Investment Management, the $27 billion multi-boutique firm that supports Antipodes Partners across non-investment functions.

The prestigious annual awards recognise excellence in funds management, as judged by Zenith’s robust methodology, which examines each manager’s investment philosophy, the expertise of the investment team and performance over the past 12 months.

Zenith managing partner David Wright explained it was particularly difficult for active managers to outperform this year, due to historically low volatility, and the winners had done exceptionally well.

Fund Manager of the Year

Left to right: Sunny Bangia – Deputy Portfolio Manager, Graham Hay – Deputy Portfolio Manager, Jacob Mitchell – CIO and Portfolio Manager, Andrew Baud – Deputy Portfolio Manager.