Investing in turbulent times

With the sell-off in equity markets, valuations have now become a lot more attractive as compared to the historical average. Are you seeing opportunities in the markets and what are some of the holdings that have been adding value to your portfolio?

The current environment that we're seeing suits our investment team much better. When we last discussed in a webinar in 2021, no one knew what was going to happen. You would have thought that markets were going to be very tricky because swathes of the world were in shutdown, but central banks printed huge amounts of money and the game changed — markets rebounded very strongly.

We typically will struggle to keep up in that sort of environment. It's when there is risk aversion that we get a bit more excited because we've done a lot of work on these companies. And when they get cheaper, it gives us a better opportunity to invest in more of these really good businesses.

Valuations are looking cheaper, but the caveat is the price-to-earnings ratio is also going to be a bit questionable with talks about a recession or something much worse. However, the companies that we invest in are ones that we believe can deliver steady, sustainable growth, and they are actually looking quite attractive.

We met HDFC Bank, which recently came to Singapore. It's trading at valuations that we haven't seen since the Global Financial Crisis and that makes us quite excited. Elsewhere, parts of China are probably still looking a bit too expensive, but broadly speaking, what we've been doing is adding to existing holdings. We're fortunate that we manage money for St. James's Place which continues to grow, so we see regular inflows into the fund, and that gives us that opportunity.

That said, we're also looking at new ideas. There's a couple that we're quite excited about that given what's happening with markets, we might be able to pick up a lot cheaper.

With sustained supply chain disruptions coupled with the fact that interest rates may have a limited impact on inflation, it is likely that we're going to see inflation stay elevated for quite some time. How do you position your portfolio to ensure that we have a good hedge against inflation?

A lot of people still believe that inflation will be transitory and not structural. If you look at the long-term drivers of inflation, it is the cheap labor and it has come to an end — it was cheap labor from China and Eastern Europe, but there isn't really any cheap labor at the moment.

And another point to note, there are three ways to solve a debt crisis. One is to default, which you can't do if the debt is in your own currency, so that's a non-starter. Then, it was to live within your means, which is politically unpalatable. The third way is to inflate your way, so to some extent, the central banks actually wanted inflation. The trouble is, once the inflation genie is out of the bottle, it's really difficult to put it back in. So, we are of the belief that inflation is here to stay for the foreseeable future, and that in itself changes spending patterns as well — it almost becomes self-fulfilling.

There are a few ways that we can hedge inflation in our portfolio. One is to buy companies that have pricing power, and we have about a quarter of our portfolio in consumer companies with very high gross margins. This is important because sometimes there's a delay — you get input costs going up, but they can't increase prices straight away.

Supermarket businesses are really good inflation hedges. They work with negative working capital, i.e., they're paying their suppliers a lot later than you as a customer are going to pay for your goods and they can put the prices up immediately. We have exposure to a company called Uni-president Enterprises Corporation in Taiwan that has supermarket businesses which have been doing well.

The other way is to buy gold, which historically has been a hedge against inflation. We have a position in a gold mining company called Newcrest Mining. Gold has been a bit dull over the last few years, but over the long term that has normally been a very good way to preserve capital.

Another way is to own physical assets. What has been really fashionable since the Global Financial Crisis when interest rates really fell, was to have asset-light businesses. For all those e-commerce businesses that do not own a factory or not own the motorbikes of their riders, their assets are basically just people. In an inflationary environment, people can just walk out the door and not come back in. Given the huge pressure on wage growth at the moment, a lot of those e-commerce businesses are probably going to continue to struggle in this new world.

Instead, if you own physical assets in an inflationary environment, your asset prices are typically rising with inflation. We own a company called China Resources Land, and they are a property business with physical assets. We also own JD.com — they own the logistic warehouses and the trucks that will provide a hedge for you.

According to the World Bank, we are looking at global growth forecasts to be looking at 2.9% in this year as compared to 5.7% in 2021. Within East Asia and the Pacific, we are looking at a number of 4.4% in 2022. How are you positioning your portfolios in relation to GDP growth?

The short answer is our portfolios don't really change. If you look at the turnover of the portfolio, it's about 15%, which implies that our average holding period is about seven years for a company. Our investment horizon is around five years and for some companies, we've owned for decades.

We use the analogy that our portfolio is like a garden. You have some companies that are oak trees and others that are your hardy perennials that are going to flower every spring or summer. You don't want all of the portfolio to perform in one environment — it needs to perform throughout all weathers.

We've been doing this for over 30 years and it's the same thing, which is look for really good quality management — try and identify really good quality franchises and then make sure that the financials are going to be ok. Banks only lend to you when you don't want the money.

There’s definitely a tilt towards expectations of growth being subdued for the foreseeable future, but it doesn't mean you can't make money on a 3- to 5-year view.

What are some of the ESG considerations in your investment process and how has that helped you to deliver additional alpha within the portfolios?

Governance is the factor that has been overlooked most and rightly to say, there's a huge amount of talk about environmental factors and we will come on to that. But ultimately, if you buy into companies with really good management and boards of directors, you're going to be okay. When times are tough, there's a great degree of comfort in that.

If you look at the style of the SJP Asia Pacific fund, typically in times of stress, the fund will preserve capital better. In boom times, it doesn't, because people don't really care about the quality of the management or what they're doing to the environment.

The CEO and the CFO of HDFC Bank were in town six, seven years ago and back then, the Indian banks did not consider the environment, the impact of their loan portfolio nor social issues. But recently, our conversation with them was about who have the best practices that they should be copying and we shared this piece of research from the World Wildlife Fund with the HDFC Bank CEO, who made an interesting point — they want to have best practices in the governance and social aspects, but they don't want to be leaders on the environment front because the first mover advantage may not be the right one. So that's to see how good companies can continue to improve and get better.

Another example is that with our consumer exposure, we have a big problem with plastic pollution. We've introduced a biodegradable plastic packaging company called Polymateria to a number of companies that we’ve invested in, and that's going really well. There's some good take up that could be a solution to the problem of plastic that comes out of the recycling loop.

ESG has always been a part of what we do. You could use a different word and just say it just means quality. If you invest in the best companies, you're going to generate probably the best returns and they're going to see you well through the bad times.

ESG integration has helped you to sieve out quality companies through the stock selection process, but how have you helped companies move in the right direction?

Some companies are best practices. We own an Australian company called Brambles and it's a very dull business based on recycled wooden pallets. They just go through the loop — they go from the farm to the warehouse, to the supermarket, and then they go back to be repaired if they need to be. This company is one of the best.

Singapore Telecommunications (Singtel) is the second-best telco globally when it comes to ESG, but they don't talk about it. In terms of a lot of the recycling, the phone packaging and things like this, they are of high quality and Singtel thinks about these issues deeply.

Other companies are quite far behind. Our job is to just keep them on the right path, make sure they're taking two steps forward and only one back, preferably no step back. We can do that because we know a lot of private companies that are doing interesting stuff, where we can make introductions like Polymateria or we give them a nudge. There's nothing more fun than prodding the Singaporean banks and trying to create an arms race.

You brought up a few Singapore names — how have these holdings been helping with the portfolio performances lately?

Singapore as a market is always regarded as a safe haven. The other really interesting thing about Singapore is that the Monetary Authority of Singapore often, if not always, let the Singapore dollar appreciate during inflationary periods and that's quite handy for us.

We own three companies — DBS, OCBC, and lately we've been buying Singtel. Singtel is an unloved company and at one time, even our Singapore fund didn't own Singtel. Why is it attractive now is because we believe telecom assets are significantly undervalued because most investors have been looking at COVID-19 and overlooked the asset value in that business. Singtel has a new CEO who's been with the business for many years. He's an engineer, so he understands and believes that their company is probably undervalued by at least 50%. It’s the fibre cables, the telecom towers and they're also redeveloping their head office here on Exeter Road. All of a sudden you can see the share price waking up. It's very cheap anyway, but you're being paid 4% in Singapore dollars in a dividend yield, even if it doesn't go anywhere.

Not just that, but they own Bharti that's seeing a huge consolidation of the telco market. They also own Globe in the Philippines. Globe is making significant amounts of money on a payment system. Forget the telephony bit — they've got 60 million customers on the app called GCash that they make money immediately. We're pretty confident that business will be rerated.

Can you elaborate on about how you make that judgment to identify companies with good management and what that means for ESG?

A lot of analysts will focus on the numbers, but the numbers don't tell you everything. We are privileged that we can meet management on a regular basis, and what you really want to do is try and identify what makes them tick.

Do you trust them so you can talk about the culture of the company, their attitude to risk? Do they have integrity? What are they incentivised on and what motivates them? The CEO role is the loneliest role in a company, so we often ask who their mentors are and who do they rely on when they're feeling really lonely.

Now we do look at the numbers as well — we look at what is their track record over as long a period as the management have been in place and we would look at earnings per share growth, book value per share growth, dividend per share growth and compound annual growth numbers. If they're pretty steady, you know they're onto the right thing. But if it's really volatile, and we hate companies that are deeply cyclical, then it's probably out of management's hands. It could be a commodity business and they don't have pricing power. So this is the sort of work we do on the management.

You can suss out very quickly which companies are greenwashing, and which companies really believe in it. For those that greenwash, typically the ESG team reports to risk and compliance. But if they report to the CEO and the board, and the CEO is on that ESG team, you can be pretty comfortable that they take it seriously.

What’s your outlook on how active management will perform versus passive?

The thing that worries me about ETFs is they will all move in one direction if you've got a really severe crash in the market. ETFs by nature tend to own the largest companies and that could exaggerate your fall such that an ETF might be trading at a discount to its asset value.

We've managed to outperform on a fairly consistent basis over the last 30 plus years. But we have to keep working and keep testing the investment case to make sure that the process is as rigorous as possible.

That's not to say that ETFs won't outperform a lot of active managers, but it's just too hard. If you're looking at active versus passive, just really try and understand what the investment process is. Are they true to that process? A portfolio manager is never going to tell you that they buy bad quality companies, but you can tell if they do because in the bad times, quality businesses perform better. If their drawdown or their downside capture is greater than the market in a down year, they're probably not doing what they said they're doing.

What’s your outlook for China?

I think the Chinese government has taken their foot off the brakes in terms of regulations, which was very abrupt on industries such as afterschool education. It’s a mixed bag and the thing to be careful about is not correlating economic growth with investment returns.

If you look at China, it's been the fastest growing economy in the world over the last 20 years or 30 years, and it's been one of the worst performing equity markets. The reason is growth does not correlate with return on capital employed and that's very crucial. The government's hand is on just about everything in China.

That said, there are some businesses that look quite cheap. The consumer companies we own include China Mengniu and Midea Group, which is a white goods manufacturer. They look quite cheap, and typically air conditioning units in China are still under penetrated, so you can see some growth. So, it's very stock specific in China and one needs to be very careful about the regulatory environment as we've seen.

But it's so interesting because we always get questions on China, but we never get questions on India. We think the investment outlook over the long term is far greater with India because you have a much richer capitalist history than you do in China. In India, we're investing in companies that are multigenerational — we own a company called Godrej Consumer and Lisa, the chairwoman is the fifth generation. And therefore, you know how these businesses behave in really bad times, and India has had a lot of bad times.

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