Welcome back to the Rated Change with York Wealth Management.
The Rated Change is a podcast which explores the ever shifting momentum of financial markets
through the eyes of some of the brightest minds in wealth management.
I'm your host, Menon Gaddi, and in today's broadcast, we're speaking with Kevin Batoli,
the co-portfolio manager of PM Capital.
PM Capital was founded in 1998 by CIO and Chairman Paul Moore.
Its goal is to build long-term wealth by investing in global markets and Australian markets with patience and conviction.
I would say PM Capital embraces the true definition of a go anywhere strategy.
And I quite like the patience to avoid firmer rallies and wait for the strongest company in space to survive a sector pullback
before exploring investing and favorable valuations for the long term.
With this approach, PM Capital has consistently beat the average of the market since inception,
with the Global Companies Fund, as an example, averaging 12.4% over five years, 23.9% over three years, and 9.6% over the past year.
The fund has returned 9.7% since inception, and whilst the benchmark of the MISCI World Index has returned 5.8% in this period.
Kevin breaks down the process philosophy, and after returning from a very enjoyable trip in Europe,
he shares what they look for when investing in companies.
For me, I found the conversation of when they time their entry into companies to be the most interesting,
the patience and discipline required to avoid firmer rallies and wait for the strongest to survive in a sector before exploring buying into that business.
On this point, Kevin dives into detail on investing in European banks, commodities like copper, oil and gas, and other areas such as the gambling industry.
In summary, he explores investing in out of favor businesses at the right time, which I found really interesting.
Before we get into this podcast, I'd also like to encourage you to listen to the disclaimer at the end of this broadcast and to keep your feedback company.
You can reach me at mghatty at ywm.com.au.
With that being said, I hope you enjoy this conversation as much as I did, so sit back, relax and enjoy it.
Kevin Bottoli, welcome to The Rate of Change with York Wealth Management.
Thanks for having me.
Good to be here.
Why don't we kick things off by telling us a little bit about yourself, your formative years and how you got into financial markets.
Yep.
So I've been in the industry for about 18 years.
Grew up in South Australia.
Grew up in a little country town called Wakerie.
Basically, I grew up in a family where we had a lot of entrepreneurs and small business operators.
I got a really good sense early on watching people run businesses and seeing businesses fail, seeing some businesses succeeding.
It really drove a passion in me to understand why businesses succeed and fail.
I went to university, did a commerce degree, did a finance degree.
Through that process, fell in love with investing capital and the idea of investing capital as a profession.
Basically, through my reading, came across PM Capital in the early days back in 2004.
Paul, who's the founder of our business, had a position in Birdswood Casino.
At the time, they were being acquired by James Parker. I remember seeing that article in the AFR.
Basically, from there, following the business and then getting the opportunity when I came over to Sydney to work with Paul.
I've been at PM Capital for 18 years, as I said.
When I first came into the business, it was really about, as an analyst, building out our coverage of the Asia region.
If you look up until that point, you didn't really need to participate in Asian equities from a local perspective.
You either bought really good quality businesses with IP in the US or Europe or Japan, which might have manufactured in China.
That wasn't really a China or Asia story. It was a global consumer story.
We bought commodities as these emerging markets build out their infrastructure.
What we saw happening and the business saw happening at the time was this domestic consumption story growing.
I was tasked with building out the coverage of that sector and that area of the market.
Over time, it's morphed. We've had a period where now, if you look at my role within the business,
co-portfolio manager of our global product, co-portfolio manager of our Aussie equities product,
look after the commodity space, look after the gaming space, look after parts of the consumer space.
A wide variety of coverage, but that's essentially how we work within the business.
We don't pigeonhole people to sectors. We really want them to go out there and find the best ideas they can possibly find in markets.
Right. Let's dig into PM Capital a bit more. Paul Moore was the founder and then you joined.
What was his founding philosophy? You touched on you do cover quite a lot of areas.
What's actually the investment approach?
Essentially what we're really trying to do, and we've got a great slide in our presentation deck,
and at the top it talks about the key objective, and that's really building long-term wealth for our clients.
That's a pretty generic statement, but it's important about how you go about that.
Our belief, and the belief that Paul's built and instilled in us in the business,
is to achieve a return over and above the index over the long term, you have to be doing something different.
The reality is all investors tell you they will do something different,
but the vast majority of people are hugging your benchmark and they're doing very similar things.
What does that mean for us? What it means is we're really focused on a select subset of the market.
The portion of the market, the 5% to 10% that we deem to be undervalued,
and then on the flip side, the 5% to 10% that we deem to be overvalued.
We really want to focus on those parts of the market.
Again, people say they do that, but if you look at the vast majority of portfolios that talk about concentration,
high conviction, they might have 100, 150 stocks.
The reality is our business is built around, and our portfolios are built around concentrated portfolios,
typically 20 to 30 stocks, but even that masks a greater allocation to what we consider
four, five, six, seven broader themes across a portfolio, and we really build them out over time.
How do we get to that point?
As I said, we're really focused on how business generates capital over the long term,
how it generates its cash flow over the long term, so we're focused on that,
but what drives the decision to look at a stock is valuation.
We're really looking for that valuation observation in the beginning that drives the decision to start the detailed research process.
Valuation in and of itself can't be the entire part of the puzzle.
We need to see and understand the entry catalyst that allow you to buy something or that makes something mispriced,
and then along that journey in doing the research, we need to understand pretty quickly the catalysts
that are going to allow that business to rerate over time, because often what you do is when you find
what you consider to be undervalued stocks, they can stay undervalued for a very long time.
They don't have the catalyst to drive that rerating, so valuation alone is not enough.
We need those entry and exit catalysts, and another thing that we do,
which is probably different to a lot of managers, is we set our exit criteria when we buy a position.
We know the catalyst that we want to have play out, and we don't change those consistently.
We don't run a 12-month target price.
We're a long-term investor.
What we see in a lot of our positions, and what I often say, is we're arbitraging our long-term view on a sector
or a business with short-term machinations in markets.
We all have long-term assumptions.
It might be around the earnings growth and what type of multiple that should trade on.
It might be consolidation in an industry.
It could be many different things, and we're really waiting for those dynamics to play out,
and they can play out over five, seven, ten years.
Global brewing is a good story.
It's a story we had in our portfolio in a sector thematic that at its peak was 20% of the portfolio,
but that's something we played over a 15-year period.
It was a global consolidation, global premiumization story, and through the course of that,
we owned 13 to 15 different businesses, and of that, half of them would have been taken out.
We're a long-term investor in nature.
We're concentrated, and we're very high conviction around our positions,
and that's built on the research that we do from the bottom up.
Right. Before we dig into the two funds which I want to discuss, can we discuss the mechanics a bit?
From what you're saying, is the strategy essentially growth and raise of price bottom up,
but is it a go-anywhere strategy?
Because you're discussing you can do commodities, you can do tech, you've got the global and the Australian.
Is it a go-anywhere type of strategy?
Because I'm looking at the website.
There are a number of different vehicles and funds which you currently cover,
and the other question, which I wouldn't mind you answering off the back of that,
if it's a go-anywhere strategy, and I'm looking at a lot of the numbers, say,
comparing the global fund compared to a lot of global fund managers out there,
they all got, unfortunately, had a very, very good run-up after COVID,
and then a lot of them essentially gave back their returns for two years
and about three months when essentially the interest rates changed,
but your fund appears to take a little bit of a dip and then continued that move up,
I assume that's associated with the commodities.
Can you also discuss, as you're saying, you're looking at the exit?
We're discussing off air essentially how you use derivatives to deal with that level of volatility
to protect what you're comfortable getting out of,
but also to try to get a bit more cream on top.
I'd be really interested to hear how that all mechanics work.
Yeah, it's a bit to unpack there, but back to the kind of first question, you're correct.
It goes back again to the point I made in my previous remarks around to generate a return
over and above the mark, you have to be doing something different.
So what we've found is that by having a very open mandate,
that allows us to be different to other people.
So it again goes back to the founding of our business.
Our funds were founded with our own capital and the way we would invest our own capital.
So we want to have maximum flexibility in our ability to buy opportunities when they arise.
So what that means is long, short, no limitation on the amount of cash we can hold,
which is important in a fund that invests around thematics,
because a lot of the time when a theme plays out that might be say 15 to 20% of your portfolio,
you tend to be selling a lot of the stocks at the same time.
So we want to have the flexibility to sell that and not be constrained by 10% cash limit.
We're also not sector, we're not focused on gig sectors, we're not focused on geographic limitations.
We're basically asking our pool of analysts, and we think we're all analysts,
I might have a title as a portfolio manager, but I view myself first and foremost as an analyst.
What we're out there to do is go and find the best opportunities that we can find.
One of the mistakes I think other managers make is they think having a big team is better
and making sure you have full coverage of an entire universe.
But if you think about how that actually plays out from the perspective of the people that are doing the work,
you might say, Murdoch, you're going to be looking after the commodity space for me.
That's your sector, that's your Remy.
I want you to go out and look at that, and I want you to come back and give me some ideas.
How are you compensated? You're compensated by coming up with ideas.
And if you're compensated by coming up with commodity ideas, what are you going to do?
You're going to come up with commodity ideas, regardless of whether or not you actually think there's true mispricings.
What we tell our analysts to do is go out and find the idea wherever it might eventually.
We have a pool of analysts that are essentially out there to do that.
The second point was around recent performance.
Obviously, that goes back in heart to our focus and our myopic focus on valuation.
That's the starting point.
And valuation is not just important at the point of entry.
It's important across the journey of owning a position.
It gets a point where fair valuation is reached.
And by setting that exit criteria and setting the catalyst that we believe will create a stock to rerate over time
at the beginning of the investment, that allows us to be very disciplined around selling positions when they reach those targets.
So a classic example for us has been the commodity space.
Now, we were investing very heavily in that during COVID period.
And it was all based on our view of downside protections for valuation and a flaw being placed in some of the commodity markets,
particularly commodities like copper, which meant that the downside in the spot price was relatively protected.
But the fundamental view for owning those positions was around our view of the incentive price
and the need for a much higher copper price longer term to drive new supply into the market.
Now, when we were investing in the space in 2020, people were telling us we were crazy because COVID, economic recession, Dr. Copper.
You couldn't have got a worse period for commodities.
But when we looked at the valuation of a business like Freeport Macmaron in the US, at spot prices,
which we thought were protected to the downside, the business was trading at a mid-teens free cash flow yield.
If our view of incentive pricing was right, which was $354, you had a business that was on 30%, 40% free cash flow yields.
So that's how we form that.
And we have that view of where we think those commodity prices will go over time.
And when they get there, we start trimming and exiting those positions.
And as you mentioned, we can use derivatives and we use derivatives options primarily in a couple of ways to help us get set in new positions.
So stock might not quite be there.
So we can sell puts, allows us to get into where we want to enter a position, makes us be disciplined around that entry price.
And then on the exit, again, the same thing, we can sell calls and it allows us to, it puts us in a position where we're disciplined around selling or trimming positions
and allows us to take advantage of volatility or heightened volatility in some of the sectors we might be in.
So I think so.
So the key point around the differences in the moves over the last couple of years has really been that focus on valuation.
Stocks performed well, particularly growth and momentum.
And if you've got a fundamental view of where valuation sits, sometimes you might get out early.
But what you're not doing is you're just not playing that momentum story.
And eventually when that momentum story changes, and it was when rates moved in the back half of 2021, that you saw a big pitulation in those sectors because there was no downside support for valuation.
And again, it goes back to the comment I made in the introductory remarks around alignment.
We've got our own capital in these businesses and we've been doing this for, I've been doing it for 18 years.
Paul's been doing it for 30 years. PM Capital has been around for 25 years.
It's the same process and philosophy that we've been applying for a very long period of time.
We've done it across multiple cycles.
One of the things that I think you've seen with some of these new funds that have entered the market is there's lots of Johnny-come-lately funds.
They pop up, they get one sector correct, they get one cycle correct, and they look like superstars.
The reality is you need to be able to prove that you can do it over multiple sectors.
So that's the tough part, and it's very hard for investors to rotate across themes and ideas and market cycles. It's very difficult.
Yeah, I 100% agree with that.
The other thing I've seen close that helps in that particular space is a hedge fund out of the States that runs the JIT model,
growth, inflation, government policy, and then breaks it down with the four quads.
So essentially using monetary policy and identifying which asset class does well or poorly.
That's the only way that I've currently seen as somewhat of a Rosetta Stone that half does that,
but it's another thing to actually execute and get that done well for an 18-year period.
It is very hard because while we might be long-term investors in nature, and people like the sound of contrarian, high conviction, etc., etc.,
a lot of the time what that means is you're talking to people about stocks that are grossly out of favor.
Because it's common sense to say that for something to be mispriced, it needs to be unloved or misunderstood.
So if everybody understands something and everybody likes something, it's difficult to find things that are mispriced.
So when you have that view, it's hard to maintain the conviction because as an industry,
we draw ourselves to the shortest of data points, which is daily share price and daily unit price.
And that can make it difficult.
So there's two funds which I use quite a lot.
It's the PGF PM Global Opportunities Fund and the Global Companies Fund.
The two questions I have, because I really want to get into the macroeconomics and you've covered how the philosophy and everything works there,
is how's the performance been for both of those?
And the other part I want to mind you covering is the PGF pays a phenomenal dividend and it's quite robust for a number of years to come.
It's not guaranteed, but it's quite robust. Can you also cover why that is the case?
So essentially, as you said, there's two global products that we have.
It's essentially the same strategy. So we look at that pool of capital as being one pool of capital.
It's just segregated into two different vehicles.
And the two vehicles basically allows different types of investors to capture.
So we've got the Managed Fund, which is the Global Companies Fund, which is a unit trust.
And then you've got the PGF or the PM Capital Global Opportunities Fund, which is a listed investment company.
But essentially, they have the same remit and mandate around what they do and they have essentially the same positions.
Now, the Managed Fund has been around since 1998, which was the first fund that PM Capital had upon founding.
And the PGF was a fund or a listed investment company that we launched in 2013.
So again, the strategy is very similar.
Big differences between those two is obviously a Managed Fund unit trust pays out distributions.
A listed investment company, you know, you'll pay a dividend when you have retained earnings.
So obviously, good performance over a long period of time.
If you look at the PM Capital Global Companies Fund, which has been around since 1998,
we've generated three times the return of the index over that period.
Now, if you look at the listed investment company, it's been around since 2014, a lot of retained earnings.
So it gives us the ability to actually pay a consistent dividend.
One of the things that we've learned over time is that the vast majority of investors in those products are retail investors
and to them, dividends are very important.
So the ability to pay a consistent dividend, and that's obviously dictated to by the board of the PGF,
which is a separate vehicle in and of itself, but the ability to pay that is really important.
And we think that's something we've guided that the dividend that we have today is one that we think we can sustain,
given our current retained earnings for the next four or five years.
So it's very important to maintain that dividend.
So what is that dividend?
So that dividend is essentially our retained earnings over time.
So when we sell stocks, we realize the capital gains because the LICs, they are essentially everything.
So on the income account, what's the percentage?
So I think today, quote me if I'm basically, I think it's about an 8 to 10 percent dividend yield.
So past 12 months, including, you know, what would that average return be?
So the average return.
So if you look at our broader equity funds over the last couple of, so the way I think about it is from the underlying return of the portfolio.
So over a long period of time, as I said, we've done that kind of three times, you know, the market.
And I think that's the most important number to kind of really focus on because what people often forget when they see a one or two year number or three year number,
and our numbers have been very good and it's been around those those investments in particularly in commodities, but also European banks,
is the is the impact of compounding over a long period of time.
And that's really the most important part.
Yeah. So I'm just looking at the benchmark here actually on the chart.
So in 2000, if you stuck in 100 grand, it would probably be worth about just shy 600000 whilst the growth fund would be worth what's that nearly 1112.
Comparison. Yeah.
It's very interesting. So you just got back from Europe. Yes. God, I wish we were all in Europe right now.
Sitting on a beach, hitting up Reims. I want to go back to Grace. Miss Grace.
We just screwed up our travel really bad and now flights are so expensive.
And then Buddy Joyce came out as well and said everyone's like, he's going to bring the flight prices of flights down in there.
Like, yeah, not yet, champ. Yeah.
Anyway, how was Europe? Yeah, it was good. So I was over in Europe pretty much all of March.
And I was over there with our other co portfolio manager of the Aussie and global portfolio is John Whelan.
And there was really two kind of purposes for the trip. Got a lot of positions in Europe.
So essentially went and met the management teams and the companies that we own in the portfolio.
So portfolio maintenance and then obviously new idea generation.
And that was particularly around, say, the industrial space in Europe.
We went to a couple of conferences while we were there. European industrials, European financials.
So yeah, it was a four week trip. A lot of corporates.
Five countries and hugely beneficial for us and part of the ongoing process for what we do in terms of the background due diligence and work we do on new stocks.
And as you say, it was something that was made more difficult in the past couple of years, given COVID.
Yeah. So with Europe, obviously we've seen a number of banks fall over, you know, Crete, Swir, all type of stuff.
So how robust do you think is the financial system currently offshore?
Yeah, it's an interesting one because if you look at our European, as I said, European banking has been one of our bigger portfolio positions.
And people say when you say European banks again, people go, oh, European banks, you know, that's credit Swiss.
You know, it's some of these big investment banks.
But the reality of what we hold across European banking space is very much concentrated around certain markets where we see the competitive dynamic dramatically changed to what it was 10 or 15 years ago.
It's becoming more Australian like than it is European.
So most people when they think about Europe, they think about it being very competitive marketplaces.
You've got banks from one market going into a neighbouring country.
So pre the European debt crisis, banking markets were actually quite fragmented.
But what you've seen is you've seen the European debt crisis be a catalyst for consolidation in certain markets.
So two biggest areas where we're invested is the Irish banking market and the Spanish banking market.
Now, if you look at, say, the Irish banking market, Irish and Spanish, I was not going to pick that.
I remember back in the good old days was the Irish Dutch sandwich.
He did all your banking on that one street in Ireland and then you had all your intellectual property in Holland.
Yeah, that's I don't think that's the case anymore.
So if you look at you look at the Irish banking markets, it's very attractive banking markets.
There's two banks that dominate.
So Bank of Ireland and Allied Irish Bank.
And given the disruption that was caused over the last decade by the financial crisis in Europe,
it meant regulators allowed incumbent banks to consolidate.
And that's not something they were allowed to do prior to that.
The regulators were happy with fragmented banking markets.
Spain's exactly the same.
Spain is a market where the top three or four banks are now 65 percent of the market.
You go back a decade ago and the top 10 wouldn't have been 60 percent of the market.
So a dramatic change in the landscape.
And there are also markets where the banks have simplified.
They've sold off international exposure.
They've bought focus back on their domestic retail banking businesses.
And that we think that makes for a better business going forward and one that can generate higher returns.
So if I'm understanding correctly, I think I think I am.
So essentially what you're looking for is you're looking for a big sector of the market or a particular area that's had his head knocked off.
And then how you survive down the bottom is they will consolidate, fix the balance sheet,
you know, tighten the belt type routine.
And then you're trying to get in at that particular level, then starting heading up.
You mentioned as well you like the gambling space.
So this is actually very, very topical right now.
I'll tell you all fair why.
But essentially we're seeing due to the increased taxes, the screw ups in the states, you know, it opened up.
There was a huge boom through that particular period.
You said point points bet.
Now points better got torched because there was two main competitors in the state that took all the businesses.
But all the other competitors that they're still the same overheads.
Right. But there's a massive consolidation play currently, both domestically and internationally in that particular space after same scenario, which you're discussing before.
They're the huge uplift with the covid.
Right. You know, everyone loved to gamble.
But then it's all kind of come off.
Is that essentially what you identify as an opportunity?
So it's it's an astute observation because the reality is that is exactly correct.
We want to identify long term structural thematics that we believe will play out over time.
And we want to use the short term machinations of markets to be able to buy that because things go from being over loved to over hated in through a cycle.
So you cannot you can be patient and wait for opportunities to arise.
You mentioned sports betting. Now, it's an interesting one because our gaming exposure is has largely been and still largely is today around Macau, which has been through a lot of disruption through covid.
But we do have a position in Flutter in the sports betting space.
Now, I could talk about Flutter for hours, but I think we've got the time.
But what was and what's really interesting about that story is it was one that was really first identified to us when we traveled to Europe back in 2017.
And we were looking at the sports betting businesses listed in the UK.
So at the time there was GVC, which is now Entain, William Hill, which is now was acquired by Caesars and Patty Power Betfair, which is now essentially the Flutter business.
And we were looking at the sector then because the UK, which was a large, obviously the largest exposure for those businesses, was going through the triennial review, which was looking at regulation into the betting shops.
So your local TAPs. And there was a lot of uncertainty around what that regulation would do to the earnings power of these businesses.
So the stock sold off. We didn't invest at the time because we couldn't get comfortable around what that impact was going to be and end up being a large impact.
But one of the things that stood out to us is that all three operators were talking to us about this opportunity that was they hoped over time going to play out in the US market.
The US market, biggest gaming market in the world, but where you didn't have legalised sports betting.
So we went away and I went away and I tried to do as much work as I could to understand what was at play in the US and how that might unfold over time.
And then obviously in 2018, you got the repeal of the PASPA law, which was the law that prohibited every state outside of Nevada from actually betting on sports.
And it was because Chris Christie, the governor of New Jersey at the time, took that law to the Supreme Court, got overturned on the basis that the federal government couldn't tell states how to tax their populace, which allowed New Jersey to open up.
And over that period of time, you've had, I think there's 30 plus states now that you have legalised sports betting either online or through retail.
Now, what was interesting is COVID pulled forward a lot of demand.
People were at home that...
What else did you have to do except for drink, walk around the block?
Propensity to spare money.
But the other thing that it did is it drove this focus with rates being zero on anything that was growth.
So if you look back at that time, the acquisitions that were being made in the space, the IPOs that were coming to market, points bet being a classic example, people were just chasing market share and customers.
So it led to the market to do some really dumb things.
But then when the rate environment changed, so did the attitude of investors and it became about profitability.
So you had a business like Flutter, which was trading at 160, 165 pound.
Stock basically gets cut in half because there's this concern that the industry is never going to make money.
But we know from the work that we've done, we understand how these sectors or this sector plays out over time and the consolidation you do see and the scale that the number one player
and the benefits of scaling the number one player can bring.
And we actually thought that that was magnified in the US because of the structure of how the market is set, basically state by state legislation.
So it makes it hard for someone to come in and just put their product across the entirety of the US market.
So we bought that position in March of last year when it was trading at about 80 pound.
Now, what's interesting when you look at that business is when we bought the business, we had a fairly conservative some of the parts valuation.
You fast forward to September, October of 2022 and Fox, Rupert Murdoch had the opportunity to buy an 18% or has an opportunity and an option to buy an 18% stake in that business.
But they couldn't agree on price.
So it went to arbitration and arbitration essentially valued the phangel, which is the Flutter's US business, at about 17 and a half billion pound,
which was essentially the entire market cap of the Flutter business at the time we bought it.
So we got over a billion pound of earnings essentially for free.
But it highlights how something can go from being in favor and out of favor, despite the long term structural dynamic in the US market,
not really changing for a business like Flutter, which is the dominant number one player.
So you got a lot of people, particularly here in the local market, they wanted to find something that was exposed to US sports betting.
So they went out and bought the only thing that they could buy, which was points bet.
And the unfortunate thing is-
Points bet lost that battle.
And they did. And they were to be honest, we never had a position.
And it looks silly when the stock went to 15 bucks.
But the reality was it's a capital consuming business in the early stages.
It was competing against a behemoth, really two big behemoths that have big pools of capital.
So Flutter, as I said, had over a billion pound in EBITDA coming from the rest of the world, Australia and the UK being its two biggest markets.
It already had a product.
It had the benefit of product innovation across the globe.
Australia basically created that multi-betting product.
And they've parlayed that into- parlay is another word for multi-betting.
They've put that over into the US market and done very well.
But points bet was 100% reliant on capital markets and their ability to continue to raise capital.
And even if they got another rise off, the reality is would they ever be able to compete against those big boys?
I didn't think that they could.
So when you go looking for these opportunities, do they have to be listed only or do you look at unlisted?
Vastly what we do is listed.
Okay. So, yeah, look, these cycles we see, right?
You used to get this boom, you know, after pay.
You get that particular thing rip up because essentially, you know, one door closes and other opens, right? Opportunities.
So the most recent one, the past couple of months is our good old fan favorite, which helps me out with all my lovely social media.
Our one big friend.
Questions for today.
ChatGPT.
Yeah, I've been looking at Nvidia this morning.
I think Nvidia jumped from like what, a hundred bucks?
Adobe has gone up like four times in the past six months.
Microsoft's gone up, you know, what, 200 or 300?
Do you have any, I always get the question, you know, how do you get access to this space?
How do you participate?
What are your thoughts or do you think you can invest directly in a business to benefit from this?
Or do you think the tool which is being created, you know, that's owned by Microsoft and Google is more of a tool than you're seeing efficiencies improve inside the businesses which have a particular outcome?
What are your thoughts?
Yeah, so what I would say is very early days.
So understanding how this is going to play out is very difficult.
But that's why I say something like Nvidia's performed so well because it's the picks and shovels of, you know, this iteration and technology kind of innovation.
So that's why they're doing so well.
Being able to predict who benefits the most and who's the most impacted is going to be quite difficult.
And you're going to see that kind of play out over time.
So I think we're still early days.
You know, there's certain businesses that we've looked at that we think, you know, have exposure to that.
They might not be the direct end product, but through that supply chain or the various stakeholders, there's going to be opportunity to invest.
It's going to come back again to valuation.
I was about to ask that. Do you mind if I rephrase that, right?
You know, because we're seeing the same thing again, which you see time and time again, you get that foam of fear missing out, people ripping into it, you know, valuations start to pitch up, right?
But just going back to your philosophy about how you invest, you're trying to find, you know, the Dutch-Ire sandwich situation.
You're trying to find, you know, the consolidation in, you know, the gambling space in Australia.
How do you deal with essentially the new tech?
It's up and running. It's moving so, so quick.
You know, you have to be in it. Valuations might not be there.
How do you deal with that?
Yeah, well, I would caveat to say that we don't have to be there.
Right.
So if you look at our history and the ability to generate those long-term returns, we haven't been rotating into the things that are the most popular at the time.
We want to wait until those things become grossly out of favour and then buy them.
So we, when Fang was going, Gangbusters, we weren't in that sector, but we still managed to perform okay.
So to us, it's more, what is going to protect us over time is valuation.
So what we do want to do is we want to monitor these things like a sports betting, like commodities.
And we want to, we want to, we know it's going to be a longer, longer term thematic.
And through that and over time, things will go from overvalued to undervalued.
And we want to be in the right position and have having done the work when things are, when things are being mispriced.
Right. So a good example would be, you know, we had positions in the semi-cap equipment businesses.
So you CLAC, AMAP, the businesses that build the equipment that makes the chips.
And we initiated positions in September of last year.
At the time, everyone was talking about, you know, excess inventories in the space because of, you know, pull forward of ordering through COVID.
Everyone was worried about not having inventories. So going from just in time to, you know, I just need a lot of inventories.
You had China, US blocking of selling chips into China, the impact that would have on equipment spend.
At that point in time in September, no one was talking about chat GPT.
It wasn't on any, it wasn't in any broken notes.
You know, those businesses over a six month period rose by 50%.
But it got to a point where the valuation was no longer attractive to us.
So we sold those positions. Yes, they've gone up a little bit more from there.
But fundamentally, our job is to understand earnings power of these businesses and how you should value them.
And sometimes though that valuation, when people are looking at a share price and the fear of missing out,
what they can forget is the earnings keeping up with the multiple that you're affording that business.
Yeah, it's just such an interesting space. It's like, it's easy to look at hindsight.
Yeah, you don't do that. You wait till it comes off, consolidates, then you buy.
And then you move into the next about it, which is chat GPT. It's up and running.
And then your mind says like, yeah, but I should buy that. Right.
It's like, but then all of a sudden you're back in the next horse.
Yeah, it's just so interesting about it, how it all works out.
So why don't we discuss your outlook?
So, you know, with the markets where they are, you talk to one person on the street, I think the what's they're saying?
The biggest bet on the street right now is everyone thinks he's going to be a hard landing. Right.
And what's interesting about that is looking back at Michael Bori when essentially he called the JFC,
you put the bets on in 2006, Niling went bankrupt and then took two years for that to come out.
So there's an old quote, you know, don't be right, just make money. Right.
So in saying that, and the reason I'm phrasing that way, we've seen everyone's been short this market for a while now,
considering, but the markets had a big rally.
So what are your thoughts on where the market's going and how you.
Yeah. So again, they're always the toughest questions to answer, because for us,
we're more focused on those longer term stories and when the market kind of misrepresents and becomes very short term in focus.
And so when you get these periods where you get, you know, shorter term concern around recession, whatever,
we won't know when we realize we're in a recession, we would have already been in one for two quarters. Right.
So it's kind of backwards looking. It's always looking in the mirror.
So in a short term, it's hard. But what I would say markets, you've seen big caps again rallying.
So you fly to safety. You're seeing it not just globally, but you're also seeing it in the Aussie market.
But underlying, there's actually been a lot of carnage.
So with liquidity tighter, you know, smaller cap businesses, pre profitability businesses have been cut to shreds.
So that is, I think, going to create opportunities for us as investors to invest capital,
because there are some great businesses there that are at the at the point where they can continue to grow.
But the market's not really focusing on them as an individual business.
It's more around a shift and a move in where people are putting capital.
I was having a conversation with an asset allocator a fortnight ago, and he was saying,
yeah, over the last couple of months, we've taken all of our money out of smalls and mids and we've reallocated it to large caps.
I just think it's a bit safer now. So that flow has a material impact on particularly businesses with lower liquidity.
So we think that that actually is a big opportunity at this point to look for new ideas.
One of the things I would also add to that is the most difficult thing today is predicting earnings power or earnings power of a business.
So if you think back prior to Covid, you had a fairly steady market, you had rates low, there wasn't a lot of disruption.
Businesses were just chugging along nicely. You actually go through Covid. It's an interesting period.
For some businesses, it's been hugely disruptive. For others, it's pulled forward a lot of demand.
So on the revenue line, there's beneficiaries and there's ones that have seen Covid being a detractor to their business.
Then on the cost side, you've had inflation, which has come about over the last couple of years. You've had Russia, Ukraine.
So it's trying to get an understanding of the true earnings power. You use Australia as an example because we all know the market.
There's a lot of businesses that are tied to the health of the Aussie consumer.
And as you said, sports betting, what did you have to do? You either walked around the park, you watched TV, you put on a bet.
You also went onto the internet and bought a lot of stuff. You've seen a lot of pull forward. You've seen earnings at record levels.
So where do the earnings of these businesses re-base to is going to be key?
Into an environment where you've had the steepest uplifting rates you've had basically ever.
And preceding that, people are entering into fixed rate mortgages. And that cliff is starting to come off.
We don't know the impact of that. So what it means is it's quite hard to get the E right in a PE or in a multiple that you're looking at.
That's the thing I would say is the most important point today.
Focus on the earnings.
Because the other thing which I'm hearing a lot as well is like there's growth at any price.
People are like, yeah, we'll borrow a huge amount of money today. In 10 years, we'll pay it all back.
And they blew up. And then now I'm speaking to business owners, a very good friend, sub security business, global ones, and all their mates in tech.
All they care about right now is just tightening that belt, making sure it's profitability.
And it just reminds me, it's very reminiscent when Gillard blew up the mining industry with that super tax.
And you remember everything came off. But if you really look to what happened there, again, consolidation player, right?
The miners that survived, the ones that cut all the discretionary spending that wasn't necessary.
They focused on what they were doing. They ensured the profit margins.
They just tighten that belt and they just waited and prepared for essentially because they for the commodity price to come back in their favor.
And then the smart ones sold those assets into strength.
And then they used the last that capital to go and expand again.
Do you think that's essentially the smart, where the smart businesses right now? Is that what the strategy is?
Yeah. So it's like, put it to you like wildfire.
If we left nature untouched, you would get wildfires and it would clean stuff out and then it allows regeneration to occur and the natural process of nature taking its course.
It's the same in business somewhat. You look at what happened again, use Australia here as an example.
Money was free. It changed the way people behaved. It changed their perception of risk.
So you look at assets like cryptocurrency, you look at businesses that were basically show me stories, concept stories.
And that mindset was facilitated by your ability to get capital off people and just tell a great long term story.
And investors were wanting to hear that. So that perpetuated the story again. It just became self-fulfilling.
And management teams, they lapped it up and they went, well, I can grow. I can get capital. I can grow faster.
And then all of a sudden the light switch is flicked and it becomes about profitability.
And then you've got all these businesses that are overextended themselves. They're growing beyond their own cash generating capabilities.
But the market turns quickly. One day they want growth, the next minute they want profitability. A business cannot change that quickly.
So there's a lot of businesses out there and management teams that have been made to look the fool by listening to capital markets
and not running the business how they probably think they should have ran it.
Now, you're right. What this environment does is it weeds out the poor businesses. It reduces competition.
So survivors are in a phenomenal position. We spoke about sports betting.
If you look at that US market today, Flutter is 50% of that market.
Everyone's dialing back expenditure on promotions except Flutter. They're leaning into it because they can. They're the biggest player.
So this flywheel that they've created, this product that they can create by being 50% of the market, reinvesting, making the product better,
and you've got a competitor that sits on 2% or 3% market share, how can you invest at the same rate as a business like Fangill?
You can't. So that goes across multiple industries. So it cleans out the industry.
I think that's a big positive as you move forward. You'll be able to find great businesses that are in pretty good positions to benefit from what's happened.
And I think the best management teams you find recognize that in their businesses and they step into it.
I'm 100% going to acquire that wildfire analogy going forward.
Just the wildfire analogy, you can just see it. It just resets. It's the Australian wildfire. It just makes so much sense.
But if you look back throughout history, historically, it happens all the time.
We've got very short memories. Again, it's because we draw our attention to the shortest data point.
So we write monthly reports. People look at our monthly returns. We can have the utility.
Plus information right now. TikTok, seven seconds. Seven seconds is what it requires to essentially capture your attention.
The youth coming through today, right? It's very interesting to see what happens in about 20 years' time.
So how can listeners and investors access the funds? Are you on platforms? Are you on any investment bonds or anything equivalent?
Yeah. So as I said before, for people out there who want to access our products, you can do it really in two ways.
You've got the managed funds, which is on most of the platforms out there.
So pretty much all of the big platforms, all the relevant platforms, we're on those.
So both our global and our Aussie equity strategies. And then we've also got that listed investment company.
Now, the great thing about listed investment companies is very easy. It's like going to buy BHP, going to buy Commonwealth Bank.
You just go onto ComSec, you type in the ticker PGF, and you can buy a stock like any other.
So it's product for different types of people. So advisors out there, the managed funds, obviously an easier or an easy alternative.
But for retail investors out there, you have the listed investment company.
With the managed fund, what's the liquidity?
Daily redemption. Daily application and redemption.
Yeah, right. So if I stick in, say, with a particular platform at 12 o'clock with a cutoff, I'll get the money out the next day.
That's good to know. How much, sorry, how much money is in the fund currently?
So if you look at the listed investment company, that's about a little over 700 and the managed funds just under 700 million.
And you did touch on alignment, but what are the fees?
So basically the fees, there's your base management fee, which is one percent.
And then you've got a performance fee, which has a cash and index hurdle.
What's the index?
The index is the MSCI Global.
MSCI Global. Another question I keep getting from clients is what's the style of the fund?
And the reason I'm phrasing this is you go onto various research houses and they say, oh, there's people who are active.
But then you do a bit of digging. They're not actually active.
So what would you say is your style of investing from an activity standpoint?
So from a turnover perspective, the turnover of the funds is 25 to 30 percent.
So relatively low turnover, but it's a function of that long term investing.
So we're really focused on the things we do own.
From the tag, you often get the tags of value versus growth.
I kind of don't like those terminologies because my view has always been that those categories are porous.
You want to buy a stock that's in the value category.
You want people to realize or you want your view of the ability of that business to grow,
to be recognized by the market and then has become a growth business.
So Visa is a classic example.
I bought that back in 2011 when it was considered to be an old world payments network.
And it was viewed as being a value stock because people misunderstood or feared transition,
which didn't come to play and impact that business.
And it's continued to execute very well and grow its earnings in the mid-teens per annum.
And it becomes a growth business.
So I think it can be used as an excuse for people because they say, well, our fund was down because we own growth stocks.
No, you own stocks that were being mispriced by the market and the market's now changing the value of how they should price those stocks.
So yes, they were growth, but they were overvalued.
And you didn't take into consideration, it goes to your view or comment before, and growth at any price.
Well, this is what I'm finding difficult sometimes is you go through the list and say this is a growth fund.
But essentially, my understanding of a growth fund, it should be growth.
A global growth fund should be anything global growth.
But what we're starting to see is one just focus on the NASDAQ or just focus on this.
So essentially, this is moving up in line.
And if it comes off like 50%, oh, we still beat the market.
But I'm going to hold on a second.
Your job is to get us up the mountain, down the line of the other side.
Isn't that correct?
And again, that's why our funds have always been a very open mandate because what we found over time is capital can go in and out of whether it's growth,
whether it's value, whether it's emerging markets, whether it's developed markets, whether it's commodities, whatever it might be.
We want to be able to play any of those things when we see opportunities arise.
We don't want to get ourselves pigeonholed and being stuck there and saying, well, we really market ourselves as a growth fund.
And then all of a sudden, what are you going to do?
Or you basically start buying other things and pretending like they're growth things.
Or you see that today with technology and innovation funds.
It's like you look at some of the stuff that these people own and sitting there saying, I can't really quite see the innovation play that you've got there.
But you need it because it's the only place you can find value.
So what we try to do is not label ourselves as being something or, you know.
I think that's something quite politically, you know, maybe in or out of favor.
But like I appreciate what everyone's doing with ESG.
As an example, it's the right thing.
You should be ESG mindset.
But I've looked at the numbers.
That's actually the best way to play the history trade for the past five years has been commodities.
It's not actually to invest in a company that's associated with ESG or has a tagline or makes things pretty or this any other.
If you want to invest in that ESG trade, it's been the commodities play.
You agree with that? 100 percent right.
Now, the interesting thing about ESG is again, it's one of these things that happens in markets, which actually drives the inefficient allocation of capital.
It's pushing capital to areas where people think that it should go.
So if you actually look at and we use that as a filter, we look at those things and say, is that creating an opportunity for us to buy assets that are being mispriced?
So if you look at the best trade around ESG was actually to go and buy the businesses where this capital was sucked from.
So that was fossil fuels.
So if you look at oil as an example, the end of 2021 energy in the S&P 500 as a sector weight was 2.5 percent, the lowest it had ever been.
If you go back to the late 70s, that was closer to 30 percent.
If you go to just before the GFC, it was about 15 percent.
So basically no one was invested in that sector.
On top of that, you had shareholders basically telling corporates not to reinvest in supply.
So basically saying we don't want you to shell Exxon.
We don't really want you to grow production.
We want you to give us all the cash back because we see this cliff of oil demand in 10 years.
So don't reinvest.
Then you had governments going out and telling corporates that they couldn't reinvest back into production.
The US government, a classic example, basically not allowing businesses to reinvest back into production.
The Dutch government telling Shell that they had to reduce their emissions by 40 percent.
So all of this created an environment where it was ripe for supply demand imbalance within oil and gas space
and a mindset of corporates to change their view of returning capital to shareholders and not reinvesting it.
So we invested in that space. We invested in oil and gas. We invested in met coal.
The most overvalued stocks were wind, renewables, and businesses where they hadn't proven to the market
that they could generate a healthy and sufficient return on capital over time.
But capital went there because you had big asset allocators, super funds, big endowment funds saying,
well, we need to have an ESG component. We need to have ESG in our funds.
So push capital to that limited space, limited availability in terms of things you could buy and push this valuation up.
I'm all for ESG if it's done well and correctly and the people benefit.
Like I'm a big fan of like social impact investing and that type of thing.
What I don't like is greenwashing.
Yes, I think that's the outcome to bear.
It's just the human nature and the sociopaths out there that go, hey, you know, great idea to make some money.
Let's just push this thing. And they've got no actual interest in delivering upon it.
And then it just creates an industry, pushes everything up and then, to be honest,
I agree 100 percent.
Because if you think about our business and what we're really doing, as I said,
to answer the first question is when you're looking at when we're looking at businesses
and we're wanting to be owners of businesses over a long period of time,
what's most important to us is the ability for that business to generate and grow cash flows over time,
then what they do with that cash flow and then what the market's willing to pay for that cash flow.
That's the focus. Cash flow in very short periods of time, 12 to 24 months, can get out of whack.
You can have volatility in cash flow, but we're worried about that longer stream of cash flow.
Now, to know that, you have to understand governance, environmental, social.
We've been doing it for 25 years.
You have to do that when you are looking at cash flow.
To say that you don't do that is you're neglecting three things that drive cash flow over time.
So we've been doing it since we started this business.
Paul's been doing it for 30 years. It's the crux of what we do.
We don't need to get out there and wave a green piece flag to tell people that we're doing it.
Now, Kevin, I know you've got another meeting to jump to.
I think we definitely should have you back on because I'm really, really enjoying this conversation,
probably about six months' time.
Sounds good.
I think this will be a lot of fun, probably a bit longer one next time.
So is there any thoughts you want to leave our listeners with?
I think we've touched on a fair bit.
We've touched on a lot.
We'll have happy investing for the next six months and we'll come back and we'll diagnose what's played out.
Sounds good to me.
Well, thank you very much for coming on The Rate of Change again with your cloth management.
And I hope you have a great day.
Cheers. Appreciate it.
Thank you.
Any views expressed in this recording do not represent a view of any other third party and other sole personal opinions of the speaker.
Any reference to financial product does not constitute advice or recommendation,
and before any action you should seek proper advice from your financial professional.
Australian listeners should head to www.moneysmart.gov.au to find more information on obtaining financial advice.
To get in touch with York, head to our website www.yorkwealth.com.au.
Any views expressed in this recording do not represent a view of any other third party and other sole personal opinions of the speaker.
Any reference to financial product does not constitute advice or recommendation,
and before any action you should seek proper advice from your financial professional.
Australian listeners should head to www.moneysmart.gov.au to find more information on obtaining financial advice.
To get in touch with York, head to our website www.yorkwealth.com.au.