Mark Draper recently met with Andrew Clifford (Platinum Asset Management) to talk about the change in CEO at Platinum Asset Management and what it means for investors in Platinum funds.

Below is a podcast of the discussion and also a transcript.

 

 

 

 

Speakers:  Mark Draper (GEM Capital) and Andrew Clifford (Platinum Asset Management)

Mark:  Here with Andrew Clifford, Chief Investment Officer, or currently Chief Investment Officer of Platinum Asset Management, soon to be Chief Executive Officer of Platinum Asset Management.

Andrew, thanks for joining us.

Andrew:  Good morning. It’s good to be here.

Mark:  Shooting this in Adelaide, too, by the way. So, welcome to Adelaide, Andrew.

It was announced to the market recently that the joint founder of the business, alongside of you, Kerr Neilson, who is the current CEO of Platinum Asset Management is going to step down as CEO, still stay within the business.

I just want to talk about that this morning for our Platinum international investors.

Are you able to give us an overview? What does this actually mean for the business?

Andrew:  I think what people should understand is that we’ve built over the last 24 years, a very deep and experienced investment team. I think also it would be good for people to understand just exactly how the process works internally to understand the role, how Kerr’s changing role affects us.

Across that team, one of the things that we think if very important in coming up with investment ideas is that there’s a very thorough and constructive debate about investment ideas. If you put someone in the corner of a room and leave them to their own devices for four weeks to look at a company, on average through time, they’re not going to come up with good ideas, they’re going to miss things.

Part of our process is that the ideas, even from the very beginning, should we even be looking at this company or this industry, is something that is thoroughly debated all the way along.

We have five sector teams and also our Asia team. These are teams of sort of three to five people and they’re working away, coming up with ideas, debating them internally before they’d even presented to the portfolio managers for a potential purchase.

Then what happens is we have a meeting around that and you get all the portfolio managers for whom that is relevant and the idea is further debated and one of the things to understand about the process is we’re not trying to all come to some lovely agreement about whether this company is a good idea. We’re trying to work out what’s wrong with it.

Then ultimately, what happens after all of that, invariably there’s more questions to follow up and work to be done, but what happens is then each of the portfolio managers make their own independent decision on whether to buy that company or not.

The important role of the portfolio manager, as I see it, is everyone always thinks of them as these gurus who are making a decision about buying this stock or investing in this idea, and certainly they have that final responsibility. But I actually think their most important role is leading that discussion and debate.

Indeed, what happens in the places, that you can see that if an idea comes through to buy a certain company, if I buy it and Clay Smolinski doesn’t or Joe Lai doesn’t, when it’s an Asian stock, or Kerr does, but he buys 3% in the fund and I buy half a percent, there’s some kind of difference of opinion there that needs to be further debated and discussed. We have particular meetings where we do that.

I give this all as a background to say that there’s a very—

Mark:  It’s a bigger process.

Andrew:  —deep and proper process there.

Mark:  It’s not one person pulling the strings.

Andrew:  That’s right, absolutely. When it comes to Kerr and his role, Kerr will continue to be part of the investment team, he will continue to work away on investment ideas, which is his love. When you do this job, you’re never going to stop doing that.

He’ll still be there working away on this idea or that, as pleases him. Also, he will be looking at the ideas other people are putting forward because that’s what excites him.

He will still be part of our global portfolio manager’s meeting, which is the meeting of the most senior PMs, where we actually debate those ideas, where those differences of opinion are occurring amongst the PMs.

He’s still there going to be doing that and as Kerr would say, the demands of being a—of running a global portfolio, are not inconsequential in terms of the time and effort. What he is hoping to be doing is then being able to take that time where he doesn’t have to think about absolutely everything we’re doing to focus on what he believes are the really good ideas.

It is a change, but it may not be as significant as it sounds to people.

Mark:  I think the interesting thing from my perspective is that it’s not like Kerr is resigning from the company, selling all his shareholdings and just walking away. This is very much—sounds like a planned event. He is still going to be in the business, he’s just moving out of the CEO role so he can focus on the investment side and still remain contributing to the company. Is that…

Andrew:  Yeah, I mean, absolutely. Because I think it’s one of these things is that you, as I said, you can’t really retire from investing. You’re going to be doing it one way or the other. This is a great way for him to continue to do what he loves doing and it’s great for the rest of the organization to still have that input from him. It’s something that the younger members of the team will value because he will, as he does today, he’ll walk across the floor to talk to someone about what they’re working on and be quizzing them on that idea.

Because along with that idea, all those sort of more formal processes of how an idea comes to life, there’s also the discussions in the kitchen when you’re making a cup of tea and what have you.

He’s going to remain there as a full-time employee and part of the investment team.

Mark:  What’s he likely to do with his shareholding? Because he does own a significant amount of Platinum Asset Management. I think he said publicly in the press that he’s just retaining them. Is that—

Andrew:  Yes, so it’s hard for me to talk for him, so I can really only repeat what he has said, which is that I think at the moment there’s no intention to sell any of the stock at this stage.

Mark:  Going back to the funds for a second, what are the changes to the management of the funds and with a particular focus on the Platinum International Fund, which is the flagship fund, and also Platinum Asia. Probably the easiest one to start with is Platinum Asia.

Andrew:  Really, for Platinum Asia, there’s no changes in the management of that. Joe Lai has been running that in its entirety for a number of years now.

What you would expect with what we’ve done with Asia previously, with myself and Joe, when I used to run that, he started at 15% of the fund and progressively moved up to half and then the whole fund. That’s something—this is all part of both the development of individual members of the team and also building in that succession planning across the firm.

While there’s no intention to change that today, at some point in the future, you would expect that we will bring in another portfolio manager to run a small part of that fund and then build that up through time.

Mark:  I think that’s really interesting because Joe started out having a smaller amount of that fund, got built up, and then is now running all of it. The Platinum International Fund is not too dissimilar to that, in that Clay Smolinski, who has been with Platinum for quite some considerable time and is a very high quality investor, he’s currently managing 10% of the Platinum International Fund.

Andrew:  Yes.

Mark:  What’s going to change in that respect?

Andrew:  Clay’s also been running the un-hedged fund for a number of years now.

Mark:  Which has performed really, really well.

Andrew:  It’s performed very well, as the European Fund did, or continued to, even after Clay left, but is also—he did a very good job running that.

What’s going to happen is Clay will take 30% of that fund and what you again might expect at some point in the future, that is a third portfolio manager will be brought in there. One of the reasons for not doing that—a lot of people ask us why we’re not doing that today and it’s simply that these types of changes now, five years ago, didn’t attract a lot of attention, these days, the research houses are very focused on these changes. We’ve already given them quite a bit to think about in the last month. So, rather than make yet another change at that point, we want to leave that for a point in the future.

But people might be interested, across the range of our funds, that besides moving to that 30%, we will essentially bring—

Mark:  And then you manage 70%?

Andrew:  I manage 70%.

Mark:  You’re currently managing around half?

Andrew:  40.

Mark:  40, so you got a lot and so does Clay.

Andrew:  But some of our other funds that are similar mandates, this is not so much relevant for Australian investors, but our offshore uses product will also be 70/30. I will take over the management of Platinum Capital, whereas Clay will take over the management of—

Mark:  Platinum Capital being the listed investment company?

Andrew:  Listed investment company, yes.

Mark:  We have some invested in it.

Andrew:  But then also there are funds, the Platinum Global, which is the in fund, that its mandate is much more similar to the un-hedge fund, so Clay will take over that.

Mark:  Right.

Andrew:  They’ll be changes in other funds as well.

Mark:  Yeah. You touched on research houses. One of the things—and this is probably more relevant for Platinum Asset Management investors, rather than investors of the funds, but it strikes me that one of the key things is what the research houses say about you in their capacity as acting as a gatekeeper between you and financial advisors, like us.

What’s been the reaction of the research houses, Morningstar, Lonsec, etc.? What’s their reaction been to this, Andrew?

Andrew:  As you can imagine, we were on the phone to them, in for a meeting within 24 hours.

Mark:  You’re very much on the front foot, I must say, with that.

Andrew:  Yes. Both Morningstar and Zenith have reaffirmed the writings across our fund, so there’s been no change there. I don’t really want to speak for them either. They’re very independent in their views and their positions can be read. But essentially, I think, this was not unexpected in their minds and they’ve reaffirmed those writings, but as always, they’re watching carefully to see how we go.

Mark:  As always.

Andrew:  As it stands today, while we’ve had feedback from Lonsec, we don’t know what their final decision is at this stage.

Mark:  I do know Morningstar were out in the press last week, I think, saying they think that the management of Platinum Funds just continues as is. They were actually quite supportive in the press.

Andrew:  Yes. And I think that came on the back of the one that had that we won the Morningstar, not just the fund manager, the International Fund of the Year, but we also got the Fund Manager of the Year Award, which means that’s won against the entire, you know, all comers who are doing product across the range. And they assured me that was decided before any of the decisions anyway, but it was actually very nice timing to win that at that point for the organization and the investment team because it really recognizes what has been a period of very strong performance.

Mark:  Yes.

Andrew:  After a period where actually we didn’t think our performance was that poor, but in a relative sense, we had lagged the market for a while, by a very small margin, but I think that it was very nice to win that aware at that point.

Mark:  Absolutely.

Andrew:  We stuck to doing things the way we’re doing and the end result has been good. As I say, I’m not one to normally get too excited about awards, but it was a lovely time to get it and at this point in time as well.

Mark:  Congratulations, by the way for that. The track record, so Clay and yourself are running the flagship fund. There’s no changes to Platinum Asia. The track record of Clay and you has been really good over a long, long period of time. Are you able to provide any context around that? I know that’s actually a hard question.

Andrew:  This is the thing, I go back to where we started and talk about the process that is there, and I don’t want to take away from Clay’s excellent record, but here’s the thing, over our 24 years of history, we’ve had 14 different portfolio managers running money. Every one of them, their long-term record was one of out performance. That’s quite extraordinary. I don’t think you find that many easily, in any market.

Now, of those 14, 10 are still with us. 2 of them were other founders who have stepped aside. But I look at this say, this is the system. If I have a flippant response to people when they worry so much about the role of the portfolio manager because if I’m sitting here, I have 30 people in the office bringing me great ideas. If they only bring me great ideas, because they’re well thought through and well argued out,  then all I need to do is buy every one of them or flip a coin and buy every second one, whatever it is.

Now, there’s more to it than that. But the job of running money becomes easy when you’re supported by a strong team.

Mark:  The main message really here is that. This is very much a team business and it’s a big team. You’re probably one of the deepest teams in the country, in international equities.

Andrew:  I think in the country, very easily and across probably all investment teams in terms of depth of experience and what have you, I mean, there will be other people globally who have similar histories.

But, you know, I think the thing that we see when we talk to clients overseas, is that the things that differentiate us very strongly, not any one of these things, but a collection of all of them, is that we’ve been going for a while, 24 years. We’re managing a substantial sum of money with 27-odd billion Australian dollars. Very defined investment approach and extraordinarily deep team, and a long-term record of out performance. You’ll find that people who have got four of the five or three of the five, but there aren’t many.

What I should say, I think one of the things that stands out with overseas clients is when we say we construct our portfolios independently of the MSCI Index, is that we genuinely do. There are many other people who say they do.

Mark:  Say they do and they don’t. [Laughs]

Andrew:  But they still end up with—and some of those who’ve got great records, but they still end up with 45% in the U.S., even though they say they’re not doing that, which interests us. We genuinely are—

Mark:  You’re true to label though, aren’t you? You’re very much true to label. What you say you’re going to do, you do.

Andrew:  We do. I think that maybe sometimes in Australia that’s not valued quite as much as it could be because we’ve been around a long time and people know us. But I think it is—there’s no one else we know of that can show all those attributes.

Mark:  Our position, Andrew, is that we know the depth of your management team at Platinum Asset Management, and you individually have been managing that team for the last five years officially, I believe, in any case.

Andrew:  Officially, yes. Unofficially, for longer than that. [Laughs]

Mark:  Yeah, that’s right. [Laughs] From our perspective, nothing has really changed other than it’s a change of role for Kerr, but he’s still in the business. We’re still positive on Platinum Funds, clearly.

Have you got any last thing that you would like to say for our Platinum investors or PTM shareholders?

Andrew:  I think the other thing that people ask about is, I’m taking on this additional role of CEO and what are the—how much of a workload, how does that—I guess the fair concern is how does that detract from the investing side of things?

Again, I think that not everyone will be aware of just how strongly our organization, that investment team is supported by the other functions. Liz Norman, who was there on day one and I think most clients and financial planners in this country know her. I make the joke, I walked into the Morningstar Awards and everyone is saying, “Hi, Liz. Who are you?”

Mark:  [Laughs]

Andrew:  But you know, he’s run all of that part of the business for 24 years, does an extraordinary job. On the other parts of the business, the accounting, legal, compliance, tax, we had a great founding CFO, Malcolm Halstead. He left the business a few years ago, but he built an extraordinary team of people. There’s all these boring things people wouldn’t know about, portfolio accounting and registry, but these are very important functions because when they go wrong, they can create havoc and they can cost—well, they never cost the clients money but they’ll cost—

Mark:  They cost the business and it’s a management distraction.

Andrew:  It costs the business money and a lot of distraction and we have an incredibly strong team there, now led very well by Andrew Stannard, our current CFO.

When it comes to the role of CEO, the reality is that Liz and Andrew and their teams, they run the business. We want an investment person as CEO because ultimately the CEO makes the final, critical decision on important things and we want those decisions taken from a perspective of is this going to impact the investment process? You can have all these great ideas, we should have this product, we should do this, we should open an office in New York, we can have all the great ideas in the world, but ultimately, they need to be run through the filter of how does this impact the way the investment team functions.

All of those things, those sort of decisions, can impact and hurt that and that’s why I’ve taken on that role. In reality, yeah, there will be times where there’s more to do, but in fact, the way it’s worked, is Kerr and I have already long divided those responsibilities. So, most of the accounting and compliance-type discussions where it’s come through to the management committee, which is Andrew Stannard, Liz, Kerr, and myself, they’ve tended to be my area and Kerr is focused more on the client side of the business. I’ve been part of those discussions for 24 years, so it’s not like I have to all of a sudden get on top of, or how does this work or how does that work? I’ve been there the whole time.

There will be some time into that, but I don’t believe that it will be substantial.

Mark:  Good answer. Andrew, all the best for the new role as CEO and I know you’ve been there forever [laughs], so all the best for the transition. Thanks very much for making the time to talk to us about it.

Andrew:  Thank you.

[End of Audio]

Transcription by Fiverr.com bethfys

Thursday, 15 March 2018 05:42

Shorten's tax grab from retirees

Written by

The ALP has proposed that if it wins Government at the next election it will scrap cash refunds that are currently paid to investors with surplus imputation credits they receive from shares that they own which pay franked dividends.

Bill Shorten claims that only the wealthy will pay the tax, clearly continuing his class warfare with ‘the big end of town’.

He also said “a small number of people will no longer receive a cash refund but they will not be paying any additional tax”.

With all due respect to a potential future Prime Minister, this is rubbish! 

The Australian reports today that Treasury analysis of official tax data shows the largest group of people to be hit by Labor’s $59bn tax grab will be those receiving annual incomes of less than $18,200, the majority who receive the Age Pension.

In fact the likely number of people hit by this proposal is estimated at well over 1 million, bringing into question the ALP’s definition of small.

The current effective tax free threshold for a retiree couple over age 65 is around $29,000 each, courtesy of the Seniors Australian Tax Offset and of course the $18,200 tax free threshold that applies to everyone.

Therefore any retiree who’s taxable income is less than that, is currently not paying tax and at risk of having their surplus imputation credits retained by the ATO.

The whole point of dividend franking – introduced by a Labor treasurer Paul Keating of course was to stop the double taxation of dividends. 

Dividends have to be paid by companies out of profits which have already paid company tax.  In the old pre-Keating world those dividends would then be taxed a second time as personal income.

Under the Keating change you would get a ‘credit’ for the company tax paid on the dividend, you would then still be taxed at your full marginal tax rate on the underlying income out of which the dividend was paid.

Critically, if your marginal tax rate was lower than the 30% company tax rate, you still paid “too much” tax.  That is why Peter Costello legislated the cash return of that overpayment in 2000.

If the ALP proposal becomes law, this would result in high income earners gaining the full benefit of dividend imputation but retirees and low income earners being discriminated against and unable to use the tax credits.  In other words retirees would become one of the few groups in the country to pay double taxation on their dividends.  The very people the ALP are alleging to protect are those most likely to lose from this proposal.

So how much do retirees (including those with Self Managed Super Funds in pension phase) stand to lose from this proposal?.  The table below sets out different levels of investment in fully franked dividend paying investments and the corresponding potential loss of income for retirees.(assuming retirees are below effective tax free threshold)

Investment Level

Dividend Rate (fully franked)

Franked Income

Imputation Credit

Cut to Retiree income under ALP proposal

$100,000

5%

$5,000

$2,142

$2,142

$200,000

5%

$10,000

$4,285

$4,285

$300,000

5%

$15,000

$6,428

$6,428

$400,000

5%

$20,000

$8,571

$8,571

$500,000

5%

$25,000

$10,714

$10,714

$600,000

5%

$30,000

$12,857

$12,857

GEM Capital is not opposed to tax reform, but we are opposed to leaders using the tax system as a political wedge for political gain that disadvantages the retiree sector.

We are deeply concerned that a potential future Government can propose in an incredibly short time frame, in a retrospective manner, such a drastic reduction for retirees’ income.  Retirees have limited capacity to increase their earnings through employment which makes them a very vulnerable segment of the community to sudden changes in Government policy.

GEM Capital will be contributing to media articles in the coming weeks on this issue and will also be talking with politicians of both sides of politics with a view of broadening their perspective on the issue and at the same time represent the interests of retirees.

Feel free to share this article with anyone you believe may be impacted by this proposal.

Wednesday, 28 February 2018 09:06

NBN faces irrelevance

Written by

NBN faces irrelevance in cities as competitors build faster, cheaper alternatives

Allan Asher, Australian National University

Malcolm Turnbull is now connected to the National Broadband Network (NBN) at his Point Piper home on a 100 megabits per second (Mbps) plan, it was revealed in Senate Estimates yesterday. But only because his department intervened to avoid delays affecting other customers.

And while the Prime Minister might be happy with his NBN connection, that’s not the case for the 2.5 million customers waiting on a connection through their pay TV or cable service who have been left in limbo.

Lauded in the 2009 Commonwealth Budget as the single largest nation building infrastructure project in Australian history, the NBN is at risk of becoming an expensive white elephant in our cities. Years of political interference, poor technology decisions and a monopoly business attitude have damaged the brand.

Rather than meeting its objective of connecting 90% of homes and workplaces with broadband speeds of up to 100 Mbps, the NBN is looking more like a giant sponge. It soaks up public infrastructure dollars and returns high prices, long delays, unacceptably slow data speeds and service standards that are now the subject of an ACCC investigation.

As a result, a growing number of competitors are bypassing the NBN by undercutting prices and beating performance standards.


Read more: The ACCC investigation into the NBN will be useful. But it's too little, too late


Adelaide bypasses the NBN

The latest challenge to the NBN came after South Australian Premier Jay Weatherill denounced the “very poor NBN outcome” and last week announced A$35 million in funding for an Adelaide fibre network alternative if he is reelected in March 2018.

The plan was warmly welcomed by Mighty Kingdom, an app and games developer who told the ABC, “I don’t have what I need to get me to the rest of the world.”

This follows news announced last year that Adelaide City Council is working with TPG to deliver an NBN-alternative broadband service to local businesses. The service promises fibre internet up to 100 times faster than the NBN, at lower prices, and with no installation costs for city businesses or organisations.

Lord Mayor Martin Haese said:

This technology will be a game changer for the city of Adelaide. It will be a boom for local businesses and other organisations, but will also attract business from interstate and across the globe.


Read more: The NBN: how a national infrastructure dream fell short


NBN alternatives for Melbourne homes and businesses

Meanwhile two aggressive startups in the Melbourne market are hoping to take a serious bite from NBN’s lunch.

Lightening Broadband is connecting homes and businesses using microwave links capable of delivering both 100 Mbps download and upload speeds. That’s better than the comparable NBN Tier 100, which offers 90 Mbps download and 30 Mbps upload speeds.

The company is constructing microwave transmitters on tall buildings, connected to the telco’s core network using microwave links. Customers within a two-kilometre radius share a microwave transmitter, requiring a dish on their roof.

Another telco start-up, DGtek is offering its customers a full fibre alternative service.

Upon its launch in 2016, DGtek’s founder David Klizhov said:

“Ideally the NBN would have worked if it was fibre to the home, but it’s taken quite a lot of time and we thought that we could have a go at the Australian market using technology that’s been implemented already overseas.”

DGtek uses Gigabit Passive Optical Networks (GPON) and runs it directly into tightly packed homes with the dense population of inner Melbourne. As a sweetener, DGtek offers free internet service to government organisations – such as schools and hospitals – in areas they service.

The threat from 5G and other new technologies

New entrant competition is not the only threat to NBN Co. Optus and Telstra are both launching 5G services in 2019. This represents a quantum leap in wireless technology that could win away millions of current and potential NBN customers.

While Vodafone CEO Inaki Berroeta has said that 5G is unlikely to replace the NBN in Australian homes, Optus Managing Director of Networks Dennis Wong recently told BIT Magazine:

Everyone has heard of concepts like self-driving cars, smart homes, AI and virtual reality, however their full potential will require a fast and reliable network to deliver. Seeing 5G data speeds through our trial that are up to 15 times faster than current technologies allows us to show the potential of this transformative technology to support a new eco-system of connected devices in the home, the office, the paddock and in the wider community.


Read more: 5G will be a convenient but expensive alternative to the NBN


5G is not the only technological game changer facing the NBN. iiNet in Canberra has launched its Very-high-bit-rate Digital Subscriber Line (VDSL2) as its own superfast network.

According to iiNet, it is made up of fibre and copper and provides a faster connection than ADSL and most NBN plans. The network is independent from Telstra and differs to NBN in that iiNet’s VDSL2 network uses its own copper lines.

Levelling the field for smaller players

The huge capital requirements of rolling out telecoms infrastructure has always acted to deter more competition in the Australian market. But following a regulatory decision of the ACCC in 2017, smaller entrants can now enjoy cost-based access to some of the largest networks – including Telstra, TPG and Opticom – allowing them to better compete both with the big telcos, and with the NBN.

By providing access to superfast broadband access service (SBAS) and the local bitstream access service (LBAS), new entrants will be able to sell NBN-like fixed line superfast broadband wholesale.

So where to for the NBN?

Yesterday the government released a working paper forecasting that demand for bandwidth will double for households with high internet usage over the next decade. The report also suggests that the NBN is equipped to meet those needs.

The ConversationHowever, cost, technology and customer service problems continue to threaten the commercial success of the NBN. Without a radical rethink, it is doomed to fail its initial mission.

Allan Asher, Visitor, Regulatory Institutions Network (RegNet) & Chair of Foundation for Effective Markets and Governance, Australian National University

This article was originally published on The Conversation. Read the original article.

We are planning to add Montgomery Investment Management to our recommended list of investments early in 2018.  In particular we are impressed by their Global Investment team who have had an impressive track record since the fund began a few years ago.

The Montgomery Global Fund is listing on the ASX on 20th December 2017 and is a portfolio of high quality global companies aiming to pay a half yearly income distribution of 4.5%pa.  We will have further details on this fund in the new year.

In the meantime, here is a sample of how Montgomery Investment Management think about investing in a comprehensive report that makes excellent reading over the Festive Season.  The articles are written by the investment team at Montgomery Investment Management, rather than a marketing spin doctor and are very informative. 

 

To read the report simply click on the picture of the report below.

Some of the content in this edition include:

1. How the changes in the $AUD impact global facing businesses

2. Why do Montgomery's own Facebook

3. Should you own Wesfarmers?

And many more articles.

 

Thursday, 07 December 2017 20:31

Bubbles, Busts and Bitcoin

Written by

Shane Oliver - Chief Economist AMP

 

The surge in bitcoin has attracted much interest. Over the last five years, it has soared from $US12 to over $US8000; this year it’s up 760%. Its enthusiasts see it as the currency of the future and increasingly as a way to instant riches with rapid price gains only reinforcing this view. An alternative view is that it is just another in a long string of bubbles in investment markets.

Nobel Economics Laureates Daniel Kahneman, Robert Shiller and Richard Thaler and many others shown that investors and hence investment markets can be far from rational and this along with crowd psychology can drive asset prices far from fundamentally justified levels. This note provides a refresher on the psychology of investing before returning to look at bitcoin.

Irrational man and the madness of crowds

Numerous studies show people suffer from lapses of logic. In particular, they:
 

  • Tend to down-play uncertainty and project the current state of the world into the future – eg, resulting in a tendency to assume recent investment returns will continue;
  • Give more weight to recent spectacular or personal experiences in assessing probabilities. This results in an emotional involvement with an investment – if it’s been winning, an investor is likely to expect it to keep doing so;
  • Tend to focus on occurrences that draw attention to themselves such as stocks or asset classes that have risen sharply or fallen sharply in value;
  • Tend to see things as obvious in hindsight – driving the illusion the world is predictable resulting in overconfidence;
  • Tend to be overly conservative in adjusting expectations to new information – explaining why bubbles and crashes normally unfold over long periods; and
  • Tend to ignore information conflicting with past decisions.

This is magnified and reinforced if many make the same lapses of logic at the same time giving rise to “crowd psychology”. Collective behaviour can arise if several things are present:

  • A means where behaviour can be contagious – mass communication with the proliferation of electronic media are perfect examples of this as more than ever investors get their information from the same sources;
  • Pressure for conformity – interaction with friends, social media, performance comparisons, fear of missing out, etc;
  • A precipitating event or displacement which motivates a general investment belief – the IT revolution of the late 1990s or the rapid industrialisation of China which led to talk of new eras are examples upon which were built general believes that particular investments will only go up.

Bubbles and busts

The combination of lapses of logic by individuals and their magnification by crowds goes a long way to explaining why speculative surges in asset prices develop (usually after some good news) and how they feed on themselves (as individuals project recent price gains into the future, exercise “wishful thinking” and receive positive feedback via the media). Of course this also explains how the whole process can go into reverse once buying is exhausted, often triggered by bad news.

The chart below shows how investor psychology develops through a market cycle. When times are good, investors move from optimism to excitement, and eventually euphoria as an asset’s price moves higher and higher. So by the time the market tops out, investors are maximum bullish and fully invested, often with no one left to buy. This ultimately sets the scene for a bit of bad news to push prices lower. As selling intensifies and prices fall further, investor emotion goes from anxiety to fear and eventually depression. By the time the market bottoms out, investors are maximum bearish and out of the market. This sets the scene for the market to start rising as it only requires a bit of good news to bring back buying.

The roller coaster of investor emotion



Source: Russell Investments, AMP Capital

This pattern has been repeated over the years. Recent examples on a globally-significant basis have been the Japanese bubble and bust of 1980s/early 1990s, the “Asian miracle” boom and bust of the 1990s, the tech boom and bust of the late 1990s/early 2000s, the US housing and credit-related boom and bust of last decade and the commodity boom and bust of late last decade into this decade. History may not repeat but rhymes and tells us asset price bubbles & busts are normal.

Where are we now?

Our assessment in terms of global share markets is that we are still around “optimism”. Investor sentiment is well up from its lows last year and some short-term measures are a bit high, warning of a correction (particularly for the direction-setting US share market) but we are not seeing the “euphoria” seen at market tops. The proportion of Australians nominating shares as the “wisest place for savings” remains very low at 8.9%.

But what about bitcoin? Is it a bubble?

Crypto currencies led by bitcoin and their blockchain technology seem to hold much promise. The blockchain basically means that transactions are verified and recorded in a public ledger (which is the blockchain) by a network of nodes (or databases) on the internet. Because each node stores its own copy, there is no need for a trusted central authority. Bitcoin is also anonymous with funds just tied to bitcoin addresses. Designed to work as a currency, bitcoin therefore has much to offer as a low-cost medium of exchange with international currency transfers costing a fraction of what, say, a bank may charge.

However, bitcoin’s price in US dollars has risen exponentially in value in recent times as the enthusiasm about its replacement for paper currency and many other things has seen investors pile in with rapid price gains and increasing media attention reinforcing perceptions that it’s a way to instant riches.

However, there are serious grounds for caution. First, because bitcoin produces no income and so has no yield, it’s impossible to value and unlike gold you can’t even touch it. This could mean that it could go to $100,000 but may only be worth $100.

Second, while the supply of bitcoins is limited to 21 million by around 2140, lots of competition is popping up in the form of other crypto currencies. In fact, there is now over 1000 of them. A rising supply of such currencies will push their price down.

Third, governments are unlikely to give up their monopoly on legal tender (because of the “seigniorage” or profit it yields) and ordinary members of the public may not fully embrace crypto currencies unless they have government backing. In fact, many governments and central banks are already looking at establishing their own crypto currencies.

Regulators are likely to crack down on it over time given its use for money laundering and unregulated money raising. China has moved quickly on this front. Monetary authorities are also likely to be wary of the potential for monetary and financial instability that lots of alternative currencies pose.

Fourth, while bitcoin may perform well as a medium of exchange it does not perform well as a store of value, which is another criteria for money. It has had numerous large 20% plus setbacks in value (five this year!) meaning huge loses if someone transfers funds into bitcoin for a transaction – say to buy a house or a foreign investment – but it collapses in value before the transaction completes.

Finally, and related to this, it has all the hallmarks of a classic bubble as described earlier in this note. In short, a positive fundamental development (or “displacement”) in terms of a high tech replacement for paper currency, self-reinforcing price gains that are being accentuated by social media excitement, all convincing enthusiasts that the only way is up. Its price now looks very bubbly, particularly compared to past asset bubbles (see the next chart – note bitcoin has to have its own axis!).

Because bitcoin is impossible to value, it could keep going up for a long way yet as more gullible investors are sucked in on the belief that they are on the way to unlimited riches and those who don’t believe them just “don’t get it” (just like a previous generation said to “dot com” sceptics). Maybe it’s just something each new generation of young investors has to go through – based on a thought that there is some way to instant riches and that their parents are just too square to believe it.



Source: Thomson Reuters, Bloomberg, AMP Capital

But the more it goes up, the greater the risk of a crash. I also still struggle to fully understand how it works and one big lesson from the Global Financial Crisis is that if you don’t fully understand something, you shouldn’t invest.

At this stage, a crash in bitcoin is a long way from being able to crash the economy because unlike previous manias (Japan, Asian bubble, Nasdaq, US housing in the chart above) it does not have major linkages to the economy (eg it’s not associated with overinvestment in the economy like in tech or US housing, it is not used enough to threaten the global financial system and not enough people are exposed to it such that a bust will have major negative wealth effects or losses for banks).

However, the risks would grow if more and more “investors” are sucked in – with banks ending up with a heavy exposure if, say, heavy gearing was involved. At this stage, I think it’s unlikely that will occur for the simple reason that being just an alternative currency and means of payment won’t inspire the same level of enthusiasm that, say, tech stocks did in the late 1990s (where there was a real revolution going on).

That said, it’s dangerous to say it can’t happen. There was very little underpinning the Dutch tulip mania and it went for longer than many thought. So it’s worth keeping an eye on. But as an investor I’m staying away from bitcoin.

What does this mean for investors?

There are several implications for investors.
 

  1. The first thing investors need to do is recognise that investment markets are not only driven by fundamentals, but also by the often-irrational and erratic behaviour of an unstable crowd of other investors.
  2. Investors need to recognise their own emotional capabilities. In other words, investors must be aware of how they are influenced by lapses in their own logic and crowd influences.
  3. To help guard against this, investors ought to choose an investment strategy which can withstand inevitable crises & remain consistent with their objectives and risk tolerance.
  4. If an investor is tempted to trade they should do so on a contrarian basis. Buy when the crowd is bearish, sell when it is bullish. But also recognise contrarian investing is not fool-proof – just because the crowd looks irrationally bullish (or bearish) doesn’t mean it can’t get more so.
  5. Finally, while crypto currencies and blockchain technology may have a lot to offer bitcoin’s price is very bubbly.
Thursday, 07 December 2017 20:22

Gerard Minack - what's in store for 2018

Written by

Well known investor Gerard Minack, who also sits on the board of Morphic Asset Management recently produced this video on this thoughts for investment markets for 2018.

This video was produced for the Morphic Asset Management roadshow and has been reproduced with their permission.

 

Thursday, 07 December 2017 20:17

Perception vs Reality - Identify the next big crisis

Written by

By Geoff Wood (Morphic Asset Management)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

OVERESTIMATING RISKS

Humans tend to fear spectacular, but unlikely events. This is the proposition that Bruce Schneir makes in his book “Beyond Fear”.For example, European tourism has been significantly impacted by much talked about terrorist attacks despite the extremely low probabilities of something occurring to any individual. With the anniversary of October 1987 recently, it was remarked that “the week after the crash people started worrying about a crash”. The more recent an event’s occurrence is to you, the more likely you are to think that event is going to happen (when in fact it’s actually a lot less likely).

UNDERESTIMATING RISKS

What does this look like? Overall we tend to underestimate threats that creep up on us. Humans are ill-prepared to deal with risks that don’t produce immediate negative consequences, like eating a cupcake or smoking cigarettes. For example, surveys show more people fear dying from cancer than they fear heart disease.

As markets push on globally to new highs and talk of bubbles emerges, I thought it would be timely to take a look back at the last century to see what the world looked like when markets were making all-time highs before a big correction.

In the below table (Figure 1), we identify seven major highs in the US S&P 500 stock market. The criteria for identifying a “major high” was twofold:

  1. the market was making highs; and
  2. it was followed by a market fall of at least 25% in the following 18 months. Why 25%? Because falls of 15-20% are relatively common in a bull market. The ongoing bull market since 2009 has already had two of these episodes.

The first thing that should strike a reader is how rare these events are: seven times in 90 years so roughly every 12 years. So in one’s investing life (~40 years), there should be on average 3 “events”. For all the talk of fearing crashes every year, one should not bank on them too often – meaning the old saying “time in the market is more important than timing the market” has a ring of truth to it.

Importantly though, note that they are not evenly spread at 12-year intervals as we observe a clustering around the 1960s and the early 2000s. For whatever reason, these events have tended to “clump”.

FIGURE 1 – MARKET HIGHS USING OUR TWOFOLD CRITERIA

Source:Bloomberg, Team Analysis

DELVING INTO THE DATA

I then looked into a selection of market and macroeconomic data points to see what they were indicating at these market tops (Figure 2). Some statistics include:

  • the level of unemployment;
  • the Purchasing Managers’ Index (PMI) levels, which are surveys quantifying manufacturers order books;
  • consumer surveys to gauge their optimism;
  • and the Federal Reserve’s level of interest rate and perhaps more importantly how much had it changed coming into the high.

The first thing to note, which is to be expected, is there is not one consistent signal across all the outcomes. I say if there was consistency, markets would already be using the indicator! But a few pertinent points do jump out:

  • stock market highs before a crash have occurred two thirds of the time when unemployment was below 5%;
  • in most cases, the Fed has been hiking;
  • consumer expectations have been elevated but falling;
  • and PMI surveys of future expectations have been mixed.

However, the last two market highs were made with confidence starting to wane, while for prior occurrences it was strong and strengthening.

FIGURE 2 – ECONOMIC DATA AT THE HIGHS

Source: Bloomberg, Team Analysis

VALUATIONS AND MARKET DYNAMICS

S&P valuations have had a wide range from 10 to 25x price/earnings (P/E) over the last century, reflective of the wide range of deflation, inflation, reflation and stagflation that markets have lived through.

We find that market tops in the S&P have tended to occur when the market was expensive – but not eye wateringly so – at around 20x. The 2000 dot com top was an exception with the market trading closer to 30x.

In most cases, P/E’s are expanding into market tops, which is a sign of continued confidence about the future (Figure 3).

FIGURE 3 – VALUATIONS AT HIGHS

Source: Bloomberg, Team Analysis

WHAT DOES THE RUN-UP TO A PEAK LOOK LIKE?

Are stocks losing or gaining momentum into the peak?

Figure 4 looks at the path coming into the peak. Prices have generally risen 20% or more in the 18 months preceding the high and are 30% above any lows in that same period. The range can vary hugely with “blow-off” moves off 48% in 1987.

Breadth measures how many stocks in the S&P 500 are making 52-week highs. A strong market is driven by many areas. For the different dates studied here, there are mixed messages as the 1987 high was across the board, while the 2007 high was only driven by a small number of areas. It seems to us that the overriding factor/indicator is either low breadth or narrowing breadth.

The Relative Strength Index (RSI) in Figure 4 measures the consistency of buying and a figure over “70” is largely seen as overbought or overvalued. All market highs involved the monthly RSI being around or above the widely sighted 70 figures, signaling consistent strong buying over an extended period.

FIGURE 4 – MARKET DYNAMICS AT THE HIGHS

Source: Bloomberg, Team Analysis

HOW ABOUT OTHER ASSET CLASSES?

Lastly, I thought it would be instructive to look at how other asset classes were performing into the equity market top. If something is going wrong with liquidity or the economy, these assets should be reacting as well (Figure 5).

The bond market is generally seen as a better identifier of recession risks than stock markets and as such, it typically starts to price the central bank cutting rates in advance forcing the yield curve to flatten. The yield spread between the two-year and ten-year yields in a healthy market is typically around 100bps but going into the last two corrections was significantly lower.
Credit markets are also worth watching as again there is a view that credit “fails” before equities. My examination shows this is indeed the case: in the last few cases, spreads have been widening while the market went into a top because of the credit market prices increasing default risks.

FIGURE 5 – OTHER ASSET CLASSES AT A STOCK MARKET PEAK

Source: Bloomberg, Team Analysis

SUMMARY

So back to the original question. What does underestimating risk look like?
The highest risk points for investors, with the benefit of hindsight, was when there appeared little left to worry about. Unemployment was low; consumers were confident; and investors were willing buyers of equities month after month, driving big market moves upwards into the end. I would speculate that during these periods, the “fear” became more about “fear of missing the rally” rather than avoiding a crash.

On the flip side, when everyone is talking about risks such as Europe imploding or North Korea firing missiles, this may just be the time to buy.

One last thing to bring to the reader’s attention is the risk of “false positives”. We only know in hindsight what the tops were. The data can also be consistent with outcomes where a market top doesn’t take place. The most recent example of this was just last year: credit spreads widened, driven by falling oil prices; PMI surveys fell below 50 (indicating a contraction); and the market dropped more than 15% at one point. Yet the data reversed and the market rebounded to new highs. The market is not designed to be easy…

Taken all together, the analysis supports what we have written before: this bull market is moving to the late stages but these indicators I have analysed do not indicate a market top is imminent yet.

As the market continues its grind higher, we will be aiming to stay alert to market complacency and a change in these indicators.

 

Monday, 27 November 2017 19:11

Subscribe for GEM Capital's e-news

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Every month, GEM Capital produces an e-newsletter containing articles of interest to investors.

It is put together by us, and not by a marketing spin doctor.

If you haven't already - feel free to subscribe for it - it's complimentary.

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Investment research mouseEvery bull market has it's pin up boy.  In the early 2000's, it was the technology stocks where we witnessed companies 'reinventing' themselves by adding .com to their name, accompanied by large share prices increases.

Today, the Technology companies that are rising rapidly are underpinned by significant growth in revenue and profits, something that was missing from much of the tech sector early this century.

But there is a new 'Next Big Thing' that is attracting investment, probably from many who have not seen market cycles before, or fads come and go.  We are of course referring to Crypto currencies, led by Bitcoin.

At this point we wish to make the point that when discussing crypto currency it is important to separate the technology behind crypto currency from the currency itself.

The technology behind Bitcoin and other crypto currencies, known as Blockchain, is real and likely to influence the financial system around the world as banks, stock exchanges and share registries are investing heavily in the technology.  Put simply “The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.”

Picture a spreadsheet that is duplicated thousands of times across a network of computers. Then imagine that this network is designed to regularly update this spreadsheet and you have a basic understanding of the blockchain.

Information held on a blockchain exists as a shared — and continually reconciled — database. This is a way of using the network that has obvious benefits. The blockchain database isn’t stored in any single location, meaning the records it keeps are truly public and easily verifiable. No centralized version of this information exists for a hacker to corrupt. Hosted by millions of computers simultaneously, its data is accessible to anyone on the internet.

So the technology behind Bitcoin and others is real and is likely to materially impact the global financial system, particuarly to reduce processing costs and times and 'cut out the middle man'.

Our concern in this article revolves around the trading of Bitcoin and other crypto currencies by those seeking to get rich quickly.  The chart below tracks the rise of some of history's great bubbles, including Bitcoin.

What prompted us to write about this is when I began seeing a friend of mine uploading a Bitcoin market report everyday on Facebook and scoffing at those who invest in "old world" sectors like fixed interest and the share market.  I can remember these type of conversations during the tech boom of early 2000's.

 

We are not professing to be experts on Bitcoin, or cryptocurrencies, we simply wish to highlight the issues that we would want to satisfy ourselves with before investing.  You can then make your own conclusion.

Cryptocurrency is a form of digital money that is designed to be secure and, in many cases, anonymous, making it ideal for money laundering, organised crime and drug/arms dealers.

It is a currency associated with the internet that uses cryptography, the process of converting legible information into an almost uncrackable code, to track purchases and transfers.  There are new cryptocurrencies being issued every week, and these are known as Initial Coin Offerings.

It is being suggested by enthusiasts that cryptocurrency will become the global currency benchmark, replacing paper money and the existing financial system.  We would caution against such a view as one of the key differences between cryptocurrency and say $USD, is that there is a Government standing behind the $USD.  So unless the Government were to default, the currency has value.  There is no Government support behind cryptocurrency.  In fact recently the Chinese Government  announced that public cryptocurrency exchanges would be shut down.

Our other questions include:

1. Why are cryptocurrencies not being embraced by larger insitutional investors, often referred to as 'smart money'?

2. What legal protections are available to investors who trade cryptocurrency in the event of fraud or other online mischief?

3. What is the intrinsic value of what investors are buying?  (ie the intrinsic value of buying a company is the future cash flow a company generates)

 

We leave this article quoting two famous investors (made famous for different reasons).  

Jordan Belfort, the original "Wolf of Wall Street" says that initial coin offerings "are the biggest scam ever" and "are far worse than anything I was ever doing".

Howard Marks, one of the worlds most famous investors, from Oaktree Capital talked about cryptocurrencies in his recent investor newsletter.  His word of caution was "They're not real".

 

 

Thursday, 12 October 2017 15:12

Business model disruption has only just begun

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From a presentation by Hamish Douglass (CEO Magellan Financial Group) in October 2017

 

There’s a lot of business model disruption in the world and many companies will be left behind by the changes. There will be winners and losers in the years ahead, but sometimes business model disruption isn’t obvious. There are first-order effects when you have changes to business models, but when new technology and new businesses develop, it affects other businesses and other industries and it’s often not foreseeable. This is Part 1 of a two-part transcript.

Watch for second-order effects

If you look at a photograph of the Easter Parade in New York in the year 1900, it is full of horses and carriages. If you fast forward to 1913, the photograph is full of petrol-powered automobiles. Think about what had to happen, such as rolling out petrol stations. Transportation fundamentally changed in 13 years. In 1908, Henry Ford rolled the first Model-T Ford off the production line which enabled an automobile to be mass-produced at an affordable cost.

Many first-order effects are fairly obvious. If you manufactured buggy whips, you effectively went out of business. If you collected manure in the streets, you went out of business. There were 25 million horses in the United States in 1910 and 3 million in 1960.

The second-order effects aren’t as knowable. The second-order effects are what the automobile enabled to happen. An entirely new industry could move goods around far more efficiently. People could start the urban sprawl and move further away. We developed regional shopping centres due to the automobile.

Consider a simple change in technology, the automated checkout, such as in Woolworths and Coles in Australia. Walmart started rolling out these automated checkouts in around 2010 at scale and the other major retailers started doing the same. The first-order effects were a loss of jobs of the people working the checkouts, and retailers reduced their costs. And if one major competitor does that, other competitors follow, otherwise their cost structure is out of line.

But what of the second-order effects? Chewing gum sales have lost 15% of their volume since the introduction of automated checkouts in the US. The checkouts have disrupted the business model of impulse purchases. People do not drive to the supermarket to buy chewing gum, but when you used to stand in those checkout lines, you would pick up some chewing gum. I think mobile phones have had a bit to do with it too, because you now do other things when you’re standing there.

Our job as fund managers is to try and spot the next Wrigley. In 1999, at the peak of the technology bubble, Warren Buffett was asked by a group of students why he doesn’t invest in technology. He said he could not predict where the internet was going but investing in a business like Wrigley will not be disrupted by technology. And look what’s happened. Wrigley sales had gone up for 50 years, every year, before this change happened.

The pace of change is accelerating

Technology adoption appears to be accelerating. The chart below shows the number of years it takes to reach 50 million new users. We saw the rapid adoption with smart phones, and it only took Facebook five years to move from 1 billion to 2 billion users. These new technology-related businesses can scale at an incredibly fast rate.

I think there’s a whole series of factors explaining why this is happening, and a lot of things are starting to come together.

First, globalisation and the internet have enabled products to spread rapidly to much larger audiences around world. A second factor is the digitalising of goods and services. We have digitalised books, newspapers, music and videos. With Facebook, Google or Netflix, all their services are digital goods. Instead of spreading atoms around the world, we’re now spreading bits around the world where an identical copy of a digital good is produced at zero cost.

Third, the mobile phone today is more powerful than the world’s most powerful super-computer in 1986, in the year I left school, which is absolutely incredible. And now we’re connecting all these devices in ‘cloud computing’, where massive data farms don’t need computers to sit locally, and you can share all this information. So there’s a whole lot of infrastructure and change that’s enabling very rapid change.

The incredible power of two digital platforms

Consider the ‘GAF effect’ from Google, Amazon and Facebook. I don’t mean specifically those companies, but how they are affecting industries and important business models. First is the advertising industry. Google and Facebook know an enormous amount about their users. Anyone who uses Google has something called a Google timeline (unless you’ve opted out of it). On your Google timeline, in your user settings, you can go back five years and it will tell you exactly what you did five years ago if you carried your mobile phone, and most people do.

It tells you what time you left your house, whether you walked to the bus, which bus you boarded, if you went to work or not because it knows the address. If you take any photos on a day, it will put those photos on the timeline. It will tell you where you went for lunch, when you went home and if you went to dinner, it will tell you the restaurant. And this goes for every other day of your life for the last five years. It’s collecting enormous amounts of data about you, as are Facebook and others. That enables these platforms to start highly-targeted advertising and make it incredibly efficient.

In the last decade, traditional print advertising has lost about 24% market share, and I predict this will go to zero. It is extraordinary that outside China, two companies (Facebook and Google) have taken nearly the entire market share of a global industry that had many, many players in the world – magazine producers, newspapers producers, classifieds producers. All this revenue has ended up with two digital platforms that have this massive network effect. Television advertising, which is the largest pot of advertising money, has not yet been disrupted. We’re starting to see the rise of YouTube but it is still relatively small, as shown below. It’s probably got between US$6-8 billion of revenue at the moment, but it’s an industry with US$150-180 billion of revenue outside China.

Television is next

The television advertising business model is the next to fall due to two big factors. We’re experiencing the rise of these streaming video services. Think of Netflix, Amazon Prime, Stan, and Hulu, and Apple wants to enter this game. These businesses are spending enormous amounts of money on content creation. Amazon and Netflix this year will spend US$10 billion creating original content. They are far outspending anyone else on the planet. Facebook just bid US$600 million for the Indian cricket video streaming rights and were outbid by News Corp’s Fox. I think that’s one of the last-ditch efforts to protect sporting rights and there’s a battle going on between the television and the movie networks. Apple and Netflix are bidding for the next James Bond.

They are taking viewers away from television and pay TV which reduces advertising revenues. Then on the other side, the costs of producing the content and buying the best shows is being bid up. It is not a great business model if your revenues go down and your costs go up.

We’re also seeing the advent of new video advertising platforms. The streaming services are not advertising businesses, they are subscription businesses. But YouTube and now Facebook (and they’ve just launched Facebook Watch) are advertising business models, and I believe that a huge amount of the revenues that are currently in television and pay TV are at risk. It’s fundamentally different, because this is targeted advertising. These platforms know so much about the users that advertisements can be delivered specifically to what the users are watching on these new platforms.

The television advertising model as it currently stands gives a number of companies in the world a huge advantage because there are massive barriers to entry to promote products on television if you want to advertise at scale. It will be much easier to enter one of these new platforms. You can do very specific programmes if you are developing a new brand on Facebook, YouTube or Google compared with advertising on television.

The Amazon effect

Amazon is a business with an estimated US$260 billion in sales (including Whole Foods), the second largest retailing business in the world after Walmart. It’s a fascinating company. They run a ‘first-party’ business, where Amazon buys the goods, stores them in their warehouse and then sells them to their users via the Amazon website or mobile apps. Then they have a ‘third-party’ business called Fulfillment by Amazon, where other retailers put their own inventory into Amazon’s warehouse and then Amazon sells that inventory to their customers as well. So customers suddenly have a much greater selection, and Amazon charges other retailers rent for having their goods in the Amazon warehouse, then charges a commission for selling to the user base.

Amazon also is a massive logistics company. They are expanding warehouse space by about 30% a year and they are incredibly advanced from a technology point of view. They have developed with a robotics company something called the Kiva robot, with about 45,000 of these robots in their warehouses at the moment. Humans are good at putting goods in a package, adding a label and sending them off. But it’s inefficient for the human picker to run around the warehouse to find the shelf where that good is stored in these massive, multiple football field-sized spaces. So these robots automatically go around the warehouse and bring the shelves holding the product to the packers.

The loyalty scheme called Amazon Prime started out with two-day free shipping, then same-day and 2-hour free shipping in a number of cities around the world. Amazon Prime members receive free video, free music and free ebooks with the service.

Amazon is a also a data analytics company. They understand enormous amounts of information about what the customer wants to buy. Amazon members see web pages that look different to anybody else’s. There are 50 million goods available in Amazon so customers receive a particular look into the world.

Amazon’s Jeff Bezos wants to fulfil all of his customers’ shopping needs. He worked out that if you want to be in their everyday shopping, you need to be in the grocery shopping habit. They started with Amazon Fresh, an online grocery shopping business that’s very niche. But if you want chilled vegetables or meats or ice cream, it’s inconvenient to have them delivered on the verandah if you’re not there for two hours. A lot of people want to look at their fresh fruit and vegetables and not have anyone else choose that for them. So Bezos bought Whole Foods, the largest fresh food retailer in the US. It had a reputation for expensive produce, lots of organics, incredible displays. On the first day Bezos took control, on the key lines people are interested in, he dropped the prices 35-45%. People shop for incredibly good, fresh groceries then everything else can be put together.

He wants to connect your home by the ‘Internet of Things’. Many goods like washing detergent and milk will have computer chips on them that will connect to the internet to know when you are running out. Washing machines and fridges will automatically generate shopping lists. He’s adopting a voice platform for your house with a digital personal assistant.

What’s next?

There’s a massive number of these revolutions. You may think Amazon and Facebook and Google are big at moment, but we’re in the early stages of where this technology and these businesses are heading. Advertising and retailing is the start. Next week, I’ll discuss which large companies will suffer, and bring in the perspectives of Warren Buffett and Charlie Munger.