Thursday, 07 November 2019 08:39

Comedy piece - Google and Pizza ordering

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CALLER:

Is this Gordon's Pizza?

GOOGLE:

No sir, it's Google Pizza.

CALLER: 

I must have dialled a wrong number. 

GOOGLE: 

No sir, Google bought Gordon’s Pizza.

CALLER: 

OK.  I would like to order a pizza.

GOOGLE: 

Do you want your usual, sir?

CALLER:

My usual? You know me?

GOOGLE:

According to our caller ID data sheet, the last 12 times

you called you ordered an extra-large pizza with three

cheeses, sausage, pepperoni, mushrooms and meatballs.

CALLER: 

OK! That’s what I want ...

GOOGLE:

May I suggest that this time you order a pizza

with ricotta, arugula, sun-dried tomatoes and

olives on a whole wheat gluten-free thin crust.

CALLER: 

What? I detest vegetable!

GOOGLE: 

Your cholesterol is not good, sir.

CALLER: 

How the hell do you know!

GOOGLE:

Well, we cross-referenced your home phone number

with your medical records.  We have the result of

your blood tests for the last 7 years.

CALLER:

Okay, but I do not want your rotten vegetable pizza! 

I already take medication for my cholesterol.

GOOGLE:    Excuse me sir, but you have not taken

your medication regularly.  According to our database,

you purchased   only a   box of 30 cholesterol tablets

once, at Walgreens, 4 months ago.

CALLER: 

I bought more from another drugstore.

GOOGLE: 

That doesn’t show on your credit card statement.

CALLER: 

I paid in cash.

GOOGLE: 

But you did not withdraw enough cash

according to your bank statement.

CALLER: 

I have other sources of cash.

GOOGLE:   That doesn’t show on your last tax return

unless you bought them using an undeclared income

source, which is against the law.

CALLER: 

WHAT THE HELL!

GOOGLE: 

I'm sorry, sir, we use such information only

with the sole intention of helping you.

CALLER:

Enough already!  I'm sick to death of Google, Facebook,

Twitter, WhatsApp and all the others.  I'm going to an

island without internet, cable TV, where there is no

cell phone service and no one to watch me or spy on me.

GOOGLE: 

I understand sir, but you need to renew your passport first.

It expired 6 weeks ago... 

Tuesday, 05 November 2019 06:35

Waste Management - turning trash into profit

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Investors seeking an industry sector  - that is almost certain to grow would be wise to take a look at the Waste Management sector.

Andrew Mitchell (Ophir Asset Management) is attracted to the sector because “Waste is a huge industry which will increase with population growth.”  He also likes the high barriers to entry in particular segments of the waste sector such as municipal collections and commercial waste.

The chart below shows the growth in core waste in Australia over a decade with a compound annual growth rate of 1.2%pa.

 

There are three main segments of the waste industry:

  1. Municipal (council kerbside household waste)
  2. Commercial / Industrial waste
  3. Building and demolition (construction and infrastructure)

Municipal and Commercial waste is generally considered ‘recession proof’ among professional investors while building and demolition waste is more cyclical.

Waste Management companies of the future are increasingly focussed on recycling, particularly following the introduction of the Chinese ‘National Sword’ policy last year.  China used to be the biggest importer of recyclable materials globally.  It took 30m tonnes of the world’s waste each year, including Australia’s.  Put simply, China used to buy the world’s recyclable waste, and it largely banned it overnight.  Australia will need to build its own recycling facilities to dispose of the waste appropriately.

Mitchell believes that “it’s becoming a social imperative that more is done with waste.  The call for more to be done on sustainability and recycling is growing louder within the community.  We believe Australians are becoming more accepting now of paying for the cost of sustainability.”

Emma Goodsell (Airlie Funds Management) says “the waste management industry is increasingly focused on building out critical recycling infrastructure.  The issue for the whole waste supply chain is that the cheapest way of doing things is usually the worst for the environment (ie landfill).  So it requires government intervention, in the form of levies on the cost of disposing a tonne of waste into a landfill, to adjust the playing field and allow for investment in recycling assets.”

The graph below shows the growth in recycling over a decade, with compound annual growth of 2.4%pa.

Landfill levies collected by the NSW government alone are approaching $1bn per year and are increasing.  Australia recycles or converts waste to energy for around 50% of waste according to Mitchell, so is considered middle of the pack by global standards compared with the US or developed European peers where this figure is around 80% plus.  Mitchell sees Government landfill levies as a potential revenue pool for Waste Management companies who are able to divert waste from landfill.

Goodsell points to Cleanaway’s joint venture with Macquarie’s Green Investment Group for a Western Sydney plant that will convert waste to energy as an example of business diverting waste from landfill.  This plant is likely to have the capacity to cut landfill volumes by 500 kilotonnes per year.

The biggest risks of investing in this sector would seem to be regulatory.  There is a lack of cohesion between State Governments which results in the waste industry being effectively different in every state.  Landfill levies can vary significantly from state to state and until recently Queensland didn’t charge a landfill levy which saw large movements of NSW waste shipped across the border.  Lack of uniformity in bin sizes across states increases costs as trucks need to be designed differently for each state.

Mitchell believes that Governments are slowly realising that more needs to be done in the waste sector, particularly with more national cohesion noting that there is now a Federal minister for waste reduction.

The ASX is home to one of the worlds’ largest listed waste management companies,  Cleanaway (formerly Transpacific Industries), and Bingo Industries is a relatively new addition to the ASX.  Mitchell is attracted to Cleanaway as “we like the more stable and defensive earnings streams of Cleanaway (mainly municipal and commercial) whereas Bingo operates in the more volatile/cyclical building and demolition space.  There are also a lot lower barriers to entry in that part of the market (Bingo Industries)”.

Most investors would associate waste management with garbage collection, where as the future lies with the recycling of waste.

 

This article was written by Mark Draper (GEM Capital) and appeared in the Australian Financial Review during October 2019

Tuesday, 05 November 2019 06:32

Best of the Best - October 2019

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The team at Montgomery Investments produce a magazine "The Best of the Best".

In the latest edition they discuss:

1. Five Global Investment Themes

2. Reliance Worldwide

3. Flight Centre

and much more.

 

Click on the report to download your copy

Best of Best image Oct 19

Friday, 04 October 2019 07:24

Retail Property - apocalypse or rebirth?

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Every month Mark Draper (GEM Capital) writes a column for the Australian Financial Review.  Here is the column that featured in the month of September 2019.

 

Often investors accept a simple thematic to determine their investment view on an entire sector.  Amazon’s entry into Australia was to be the death of our retailers, but JB Hi-Fi and Super Retail Group’s recent good results have defied this theme.

A common investment theme is that the internet will turn shopping malls into museums and investors in retail property will be left with a worthless asset.  Those who believe such a simple thematic without further investigation could well be passing up high investment income from some attractively priced retail property assets.

The bears of retail property will refer to the US experience of shopping malls being closed and 5 – 6,000 shops going out of business last year as reasons to avoid the sector entirely.

While it is true that US shopping malls are closing, Hugh Giddy (Investors Mutual) and Hugh Dive (Atlas Funds Management) believe that it is dangerous to extrapolate these closures across the entire global retail property sector as the US retail property market is over supplied.  This was due to overbuilding of malls between 1970 and 2015 where the number of malls in the US grew twice as fast as the population.  The chart below shows the level of commercial retail space in the US per person, compared with other countries.

Dive says “the thesis that all shopping malls are ruined and are going down, doesn’t account for the changing composition of tenancies”.  The better shopping centres are changing their tenancy mix to include more services and experiences.  This is likely to appeal to a wider audience including the Millennials who are less focussed on “things” and more interested in experiences.

Dive adds that “the good shopping centres are placing more emphasis on dining, entertainment, fitness, massage, healthcare and education services – things that can’t be easily delivered online”

Giddy says that “traditionally shopping centres were anchored with department stores and fashion apparel shops but those tenants are reducing space which is being taken up by medical centres and other service providers.”  Cinema admissions are still strong, and consumers are attracted to the shopping centres to watch movies.  Giddy asks “why are people still going out to the movies?, because they don’t want to only watch a movie on DVD or Netflix, it’s a social experience”.

Giddy points out that the shopping centre sector is turning into ‘the haves and the have-nots’.  The ‘haves’ are the centres that are well located in densely populated catchment areas, near transport hubs offering a diverse range of shopping and entertainment experiences.  He quotes Chadstone, Bondi Junction, Westfield London and Pitt Street Mall as examples of ‘the haves’ which are very high quality centres that have no problem filling their locations with shoppers and tenants.  This provides investors with high occupancy rates and rental income certainty.

The ‘have-nots’ which should be treated with caution, are typically located in regional locations with low catchment population, offering a narrow range of shops and services.

The strong shopping centres are also building residential apartments over them to capture value from the air rights over their centres.  Dive said that “Vicinity plans to build 900 apartments over the Chatswood shopping centre to capture value from the air rights.  In 2017 Vicinity also sold the air rights to a developer for $60m over their Melbourne shopping centre, and this development should be completed by 2020.”  Not only are the shopping centres capturing value from selling air rights, but they are also capturing additional shoppers who will reside within the shopping centre complex.

Investing into retail property can be through owning individual listed property trusts such as Scentre, Vicinity and Unibail Westfield or via managed funds and ETF’s.  Unlisted property trusts are unlikely to offer access to the type of retail properties described as ‘the haves’.

The risks to retail property investors include prolonged economic downturns that result in reduced consumer spending although Giddy says “during the GFC the Westfield Group held up quite well”.  Continued online competition will put pressure on the amount of bricks and mortar retail space required but Giddy argues that consumer brands are still going to want to have physical presence in the premium shopping centres as a branding opportunity.

Friday, 04 October 2019 07:18

Cloud computing the global growth opportunity

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Mark Draper (GEM Capital) writes a column for the Australian Financial Review every month.  Here is his column that featured during the month of September 2019.

 

What do Amazon, Google and Microsoft have in common?  They are all huge players in the world of global cloud computing.  Most would associate Amazon with online shopping and yet Amazon’s cloud business generates more than 50% of group income at a margin of 28%, and the most recent quarterly revenue grew by 37% from the previous year .  Very few large businesses have the capacity to grow at this rate.

Cloud computing is defined as using a network of remote servers to store, manage and process data, typically delivered via the internet rather than using a local server or personal computer.

The simplest example of cloud computing is business email.  Many businesses used to run their own email servers where they would buy the server hardware, buy the email exchange software and then pay an IT specialist to install and manage the email service.  That can all now be replaced by using Microsoft’s Office 365 which is a cloud based solution.  In essence cloud computing results in businesses and consumers renting services rather than owning the hardware and software.

The benefits of using cloud computing are that consumer and business users do not need to incur a large upfront cost to buy hardware and software and instead access these services more quickly, reliably and securely than traditionally.  It is often less expensive for users to access services from the cloud.  It is these reasons that provide optimism for the continued growth in the cloud.

From an investors perspective, it is important to identify 3 key segments of cloud computing.  Infrastructure as a Service (IaaS) delivers computer infrastructure on an outsourced basis.  Typically IaaS provides the hardware, storage, servers and compute services.  Secondly, Platform as a Service (PaaS) includes application development, security, databases, analytics and tools that the applications depend on to work.  Differentiating between IaaS and PaaS is difficult as they are often provided by the same company.  The 3 dominant players in these segments are Amazon, Microsoft and Google.

Scale is important for IaaS/PaaS players to support the operation of large, globally distributed data centres and the development of complex software underlying the rapidly expanding functionality of IaaS/Paas.  Kris Webster, (Portfolio Manager Magellan Financial Group) believes that the market outside of China will be dominated by Amazon, Microsoft and Google for that reason.  He says that the current annual revenue from cloud computing infrastructure is below US $100bn but forecasts the addressable market by 2030 to be US $800bn per year.

Finally, Software as a Service (SaaS) is also known as cloud application services in which end user software is rented on a subscription basis and is centrally hosted.  Common examples of SaaS are Adobe Creative Cloud and Dropbox.  Before the cloud, Adobe Professional suite of software would attract an upfront cost of well in excess of $1,000.  The high upfront cost often led consumers to pirate the software.  According to Webster, “Adobe has done a terrific job at bringing in the pirates to its network and thereby generating additional revenue, by charging a more affordable $50 monthly subscription”.

Other common examples of SaaS are music subscription services and video on demand services such as Spotify and Netflix.

Andrew Clifford (CEO Platinum Asset Management) highlights that many SaaS companies trade in the range of 15 – 25 times sales (not earnings).  He believes that the likelihood of any company growing fast enough for long enough to justify such valuations is very low.

Platinum are instead investing in companies that produce memory chips for computers and data centres that stand to benefit from the growth in cloud computing.  Some of these businesses can be purchased on single digit earnings multiples.  Platinum are also significant investors in Alphabet which owns Google.

Risks to the investment case for cloud computing exist if the switch to cloud computing is slower than forecast due to security or other concerns.  Counter to this point NAB’s IT executive Steve Day said recently “the cloud providers have realised they are so large, they can invest in the sort of security a bank like NAB could only dream of”.

With forecast growth of cloud computing of over 20%pa over the next decade, investors can not afford to ignore this sector.

Tuesday, 03 September 2019 15:10

Demergers - the hidden treasure

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Mark Draper (GEM Capital) writes a monthly column for the Australian Financial Review.

This column was published in the month of August 2019 in the AFR.

 

There have been many Australian demergers in the last 15 years and well known US investor Joel Greenblatt says “there is only one reason to pay attention when they do; you can make a pile of money investing in spin offs”.

A spin off, created from a demerger, is the establishment of a separate independent company through the sale or distribution of new shares of an existing business or division of a company. Generally the reason behind demergers is the belief that the demerged company will be worth more as an independent entity rather than being part of a larger business.  

Unrelated businesses may be separated via a demerger so that the separate businesses can be better appreciated by the market. Sometimes the motivation for a demerger comes from the desire to separate out a ‘bad’ business so that an unfettered ‘good’ business can shine through to investors.  There are many other reasons why a company would pursue a demerger, but broadly the idea is to create the environment where 1+ 1 = more than 2.

Paint company Dulux is the poster child for the demerger Fan Club according to Matt Williams (Portfolio Manager Airlie Funds Management).  He quips he is the founder, president and treasurer of that club.   “The simple fact is that demergers have a higher probability than not, of adding considerable value. In 2010 Orica shareholders received one Dulux share for each share they owned in Orica. Dulux shares closed at $2.54 on its first day as a stand-alone company. Nearly 10 years later shareholders will receive $9.75 as giant Nippon Paints adds Dulux to its stable. The total shareholder return for Dulux over this period was more than 20% p.a.” said Williams.

Goldman Sachs analyst Matthew Ross in a research paper on the value of demergers showed that Australian ASX100 demerged entities on average have outperformed the market by 18.5% in the first year post demerger.

That same study found that one of the significant drivers of value for the shareholders in the companies involved in demergers, was that they typically increased the prospect of a takeover of either business.  Shareholders in demerged companies Dulux, Recall, Sydney Roads, and Rinker can attest to this assertion.  Demergers where the parent company still owns a stake such as Coles lessens this likelihood.

Williams said that “like all good things its pretty simple, demergers work because:

-      They allow good businesses previously trapped inside a conglomerate to be valued more precisely by investors.

-      Management can be properly incentivised and rewarded thereby driving positive outcomes and

-      Companies are able to be taken over, or if not at least a ‘control premium’ can start to be factored into the share price”

Investing in spin offs is not smooth sailing immediately following demergers however as quite often the spin off company is initially sold by investors.  This is because spin offs can often represent a small holding in the context of an investors’ portfolio and therefore sold as nuisance value.  Alternatively institutional investors sell as they are either not allowed to own stocks below a certain market size or they simply do not understand the new spun out business.  After the initial period when this wave of selling is done, an investment in a spin off can be lucrative.

Joel Greenblatt says that “both spin offs and merger securities are generally unwanted by those investors who receive them. Both spin offs and merger securities are usually sold without regard to the investment merit”.  This often results in the immediate performance of a spin off post demerger being poor.  He adds “as a result, both spin offs and merger securities can make you a lot of money.”

So enthusiastic about demergers is Greenblatt that he dedicates an entire chapter to the subject in his book “You can be a stock market genius”, which is well worth a read.

The next demerger that is proposed for Australian investors to consider is Woolworths spinning off their drinks division, good luck in the treasure hunt.

 

 

Tuesday, 03 September 2019 15:00

The Best of the Best - August 2019

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Montgomery Investments team have prepared anohther bumper issue of "The Best of the Best".

This edition includes:

  • The 2 big themes for Aussie Investors
  • Risk perception for the modern investor
  • Do we view Brambles as a high quality investment?
  • Does Challengers announcement imply good news

 

Click on the image below to access the report.

Raymond Dalio (born August 8, 1949) is an American billionaire investor, hedge fund manager, and philanthropist.[3] Dalio is the founder of investment firm Bridgewater Associates, one of the world's largest hedge funds.[4] Bloomberg ranked him as the world's 58th wealthiest person in June 2019.[5]

What Ray Dalio says matters.  For further perspective we know that successful Australian global investor, Hamish Douglas (Magellan Financial Group) seeks Ray Dalio's views on a regular basis.

Ray Dalio has been involved with China for decades.  He assisted China estabilsh their stock market.  In this video he discusses the current trade tensions between China and the US and sees them as a natural development.

He also puts the rise of China in perspective by comparing it against the rise of the UK and US in history. 

Ray Dalio believes that the biggest risk for investors is not having exposure to the Chinese economy.

 

 

 

 

 

 

 

 

 

 

 

 

Transcript

Jim Haskel:
I'm Jim Haskel, senior portfolio strategist. I'm here with co-CIO Ray Dalio and the subject today is China. And Ray, you've been going there since 1984, a lot of experience, China in the news today in many different regards. Can you walk us through a little bit about your experiences and how you've seen China evolve over the last 35 years?

Ray Dalio:
I've been able to go to China since 1984 and participate and see the evolution. Yeah, and it's been quite something. The first time I went, I was invited by CITIC, which was called a window company then, which was the only company that was allowed to deal with the outside world, and they were curious about the world financial markets. I was invited there.

At the time, the city was mostly Hutongs, which are small neighbourhoods, poor neighbourhoods. I remember speaking in their office building, called the Chocolate Building, and looking outside, and we were talking about opening up. And at the time, I knew what opening up would mean. The rest of the world had a cost and level that was here and China had a cost level there, and if they could eliminate their inefficiencies, it would go like this.

And so, I looked out there and I said, "You'll see those Hutongs become replaced by skyscrapers and so on." And they told me, "You don't know China," but that force and their character and the creativity that they exhibited took them to what is the greatest economic miracle of all time.

To put that in perspective, per capita income since then increased by 26 times. The share of world GDP went from 2% to 22% today, so it's a comparable power of the United States. The poverty rate went from 88% to less than 1%. And the life expectancy increased by 10 years. There're many, many others, and capital markets, very big changes.

But I never went for making money, I went for curiosity, you know? And that curiosity brought me in contact with the Chinese people who I really, really came to love and admire. The character of them, what type of relationships that they value, all of those types of things.

And I could see that character, and I was able to, over those years, build friendships, I was able to contribute in some small ways to the development of the financial markets and see it. And I remember these people, I have a great old group of friends who were the first pioneers to set up the stock market there.

There were seven companies, each had a representative, and it was in a dingy hotel, and these people were to form the stock market and the financial markets, and so evolved, and that evolution was an intimate evolution in which I brought my family, I brought my kids.

I remember bringing my son, Matthew, when he was very young, along and we would go in, and we'd have meetings, and they'd bring cookies and milk, and he'd be there, and he ended up going to school there when he was 11. It was a whole different world. He lived there.

And that whole different world, just to give you an idea of technology, you know where they are in technology now, which is comparable in many ways to the United States, when I went, I would bring them, as gifts, $10 calculators that they thought were miraculous.

I've gotten to know the people. I go there because I like and admire the people, and I've done that for 20 years or more before we ever did anything commercially.

Jim Haskel:

And so, we're sitting in a time now where China has evolved in a big way, and I wonder, just from your perspective, as an American who's gone to China for years and years and years, how do you make sense of this growing conflict that you've written a lot about between China and the United States? What do you think is the root cause of that?

Well, it makes total sense in a historical context. You know, I've been studying economic history, I used to study what the last 100 years is, and recently, because I wanted to study the rises and declines of reserve currencies, I've studied the last 500 years carefully, and I've looked at the last thousand years.

What I've seen over and over again is that when there's a rising power challenging an existing world power, that there is going to be a conflict. There's a global order, world order, and the way that usually happens is there's a conflict and there's a war quite often, and then after the war, whoever wins the war gets to set what the global world order is.

And then you have a period of peace because no country wants to fight that country until there's a rising power challenging an existing power again. That's happened 16 times in the last 500 years, and in 12 of those times, there's been wars, and sometimes you get around them. I'm not saying this is going to be a war, but I think it's a natural development in terms of China growing, expanding.

We have a small world and it's a big country, and we're going to bump into each other, and so it's that natural conflict. And then the question is how it's best dealt with, but I think just a natural evolutionary step.

Jim Haskel:

And you've sort of put the framework around this where trade is just the symptom of this broader conflict, whereas trade is always in the financial news, but it's really just one symptom. There's also military posturing, there's other elements of this whole conflict.

Ray Dalio

Sure. History has shown us that there's this pattern. I'll describe the pattern. We're now living in a US dollar reserve currency world, so I want to look at the US dollar and the US empire. Before that, I wanted to look at the UK and the British empire, and then before that, I wanted to look at the Dutch empire, and I wanted to follow them in their various dimensions.

I read all of those stories. I looked through the numbers and I read the stories, and I could see that the stories would repeat, the same basic stories. The charts on this page show six major measurements of power.

  • The first is technology and education. 
  • Second is output, how strong the economy is. 
  • Third is trade. 
  • Fourth is military. 
  • The fifth is the strength of the financial centre. 
  • And the sixth is reserve status.

What we did is to stitch together a whole bunch of statistics so that we could measure each one of those. And so, they go back to 1500 and you could watch the cycle repeat over and over again.

This next chart shows the averages of these rises and declines by each of the factors, and I think they tell the story pretty well as to what a classic rise and decline of the empires and reserves currency status is. For example, the Dutch, back in the 1600s, late 1500s and early 1600s, invented ships that could go all around the world.

And because Europe fought a lot, they put arms on the ships, and then they could go all around the world, and the world was their oyster. They could bring back great things. And they then increased their share of world trade to be 50% of world trade.

And when they went global, typically through their businesses, Dutch East India Trading Company, they had to be enabled with military to protect their trade routes, and they developed financial empires.

As a result, we saw not only trade grow, we saw the military grow, we saw them carry their reserve currencies around, and because they were used so commonly, they became world currencies and that's what made them world reserve currencies.

And as a result, they also developed financial centres because they developed capital markets, money came from around the world to invest through those capital markets in those currencies in those businesses that were their businesses and other businesses, so they developed financial centre. Amsterdam was the centre of world cap financial markets as a result of that.

And as a result, they built their trade and their commerce together. They quite often, then, over a period of time, there were forces that led to their decline, and those forces were typically a combination of higher levels of indebtedness, others gaining competitive advantage.

For example, the Dutch ship builders were hired by the English to learn how to build great ships that would carry them around the world, and there was a change in technology, and there was really not much of a difference between the businesses, the technologies, and the governments in terms of making those things happen.

For example, the British East India Trading Company had a military that was twice the size of the British military, and they were the ones that conquered India and so on. I just put together the averages of those forces so that you could just see, let's say, the average power, and it goes back to 1500.

And you could see the blue line is the United States, and you could see its rise and then its relative decline, and you could see the emergence of China to be almost a comparable power.

You look at the red line over a period of time and you could see going back to 1500 that China was always one of the highest, most powerful country, or one of the most powerful countries, until they had the decline from about the 1800 period, but you could see that emergence. And so, to me, this is all very classic.

Jim Haskel:
Now, if you bring this back to the current conflict between the United States and China, I think what's so interesting is that you also believe that global investors must look at China and explicitly start to consider whether China should be part of their portfolios. And so, it seems kind of interesting. We're talking about an emerging conflict, but we're also simultaneously talking about there's really some merit for China to be a component of a global portfolio. Give us your perspective on that and why.

Ray Dalio

Think about it. 

Would you have not want to invested with the Dutch in the Dutch empire? 

Would you have not wanted to invested in the Industrial Revolution and the British empire? 

Would you have not wanted to invested in the United States and the United State empire?

I think it's comparable. Would you not want to invest in those places? And look at the growth in the markets. Over the last 10 years, the stock markets in China has increased, market capitalization, by a factor of four. The bond markets, combining both the government and the corporate bond markets, have increased by a factor of seven. And they're each the second largest markets in the world.

And I've had plenty of contact with those markets and with those people, the regulators and so on behind them, and I have a lot of admiration for that. I also believe in diversification. Yeah, I believe that China's a competitor of the United States, or Chinese businesses with be competitors of American businesses and other businesses around the world, and that you're going to therefore, you want to be, if you're diversified, having bets on both horses in the race.

And then I think, from investing over the years, I've been doing this for a long enough period of time to know that there's a tendency of bias not to do the new things. When I first started, we were at the end of an era where pension funds invested mostly in bonds.

Okay, then they thought it was bold to go to equities, then they thought it was bold to go to international equities, a lot of people argued against going to global equities, and so on. Emerging market equities, and emerging markets, all of that was considered to be bold.

And so, the thing that people haven't yet done, seems like the big risky thing, where, in my opinion, going where the growth is and also having the diversification is a smart thing to do.

Jim Haskel:
When you consider the merits of that, even if you agree with what you're saying, is now the time when the trade part of the conflict may be getting even more serious because we're moving from tariffs into things like supply disruptions, and export interruptions, and prevention of particular exports? Is timing an issue, or do you ignore that completely?

Ray Dalio:
Well, the markets, as you know, are always discounting timing, right? If you have a new, good thing happens and the markets rally, if you have a bad thing that happens and the markets sell off, and so the markets kind of reflect, broadly speaking, the ebbs and flows and the good and the bad.

And so, if you wait for everything to be crystal clear, everything's going to be terrific, you'll pay a higher price than if you don't. I think the real question is, are we going to go to war? If we go to war, then we're in a different world.

I don't think we're going to go to classic war, I do think there's going to be a restructuring of the world order in terms of changes in supply chains, there'll be changes in who's making what technologies, important changes and sort of those things. But I don't think that that's going to mean that there won't be the evolution of China, the evolution of the United States, and I think that that diversification is good.

Yes, I would say that now is the time. The reason now, now is the time that it's opening up. Now, you could be early or you can be late. I think that it's better to be early because, as you know, the inclusion and the MSCI indexes and other such things are meaning that they're opening up, and that will accelerate, those percentages will keep rising.

And so, do you want to be early or do you want to be late? It's better to be early that it is to be late. And I think, also, it's a time for diversification.

Jim Haskel:
Right. Investing in China can be a risky thing to global investors, that's the way they perceive it. How do you think about that relative to the other risks they're already carrying in their portfolios?

Ray Dalio:
I think that every place is risky. We're talking about relative risk, okay? 

I think Europe is very risky. When monetary policy is almost out of gas, and we have political fragmentation, and they're not participating in the technology revolution, and I can go on and on as to why I think Europe is very risky.

I think the United States is very risky in its own ways, having to do with the combination of the wealth gap, the political system, the conflict between socialism and capitalism that'll be part of our election, the fragmented decision making, so many different things, and the absence of the effectiveness of monetary policy.

I think emerging markets, in their own ways, have their own distinct risks, and I think that China has its own particular, distinct risks, which are all different. When I look at it, I think that it's less, or no more, risky in the totality than other markets, and I think what is most risky is not to have a good diversification of those markets.

In addition, the Chinese have more ability to deal with monetary and fiscal policy relative to the United States. I'm not saying everything's a plus, there're pluses and minuses. But as you know, one of my big concerns, and I've got a number of big concerns about the United States and some of the issues that are facing the western economies, and among those are the inability of central banks to be as effective when interest rates get to zero and quantitative policies, quantitative, monetary easing is not as effective.

Let me pause on that and touch on that. If you look at the difference in interest rates to zero and the capacity of fiscal policy to be coordinated, they have a lot more room to be managing those things, and they are managing. I mean, I don't know how long I've heard everybody say, "Okay, the debt problem is going to be a problem there," and so on.

Again, I'd suggest you read the dynamics of my book about the nature of debt and what countries can do when the debt is in their own currency. I also think that not investing in China is very risky. I mean, think about it. Here we are in the early part of 21st century and there's this emergence of China. Do you really want to make the decision not to invest in China and not to be there in the future?

Look, I believe every place is risky. I'm very risk-focused. I tend to see things that are going to go wrong. I have an inclination to do that. I think every place is risky, which is why I like the notion of diversification. I just want people to see China objectively.

I know, over this past number of years, that I have been very pro-China, very bullish on China, in its various ways, and people say, "Why are you so bullish on China?" And I know it's very controversial to be, particularly in this time, to be very bullish on China.

I just want to let you know that I'm sincere. Okay? I've been there. Because I hope you know by now that my main objective is to be as accurate as I possibly can. Yeah, I really admire what is being done, and I want to be a part of it, and I think our investors should be a part of it.

Jim Haskel:
I want to ask you about the best way to actually invest in China. What we see is that most of the portfolio flows go to either the private equity markets or the public equity markets, and that's a little countered to your framework of how you invest across time and throughout the world. How would you think about best approaching the Chinese markets as a new investor?

Ray Dalio:
Well, I wouldn't think of it as being any different than in any other place. Public markets and the liquid markets are going to allow all the advantages that they allow, and the private markets are going to allow all the advantages that they allow.

The public markets are going to provide the liquidity, the diversity, the ability to move positions around and rebalance and so on, which is very important to us. And then the private markets, let's say the venture markets, expose one to the new technologies and the energy that's happening in terms of entrepreneurship and young technologies there, and I think that's important.

I think there's an awful lot of money that is chasing those venture capital investments, and then I think there's a whole lot of opportunity. I would say it's a reflection, really, of how that country has changed. Wow. From my $10 calculator days, to see what the mind-blowing technologies are.

To put that in perspective, they're now the number one country in fintech, number three in AI and machine learning, number two in wearables, number two in virtual reality, number two in educational technology, number two in autonomous driving, and they are wanting fast to be number one in those industries.

They now account for 34% of unicorns in the world, by comparison the 47% in the United States and only 19% in the rest of the world. And in terms of ... That's when they start as unicorns. If they take the share of unicorn value, it's 43% versus 45% in the United States and only 12% in the rest of the world.

If you're looking at venture, I think you've got to be there, so I think it would be important not to miss out on those. As far as the public equity situation, it's analogous. You could see the market capitalization accelerating in the stock, bond, corporate bond markets, all of their instruments, and you could see the foreign flows coming in at an accelerating pace.

You can expect those markets to be bigger than the markets that we have anywhere in the world with time, and they will serve a similar purpose. As far as, let's say, the legal regulatory system, it's advanced, but it hasn't advanced as much as some of the developed countries, but it is more advanced and developing at a fast rate than most of the emerging countries.

And if you deal with the question of whether it's a more autocratic system and whether you prefer a more autocratic leadership system than a democratic leadership system, you'll have to make that choice for yourself. Don't look at it as some unique place in terms of some of those impediments, look at the whole picture.

I would say that the Chinese or Confucian way of approaching things has a lot to be said for it, so you have to make your own choices.

Jim Haskel:
Let's get back a little bit to some of the questions that investors have. For example, should they think of China as an emerging market investment, should they think of it as a developed market investment, somewhere in between, in terms of the expected return, risk, correlation of that investment? You talked a little bit before about diversification, but what about the expected return and risk of an investment in China, and how would you structure that?

Ray Dalio:
When you asked me the question of is it more like an emerging country or more like a developed country, so many different aspects of what defines an emerging country or a developed country's market vary.

So what is the size of the market capitalization? What is the legal form? What are property rights? Just so many different dimensions, but I would make as a generalisation that China is somewhere between 60 or 70% more like an emerging country, 60 or 70% more like an emerging country in those respects than it is like a fully developed country.

It doesn't have a regulatory system that is as developed as the developed countries that have been at it a while, it doesn't have some things. It has market capitalization, it has liquidity, and that's a two-edged sword. It has also greater levels of inefficiency. The greater levels of inefficiency provide investment opportunity. As a generalisation, I would describe it that way.

If I'm looking at it instead in the question of expected returns and risks, I think, as you know, I look at each market and I look at the return relative to the risk, the expected return relative to the expected risk, and the past return relative to the expected risk and what drives it.

By and large, I find developed markets and emerging markets roughly comparable, and that being able to put together portfolios of those in an effective way is the way to engineer that portfolio.

When I look at China, I think that the expected return relative to the expected risk will be equal to or perhaps higher than elsewhere, partially because of the fact that there's the diversification that you could have and put together well.

But also partially because of the greater capacity of the central banks, the central bank, I should say, in being able to ease monetary policy and also run fiscal policy to be able to have a higher ratio. I think that that would be a plus.

Jim Haskel:
You've traced the arc over the last 35 or so years of Chinese history and described the evolution, if you look now forward five, 10, 15 years, what do you think the highest probability, what will we be looking at when we look at China's evolution?

Ray Dalio:
We'll be looking at a very different world, and we'll be looking at a very different China, and we'll be looking at a very different United States in five, 10, 15 years. In some ways that we will never be able today to anticipate, and in some ways that are inevitable in kind of the same sort of way that demographics is inevitable.

The following charts probably help to answer your question. They show a number of statistics, including the sizes of the economies, the relative sizes of the economies, the relative shares of world trade, the shares of the global market equity market capitalization, the shares of the global debt market capitalization over the next number of years.

These projections are based on our 10 year forecast that look at a lot of indicators to determine what the next 10 years growth rate is going to be, likely to be. They're based on the relationships between those types of growth rates and changes in market capitalization, and also work that's now being done to develop the market capitalization and open those economies.

They're not going to be exactly accurate, but they're going to be probably pretty much accurate. In a nutshell, it's going to have the largest economy in the world, the most trade in the world, the most market capitalization in the world.

Jim Haskel:
Those are big changes.

Ray Dalio:
Yeah. And the United States, and Europe, and Japan, and emerging countries are going to have big changes, too.

Jim Haskel:
You're sketching out a continuation of some dramatic trends that have already taken place. Any threats that you see to that progress going forward?

Ray Dalio:
Well, I mean there're always threats. I think the threat is the threat of conflict with the United States in whatever form that'll be. And then, there are always threats. They have to do with probabilistic things. You can have threats that'll affect our countries in terms of anything from climate change issues, pandemics, political disruptions. There's that whole range that can affect any of those countries.

Jim Haskel:
Ray, we've covered a lot. We've talked about the evolution of China, the opening of the capital markets, how to think about it from an investment point of view. I thank you for your time and perspective, and I look forward to sitting down once again and updating this in the not too distant future.

Ray Dalio:
It's my pleasure. It'll always be interesting.

Friday, 19 July 2019 10:29

Afterpay - the elephant in the room

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The daily gyrations in the Afterpay share price recently has given investors motion sickness.  In the light of new information ranging from the Austrac investigation, to Visa announcing a competitive threat, Afterpay investors have been re-examining the investment case.  Here we outline some of the thinking from 3 professional investors on this ASX top 100 company.

Afterpay has changed the habits of millennial spenders who prefer to pay in instalments mostly with debit cards to avoid the punitive interest rates and application process of credit cards.  Afterpay users purchase goods upfront and pay for them in 4 instalments, but the retailer receives the funds upfront from Afterpay. The consumer doesn’t pay interest on the transaction.  

Afterpay makes its money from charging retailers a merchant fee based on the transaction size.  Although Afterpay can charge a late fee in the event of a failure to repay the outstanding amount, the majority of Afterpay’s revenue comes from merchant fees.

“Retailers love Afterpay as average purchase size increases” according to Nathan Bell, Intelligent Investor.

Bell believes that the Austrac issue is of little long-term consequence, even under a worst case scenario.

Andrew Mitchell, Senior Portfolio Manager, Ophir Funds Management was one of the first institutional investors in Afterpay and says that while Australia now boasts 2.5m active Afterpay users since starting 4 years ago, “this is a sideshow to the real opportunity lying offshore with the US market approximately ten times the size and the UK market around three times larger.  Early signs are positive in the US where the monthly rate of customer signups has been higher than the experience in Australia with already over 1.5m active users after just 12 months.”

Late last year when Afterpay’s share price was under intense pressure, Mitchell travelled to the US to speak with retailers personally.  When he discovered the surging take up rate of Afterpay by several leading US retailers, Ophir doubled their position.  Afterpay recently confirmed that they have 4,400 retail partners in the US.

Nathan Bell thinks that Afterpay collecting so much data on spending habits could also lead to new services.  In a wildly bullish scenario he says, Afterpay could eventually have much more in common with a bank than it does today.

Michael Glennon, Glennon Capital is of the view that by being the first to the market does offer the company an advantage. “The best case for Afterpay is that it becomes a globally recognised brand like American Express” he says.  He thinks management is doing a good job and while Visa announced plans to enter the buy now pay later space he adds “these people (Afterpay) have got it right, I’m not sure Visa will get it right”.

Some broker research is dismissive of the threat from Visa as 80% of people using Afterpay don’t have a credit card, and instead use a debit card.  Glennon says that while the threat from Visa may not be in itself company changing, it does tell investors that “if Visa are looking at Afterpay, then you can bet others are too”.

Other risks to the Afterpay business according to Andrew Mitchell include ensuring responsible lending to consumers is adhered to, changes to regulatory framework governing the buy now pay later industry and a material increase in bad debts.

Nathan Bell adds “there have been several governance issues, and the founders have been selling large amounts of shares. This is typically a big red flag, but I would sell some shares at the current price too if I was them.”

The big elephant in the room is valuation. While rapid revenue growth is assured given its early success in the US, Afterpay must continue to grow sales quickly to justify a forecast market value to sales ratio of around 10x revenue based on 2021 estimates.  Those investors with grey hair will recall that the last time the market priced businesses on a price to sales basis (rather than price to earnings) was during the dot.com boom.  

Future growth in the US could of course justify the lofty valuation, but investors would be wise to closely monitor the US rollout.

 

This article is general advice only.  The author does not own shares in Afterpay.  This was published in the Australian Financial Review during the month of July 2019.

Monday, 01 July 2019 08:36

India - the next big growth opportunity

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For investors simply seeking growth tail winds, India has a far clearer economic growth story than China according to Douglas Isles, Investment Specialist at Platinum Asset Management, although he acknowledges that in practice investing is more nuanced.  

Already the world’s 5thlargest economy, with forecast growth of 6-8%pa over the next decade, India is likely to become one of the three largest economies alongside the US and China by 2030.

It is unlikely to be another China though, as India’s Government can’t simply mandate growth in the same manner as China. India is currently where China was around 15 years ago according to Mr Isles based on GDP per capita figures.  Each home to populations of around 1.4bn people, India and China are to become economic heavy weights in the coming decades.

 

 

 

 

India’s scale is extraordinary.  By 2025, one fifth of the world’s working age population will be Indian.  By 2030 there will be over 850 million internet users in India (currently around 500m) Source: Australia’s Dept of Foreign Affairs and Trade.

The Modi Government was re-elected in a landslide victory in May.  His first term was punctuated with many reforms including the introduction of GST, bankruptcy and insolvency changes, digitisation of subsidies which has resulted in large numbers of Indians now having bank accounts, and a steep rise in infrastructure spending on building roads, rail and electrification to power the nation.

India’s road and rail networks are critical to increasing its population’s standard of living and economic prosperity as they connect farmers to markets, children to education and goods to consumers.  During Modi’s first term, India built almost 200,000 km of rural roads. (that is building the road from Adelaide to Melbourne 275 times).  The number of rural villages connected by roads grew to 91%, up from 56% in 2014.  

Modi’s new Government has pledged 100 trillion rupees (US $1.44 trillion) over the next 5 years for infrastructure investment. This is huge considering the expenditure on roads and railways was only about 1.2 trillion rupees for the 12 months to March 2019.

Jack Lowenstein, Morphic Asset Management, believes that the infrastructure sector is one of the greatest opportunities in India and the sector presently looks cheap.  He adds “financials offer the best returns in India, but having seen so many false bottoms to what is now a nearly decade long bad credit cycle, we are going to sit on the sidelines until we see momentum in the recovery story.”

Douglas Isles, empathises and says “India’s banking system has gone through a process of repair, which sets it up for the prospects of an investment boom, perhaps akin to what we have already seen in China. 

This should be good for banks, and companies benefiting from investment in infrastructure. While it benefits the consumer, stocks in that area are well-liked, and the overall market, like the US, trades at all-time highs. This is a stark difference from China, but note that India is at an earlier stage of its economic evolution, and as a democracy, remains more chaotic than its northern neighbour.  The paradox of markets is that a simple growth story does not make such a simple investment case.”

Investing in India through global ETF’s or actively managed funds is the obvious way of gaining exposure to the India thematic.  But it is not just Indian companies that stand to prosper from India’s infrastructure boom.  

Australian businesses who provide finance, maintenance / construction expertise, or other products and services could also be beneficiaries.  

Some of the questions that Australian investors need to ask themselves are:

  1. What Australian goods are likely to be sold to Indian consumers (think A2 milk to Chinese consumers)
  2. What Australian expertise could be exported to India? (perhaps education, infrastructure maintenance)
  3. What Australian companies may be able to assist in the financing of Indian infrastructure? (Macquarie Group is the business automatically linked to infrastructure investing)
  4. Will the increase in infrastructure spending create the environment for another resources boom?

As legend investor Kerr Neilson (Platinum Asset Management) says “Investors have to invest on the basis of what the world is likely to be, rather than as it is now”.  Therefore investors would be wise to think about ways they may be able to gain from the rise of India over the coming decades.

 

This article was written by Mark Draper and published in the Australian Financial Review in June 2019.