What are the best opportunities for investors?

18 April 2017

Publication: The  Constant Investor
Author: Alan Kohler
Date: 18 April 2017

In the FUNDamentals, we invite fund managers to write exclusively for The Constant Investor and address our question of the week.  We also summarise the latest opinions of leading fund managers to bring you a range of views in one convenient location.

What are the best opportunities for investors?

John McBain  – Group CEO of Centuria Capital

Listed and unlisted real estate can provide both yield and capital gain 
2017 hasn’t been the easiest year for investors. Facing into media and market noise about low rates, global market volatility and geopolitical uncertainty can feel a bit like staring into the abyss.

It’s dark, hard to see your way through it, and while the risks are visible, the end destination is murky. There is a whole conversation to be had about investor expectations in that environment – are investor’s target returns and reality just too far apart? In many cases yes. In others maybe not, as long as we think more broadly about opportunities. In more uncertain times, there is a real appetite for investments which can provide a stable, yet reasonable yield, without foregoing the possibility of capital growth over time. That’s where Australian commercial real estate comes in. As an asset class it behaves somewhat differently to markets that react strongly to some of the risks I talked about earlier, making it worth a closer look.

Both listed and unlisted real estate can offer investors strong yield as well as potential for capital gain, and in our view, should be included as part of a well-diversified investment portfolio. In the case of the Sydney office market, offshore money looking for a safe haven has played its part in keeping demand buoyant and prices robust. In the last year, we had 27 billion commercial property sales around Australia and almost 40% of those sales went offshore, driving prices down and yields up. With a lack of quality stock on the market, that trend looks set to continue.

Over the past year AREITS have either met or exceeded guidance over the period and continue to perform well. Average REIT gearing is also low at around 27%. Unlisted Property has also performed well. The Property Council/IPD Unlisted Core Retail Property Fund Index total return for 2016 measured 18.3% and we would expect similar returns from unlisted for 2017. What it comes down to is that property plays an important role in a diversified investment portfolio, and investors should look at both listed and unlisted investments backed by a quality manager.


Jacob Mitchell  – CIO at Antipodes Partners

Buy Baidu, China’s answer to Google
Antipodes Partners views Baidu (NASDAQ: BIDU), a top 10 holding across its Funds, as one of its best equity investment opportunities today. Antipodes Partners seeks to take advantage of the market’s tendency for irrational extrapolation around changes in the operating environment, identify great businesses temporarily mispriced and build high conviction portfolios with a capital preservation focus. Our investment in Baidu is great example of this process at work.

2016 was a difficult year for Baidu, China’s dominant internet search company, with uncertainty created by regulatory change. From May 2016, China’s Internet regulator began tightening regulations governing certain segments of internet search. As a result, Baidu was forced to reduce the number of ad slots on its results page, pay a new 3% tax on turnover and have all advertisers registered with a central government body meaning revenue growth has temporarily stalled. Meanwhile investments outside of its core search business (known as O2O), including online food delivery and movie ticketing were a drag on profits costing the company close to
$2bn for the year.

Often however the best investment opportunities come at the toughest of times for a business. Baidu’s Internet Search business remains extremely profitable with operating margins of close to 50% and is more dominant in China than Google is in the United States. We believe sales growth can return to a mid-20% range, last achieved in 2015, as a majority of its advertisers return to the platform. Further, losses in the O2O business will be curtailed this year and the company will shift the sales model to click rather than transaction based which should accelerate revenue performance. Baidu’s video streaming service iQiyi continues to grow with revenues now exceeding USD$2bn, and 125m users consuming content on the platform every day. The company’s artificial intelligence initiatives have provided a pathway to more than 60 partnerships with Chinese automakers and commitments for their map and search technology to be installed in over 150 vehicle models by 2020.

At Baidu’s enterprise value of USD$48bn we are paying a forward valuation of just 10x operating earnings for the valuable search business, while attributing no value to the O2O, iQiyi and the Artificial Intelligence initiatives. The market has extrapolated as permanent what we see as a transitory set of issues, thus providing a great asymmetric investment opportunity. Backed by a significant margin of safety and multiple ways of winning we highlight Baidu as one of the most attractive risk-reward opportunities within our portfolios at present.


Steve Johnson – CIO at Forager

The best investment opportunities are in Europe
Europe is the most promising investment market in the world. And the companies we own are telling us that the economic backdrop is nowhere as bad as most investors think.
The Forager international fund owns shares in Flughafen Wien, Vienna’s international airport, which is listed on the Austrian stock exchange. Since October, growth in the number of passengers travelling through the airport has been more than 5 per cent, more than double previous growth rates. Our analysis suggests this is a trend reflected across Europe, with those airports that aren’t capacity constrained reporting healthy traffic growth. Airport passenger numbers and economic growth are highly correlated. That is inconsistent with widespread investor antipathy towards the region (I recently heard a fellow institutional investor describe Europe as “uninvestable”), which is why the shares are still cheap. But if the region can clear a few political hurdles this year, that could all change in a hurry.

Three big European elections this year hold the keys to the region’s future. The Dutch have, and the French and Germans will soon go to the polls. On the back of British voting for Brexit and Americans electing Donald Trump leader of the US, many pundits and investors fear more protest votes and, ultimately, the unravelling of the entire European Union. This risk is not to be dismissed. We contemplate it with every stock we look at and construct our portfolio in a way that makes it as robust as possible to these events transpiring. But in a world of low interest rates and high asset prices, Europe is the last remaining bastion of value. With a cheap currency, early signs of economic improvement and one potentially problematic election behind it, it should start getting a lot more attention.


Michael Slack – Head of Research at Martin Currie

Woodside strikes an attractive balance between capital deployment to growth and capital returns to shareholders
Woodside (ASX: WPL) has long been regarded as ex growth and therefore was unattractive from a capital growth perspective, particularly in an industry such as Oil and Gas, where if you don’t spend capex, production declines naturally.

We think that has all changed in the past 3 years as WPL has amassed a portfolio of growth options ranging from short to long dated projects:

  • Acquisitions of Apache’s Australian assets, with a long dated Canadian LNG option thrown in.
  • An interest in the largest oil discovery in the world in recent times in Senegal.
  • An interest in a stranded gas asset, Scarborough located offshore WA.
  • Exploration success in Myanmar has provided WPL with options for steady production growth over the next 10 years.

Couple this with near term, low capital intensity, brownfields expansion opportunities at Pluto LNG and medium term options for backfill at North West Shelf LNG and WPL has the opportunity to strike an attractive balance between capital deployment to growth and capital returns to shareholders.

Of course, an investment in WPL is always going to be impacted by the oil price, which impacts not only revenue from oil production but also revenue from LNG sales through the gas price link mechanism and we are bullish here over the medium term.

We believe oil price performance is a function of 2 time horizons, the near term where the market is temporarily oversupplied and the supply side is restricting capital while this imbalance sorts itself out in a lower price environment and the medium term, say 5 years out, where that reduced capital expenditure manifests itself in supply shortages such that the industry needs prices to incentivise large capacity additions to the market, such as deep water developments.

We think this incentive oil price is materially above today’s price and that WPL is well placed to provide new capacity into this environment. So while we are waiting for the oil market to sort itself out, WPL, a high cash generating business, will progress its options to be ready for investment whilst providing attractive returns to shareholders.


Matt Wilson  – Head of Financials Research and Senior Portfolio Manager at JCP

Reducing exposure to Australian banks will reduce tail risk and help diversify
What is the best opportunity for investors? Reducing exposure to Australian banks.

Normally ‘reducing exposure’ wouldn’t be considered an opportunity, but large exposures to Australian banks, both directly, and indirectly through index funds, have created a significant risk position for many investors.

We remain vigilant to the vulnerabilities of the Australian economy, specifically focussed on the risks of a housing market slowdown given high levels of household debt, rising global interest rates, and record low wages growth to support these extremely high debt levels.

As we stand today, these issues are becoming more mainstream, and it is very clear that these pressures are building with: ‘out of cycle’ rate rises already begun, more macro-prudential measures put in place, and a slowing building approvals cycle.

Within such a ‘hardening’ environment, there are increasing risks for Australian banks exposed to high levels of household debt supported by comparatively low levels of bank capital. Reducing exposure to banks may significantly reduce the ‘tails risks’ for many investors and improve the diversification of their equity portfolios.


Jamie Nicol  – Director and Chief Investment Officer at DNR Capital

Defensives are no longer defensive
Investment markets are at a turning point according to DNR Capital chief Investment Officer and Director Jamie Nicol and there are some clear ramifications, particularly for self-directed investors.

In short we believe defensives are no longer defensive. They are now relatively expensive and their growth outlook is inferior to other options.

We are moving to underweight bond proxies such as infrastructure, property and utilities and are now focused on companies that we believe can pass on inflation to their customers. Margins in low quality businesses we believe will be squeezed as inflation rises.

We believe earnings growth is likely to come from cyclically exposed companies or growth companies.

Our move from defensives is to diversified financials, building and resource exposed companies.

In these spaces we like Macquarie Bank (ASX: MQG) and QBE (ASX: QBE); Lend Lease (ASX: LLC) and James Hardie (ASX: JHX); and BHP (ASX: BHP), Aurizon (ASX: AZJ), South 32 (ASX: S32).

Other quality companies which we believe offer good growth prospects in this transitioning environment include Healthscope (ASX: HSO), which is leveraged to the ageing population, internet models such as Seek (ASX: SEK), Treasury Wine (ASX: TWE), which has good exposure to the Chinese consumer growth story and other stocks with very strong market position such as the big banks, Woolworths (ASX: WOW) and Brambles (ASX: BXB).
We also believe financial software provider IRESS is a strong company with sound growth prospects in the current and emerging environment.


Fundie Fragments

A growing middle class in emerging markets to drive global investment for decades to come
The burgeoning wealth and size of the middle-class, especially within emerging markets, is set to shape the global economy in the foreseeable future. The shifting consumption patterns that will come from it “will be one of the most enduring investment themes of the next 50 years,” writes Greg Goodsell, reinforcing the “need for more and improved infrastructure around the world in order to meet the needs of this new, powerful and demanding consumer.”

Some thoughts on Australian House Prices
Australia’s residential property market is at a crossroads. While some claim we are on the precipice of a housing collapse, others optimistically expect housing to continue along its current growth path. Merlon Capital believe that, on balance, “the housing market is 5-15% overvalued relative to ‘mid-cycle’ levels.” Despite this, they conclude that “aggregate rents and household incomes will continue to grow which will cushion the overall impact on dwelling prices and that the exposure of the household sector to higher interest rates means that the time frame over which interest rates will rise could be quite protracted.”

Could Automation Eat Your Job?
Much has been written about the threat to the labour market of automation. The central question is whether enough new jobs will be created to repurpose those in the labour market whose jobs have been or will be automated. The challengefacing government, then, is to “respond by reshaping education and vocational training to help workers adapt to this fast-evolving technological world.”

Avoid ‘piecemeal’ portfolio creation
Adding an investment to a portfolio without understanding how it fits into a broader investment strategy is a common mistake, writes Vanguard’s Robin Bowerman. “Without a plan, investors often build their portfolios from the bottom up, focusing on investments piecemeal rather than on how the portfolio as a whole is serving the objective.” A well-planned portfolio, by contrast, understands the purpose of asset allocation and diversification, and approaches every individual investment accordingly.

A Brit’s View of Brexit
Alongside the election of Trump, Brexit has come to be viewed as the biggest self-inflicted policy wound of 2016. Against this pessimism, Jonothan Knowles of Capital Group believes that Brexit, if done right, will leave the United Kingdom in a favourable economic position, with the possibility of more open trade than ever before. Of course, the outcome will depend on the ability of the UK government to facilitate the transition over the next three to four years.

A House Divided
March saw continued signs of global growth, despite ongoing political uncertainty. Encouragingly, Purchasing Managers’ Indices (PMIs) reflected strong growth momentum in both the US and Europe, spurred on by strong gains in employment and firming price pressures. At home, an increase in domestic final demand, coupled with flat mining investment, has contributed to the first time, since 2013, that Australia’s shrinking mining sector has not detracted from GDP growth.

Regulators Late to the Debt Party
Two weeks ago, the Australian Prudential Regulatory Authority (APRA) announced its intention to constrain interest-only loans for residential property. While this move was widely
supported, some still believe it “represents a reactionary policy that does not target either an appropriate pricing framework for housing or a desired annual rate by which house prices should increase.”

What to be excited about in 2017
It is easy to get caught up in the global instability that presently dominates the news cycle. When disaggregated, though, the global outlook appears a lot more promising. Platinum’s Chief Investment Officer, Andrew Clifford, suggests that despite all the unknowns, there are ever-increasing opportunities for value investing, especially in Europe and China. As Clifford quips, “this is when money is made in markets.”

Can Emerging Markets Overcome Risks From America?
Emerging market (EM) fundamentals continue to trend upwards. AB’s Morgan Harting expects this trend to continue as the external balances of these countries improve and their currencies firm. Among other things, Harting dampens concerns borne of increasing interest rates – “as interest rates are rising, global growth is improving, so the demand for goods produced in emerging markets is improving.”

Quality is Making a Comeback
Quality stocks appear to be making a comeback, having remained noticeably absent from last year’s Trump-inspired market rally. “It appears the upward trending share market in Australia became more inclusive in March in terms of high quality, premium priced corporate success stories,” says Rudi Filapek-Vandyck. Reflecting this, a survey of active fund managers revealed a “return to quality stocks now that the huge gap that existed between deep value and quality industrials has narrowed considerably.”

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