MASTERCLASS: Liquid Alternatives - May 2019
May 3, 2019
Sue Lee: It's been a strong start to the new year for major stock markets across the world after ending 2018 in a volatile meltdown. Is this a fresh start for global investors? Three experts are here now to help us navigate both the challenges and opportunities when putting money to work overseas. Clive Gillmore is the Group CIO and CEO of Mondrian Investment Partners. Also, with us is Conor Muldoon, a Portfolio Manager at Causeway Capital Management, and David Nadel. He is the Portfolio Manager at Royce Funds. Welcome to Asset TV's Global Investing Masterclass. Great to see all of you guys here. Conor, let's start with you. From the dysfunctions in Washington to UK Brexit vote, that's hopefully going to come up, who knows? Is the market decline truly behind us? Where are we now given all this uncertainty?
Conor Muldoon:Thank you Sue. Asset prices reflect the expectations of market participants, and in hindsight it's become clear that investors came into 2018 too complacent. A lot of the uncertainty that spooked markets in 2018 still remain unresolved, so you mentioned Brexit, we still don't have an answer. The government is still shut down in the US, we still have yet to get a trade deal out of China and the US. A lot of those uncertainties are still around so we expect the markets to continue to be pretty volatile. What has actually changed is valuation levels, and we actually think that sets up the market for a much better risk reward as we come into 2019.
Sue Lee: What are your global equity valuations?
Conor Muldoon:So across the board, no matter which market you look at, US, IFA, so the non-US developed markets or even emerging markets, all are trading on a forward price to earnings ratio basis at the lowest levels that we've seen in five years. All markets are attractive, in particular, we would say IFA stands out as the one with the absolute lowest level of forward earnings multiples. Also, when we look at longer term valuation metrics such as cyclically adjusted price to earnings multiples, Europe and the UK standout as particularly attractive.
Sue Lee: David, where are you geographically finding favor in this market?
David Nadel: In this market and really in a lot of markets over the last many years, the developed markets have been areas that are target rich for us in particular places like Switzerland and Australia. Switzerland arguably is the highest quality small cap market in the world. We have a quality focused strategy, so it's a very good fit for us. Australia has over the last 100 years provided about double the return to equity investors as the US has largely because of a very strong dividend culture, best performing market over the last 100 years. It's a very productive place to invest. For us, it's generally investing in businesses that are capable of compounding returns on invested capital attractively. So we are not doing the typical Australia investing that's linked to commodities or to China or really more global businesses or even domestic businesses that are in service areas.
Sue Lee: Where are you in terms of emerging markets?
David Nadel: We're underweight emerging markets by a little bit but not by much, we're pretty much in line. But certainly the tactical case for emerging markets I think at this point in the cycle is quite strong. It's been a number of years of weak currencies, Brazilian Real, the Indian Rupee among several or multi year, if not all time, lows are not far off from them. The tactical case is strong. I think the structural case for emerging markets is never that strong in terms of being a permanent area of allocation. We think of emerging markets as much more tactical and developed markets as more strategic.
Sue Lee: Clive, before I ask you about your favorite regions while we have you here, how are you positioning your portfolio ahead of the Brexit vote?
Clive Gillmore: Yes. Well, interestingly enough and following on from the comments already made, I think we think equally that IFA is generally a cheap area, the areas outside the United States. But, in particular, UK basis that stand out. The difficulty in answering that question directly is because the UK can be broken down into two key pieces, the piece that's domestic and the piece which is listed companies which generate most of their earnings overseas. I think in the case of the latter, it's very clear that the currency is the most important aspect. When you watch what's happening in Brexit, you really need to watch what's happening in Sterling for primarily large cap situations. For mid small cap situations, it's slightly different because many of those are domestic and there it's much more reliant on what happens to growth in the UK going forward.
Clive Gillmore: The argument is that if there is an adverse Brexit decision that will negatively impact growth in the UK going forward. I think most of us that are based in the UK, and you may say understandably, believe that the UK is a relatively resilient economy and will remain thus even outside the economic union. But whether that will come to pass, we're not entirely sure, of course.
Sue Lee: You're not planning for food shortages?
Clive Gillmore: No, I won't be buying up any tins or stocking up in my garage, but who knows how that will evolve? In fact, there's going to be a vote of no confidence in the government as we're talking right now.
Sue Lee: What are your favorite regions right now?
Clive Gillmore: I think I've already commented about the UK but actually we're marginally overweight in the UK, and the reason for that is that many of those international companies that make up the typically larger or mid large sized companies have had a large discount put on them because they're listed in the UK, even though their earnings primarily aren't. We're overweight in the UK and we are commensurately or similarly underweight in Japan where we're about 500 basis points under the benchmark. But bear in mind, even today, Japan represents a very sizable part of the IFA index with non-US opportunity set. There were about 500 basis points under. But to put that into context, throughout the 1990s, for example, when Japan was a much bigger piece, in those days we had probably a similar or lower waiting when the benchmark was double its size to today. It's an indication of a narrowing of that underweightedness.
Sue Lee: Conor, can you share with us some sectors you might be favoring?
Conor Muldoon: Yeah, so there is a lot of uncertainty already priced in two markets and, in particular, in cyclical businesses such as banks, such as autos, such as energy companies. If we actually look at the forward price to earnings multiple for defensive companies, they're trading at almost 100% Premium that are cyclical peers. The last time we actually saw that was in 2008, so clearly there's a lot of figure price into markets and into cyclical companies in particular.
Sue Lee: David, how about you, any sectors?
David Nadel: Yeah, so we really focus pretty consistently on sectors that we view as being suitable for long-term investment. We are a buy and hold strategy. As a firm, we have an average holding period of about four and a half years so it's very much a buy and hold strategy. Businesses that are again capable of compounding their returns on invested capital over time. We find that the healthcare industry, the industrial sector which is very broad outside the US, and the information technology sector are areas of particular focus for us and are very suitable again for that type of investing. Those are quite target rich areas.
Sue Lee: What about infrastructure stocks, are emerging markets still building?
David Nadel: Yeah. We don't tend to invest in businesses where visibility is challenged. Infrastructure is an area that it's, I think, quite difficult to predict who the winners are going to be. It doesn't really suit a compounding strategy very well. I think for people who time infrastructure investments, they can make out like bandits. Ours is much more of a steady as she goes type of strategy. That doesn't really have a place but the others certainly do.
Sue Lee: What are some sectors you're avoiding right now?
David Nadel: Well, we tend to be underweight consumer discretionary. Consumer discretionary, really under the supposition that consumers are much more fickle than corporate buyers, we tend to focus on B2B type of businesses again for compounding approach. I think we're underweight, as a firm, we don't generally do a lot of investing in banks as cheap as they may be currently. It's not an area of expertise or one that we think is suitable for a long term horizon. I would say anything that is deeply cyclical or a spot pricing type of business model is the area that we tend to shy away from.
Sue Lee: Clive, how about you, what are you under and overweight in terms of sectors?
David Nadel: Yes, perhaps I should start by saying well we're underweight because we value investors and I think that certain sectors that are always associated with value investors. So you have financials, communications, utilities, and for a long while consumer staples. But one of the big changes in the last five years has been the rise in valuations or premium valuations for consumer staples. We used to be double weighted against the benchmark. We're now almost below half weighted which just gives an indication of that change of that last five year period. Elsewhere, in those traditional value sectors we remain overweight in utilities and communication stocks. But increasingly we're looking at certainly outside the United States some of the cyclical sectors which are sold off considerably, and we think some of those are now quite interesting too.
Sue Lee: That's interesting. Clive, also, ESG, environmental, social and governance investment factors are something you follow. Tell me why the long-term potentials in that approach is something that you look at?
Clive Gillmore: Well, I don't think we're the only people that follow it, I think there's an increasing view I think that all our investors, be they individuals or institutions, are interested that we take into consideration in our analysis of future profitability whether they're factors that are linked to the environment, social factors, or governance are going to negatively impact that long-term return spectrum. The difficulty is that most investors might have a time horizon typically of two years when these factors are unambiguously long-term. You will have heard before people will throw out words like demographics and productivity. If your timeline is a year and a half, they're literally pointless because they're long term in the effect they have. The same is true in environmental and governance and social factors.
Clive Gillmore: We take them into consideration by having a very long term approach and factoring in them into the worst case analysis. You may say within the United States, for example, there still hasn't gotten much traction. But outside the United States and post the Paris accord, there's been a huge change in the way that people see these factors. Almost no meeting goes by without meeting people in the European or Asian context that ESG does not come up as an issue.
Sue Lee: David, I know we've touched upon this, but can you elaborate for me a little bit more on your quality at a reasonable price strategy? What qualities are you looking for in your investments again?
David Nadel: Sure. The qualities we look for are ultimately predictable cash flow. It's very much a private equity approach to the public equity markets. What a private equity investor is interested in, since they have a longer term horizon and typically they have a need to service debt that they've layered onto the acquisition, is predictable cash flow to service that debt. In our case, we're not layering on any debt, we just want the predictable cash flow to get predictable returns. The sources of the predictable cash flow are often high portions of recurring revenue, which is another reason that we're attracted to B2B businesses. Typical profile of one of our companies is a business that provides a mission critical product or service to a corporate buyer where that business represents a relatively small portion of the operating expense budget of the corporate buyer.
David Nadel: This is stuff that is below the radar of let's say trade wars of those types of issues and allows these businesses to compound slowly. These are kind of I call them get rich slow schemes. They're often quite boring businesses that people don't really pay much attention to but they are often, in many cases in our portfolio, global number ones in what they do despite the fact that we're in the small and mid cap market cap range. Probably about a third of our holdings of 50 holdings are the clear global leader in what they do. That's I guess what we mean by quality, the price part to reference something that Conor mentioned earlier, all of us rely on volatility and we all rely on some degree of uncertainty in order to outperform benchmarks. These opportunities that we have now are golden to get higher quality businesses at deeply discounted prices. Of course, also, cyclical businesses are deeply discounted.
David Nadel: This is generally regardless of the specifics of your investment approach, this is a very interesting time for people to be looking at the equity markets as opposed to just being scared and hiding behind the veneer of uncertainty. Which is, of course, a perpetual issue. There is always uncertainty in the markets.
Sue Lee: What name can you share with us that pops in your head?
David Nadel: As a high quality business, well, there are so many to talk about. I mentioned Australia before, we've been a shareholder since the day one of this fund and Cochlear is an Australian company that invented the cochlear implant, which is a device that's surgically implanted for people who have complete hearing loss. This is a much more sophisticated device than let's say a hearing aid. They have about two thirds of the world market share in cochlear implants. It's a sector that's growing at about 8% a year because there are more people from the emerging markets who can afford the surgery to insert the cochlear implant. What we love about the business is that once it's inserted, you have a customer for life. This is literally the installed base of a product, it's surgically implanted and typically it's children who are deaf and benefit from this device. You have a customer for 80 years, you can literally run a 80-year discounted cash flow.
David Nadel: About a third of their profits come from aftermarket support of these products. Big dividend, 75% dividend payout ratio, typical for Australian companies. Why Australia has provided the best returns of any country in the world's equity investors for decades and decades. Also, an R&D leader, they spend about $100 million a year to maintain R&D leadership. That's the sort of business we would like to just buy and hold and let it do the work for us.
Sue Lee: Conor, any names you want to share with us right now?
Conor Muldoon: Yes, within the cyclical space, as I mentioned, we really like banks. So UniCredit is an Italian bank that we feel has derisked its balance sheet, has improved its liquidity, its capital position, and the market is ignoring that and is pricing it like we're heading into another [inaudible 00:15:55] crisis in Europe. In the US, we like Citigroup a lot. City has rebuilt its balance sheet very similar to what's happening in Europe right now. It's already actually returning a significant amount of capital back to shareholders in the form of dividends and buybacks. They're two of our favorite global banks right now.
Sue Lee: Do you think you're up strong going into this year? Overall, the European economy is holding up?
Conor Muldoon: We have seen growth expectations reset lower and we think that has already been reflected in valuations. As a result, we really like the risk reward of buying into UniCredit which is a bank that's trading at less than 50% of tangible buck that is on par to do returns closer to 10%, returns intangible over the next couple of years. We're very comfortable with that risk reward.
Sue Lee: Moving from Europe to a little bit East, China, how will the trade war impact global markets?
Conor Muldoon: Right now we've seen the impact as mostly been on sentiment, we haven't really seen a lot of disruption in terms of supply chains or even corporate profitability ad. Ultimately, we believe that there will be a resolution, a favorable resolution and rationality will prevail between the US and China. Our bigger concern when it comes to China is really the build up in consumer credit that we've seen in that market over a very short time period. If you look actually at consumer credit today, it represents roughly about 60% of Chinese GDP. That's already on par with markets such as Japan, developed countries such as Japan and most of Europe. We think that is going to be a significant impediment for China going forward in terms of it will impact the ability of consumers to continue to spend and grow their spending and it will impact China's ability to stimulate their economy.
Sue Lee: Do you think the global debt will ever decline?
Conor Muldoon: When we think about the global credit markets and the impact on banks, obviously, debt is somewhat tied to nominal GDP and the ability to service that is what's really important. We definitely think though there is a recency bias when it comes to credit markets where investors think back at the global financial crisis and the impact that had on any of their investments in financial companies such as banks and insurance companies. We actually view the global financial crisis as an anomaly, so if you look back at a broader historical stat and look at slowdowns or recession periods, banking institutions have typically had much lower levels of credit losses than what we experienced in the financial crisis. We definitely think this recency bias is impacting the perception of the resiliency of the banking sector.
Conor Muldoon: What we've seen since the global financial crisis is regulators have reacted, they've increased the amount of capital the banks need to hold, they've increased the amount of liquidity. One thing that We do see in the run up to the financial or banking crisis is a rapid period of long growth in these banking institutions and a rapid accumulation of debt. Those conditions are not present in any of the developed markets today, so that makes us much more comfortable with the risk reward. Ultimately, as we go through a slow down and perhaps a recession in some stage in the future, we think that these entities will be much more resilient and ultimately will be rewarded by investors with a higher rating as they prove themselves to be much stronger.
Sue Lee: Clive, what are your thoughts on how the trade war with China has impacted in the global markets?
Clive Gillmore: Yeah, I agree with pretty much everything Conor said in relation to China. But if you actually look at the root cause of why it occurred, I think there's a general consensus of most people I speak to around the world that China has not respected intellectual property rights in a way it should have done. This is something that needed to be addressed, and obviously the US president's way of addressing it was quite an aggressive stance. But perhaps that's what's required to get things moving in the right direction. I think both nations, though, and ironically given that China's a communist, are fundamentally capitalist in their way of thinking. Therefore, I think they will both want a resolution as soon as possible.
Clive Gillmore: Going back to what we talked about before, I think if you're an investor in IFA markets, many of these markets have been caught in the crosshairs. We talked about cyclical stocks, some of them for example in the auto industry and there are a range of long term challenges in the auto industry which I think we understand. But they've been caught in this, very much, in this trade war even though they're based in Europe for example or Japan. I think that to think that resolution will be good for Chinese equities and somehow good for US equities and not good for IFA equities would be incorrect. I think IFA equities, ironically, may be even more leveraged to an improvement in that situation.
Sue Lee: When it comes to value versus growth, where are you putting your money to work and do dividends still matter?
Clive Gillmore:Yeah. I think everyone who is a value investor says they're a value investor has a different lean or approach on how to do that. We use a very traditional approach, the type of approach you would typically see in the textbook, actually, which is to focus on a dividend discount model which reduces to a very simple equation is what dividends do companies pay and what's the expected growth in those dividends going forward? I think dividends definitely matter because they're an objective measure, something you can see and the growth or the G part of that equation is much more subjective and, therefore, open to interpretation and question marks. I think going back to the question you asked which is a very pertinent one about global indebtedness, you have to expect looking forward over the next 10 to 15 years, given the absolute level of indebtedness, that future growth rates will be lower in the future than they have been in the past. Certainly, in the developed world but probably in the emerging world as well.
Sue Lee: David, your thoughts on this?
David Nadel: Well, I think there's no question that dividends matter a lot. I mentioned Australia as the best performing total return market in equity history. The top five total return countries in equity history of which the US is one, although, not number one are all dividend paying societies. The US is actually the stingiest of the five in terms of paying dividends, but dividends absolutely matter. It's your quiet return that's being accumulated. All 50 of our holdings in our strategy pay a dividend. It's very common to get dividends outside the US. A much stronger dividend culture outside the US than in the US.
David Nadel: On the trade war, I don't have much to add, I would just say it'll be interesting to see how it plays out or our hand in leading this charge against China but also picking fights with Europe at the same time is not as strong as a lot of people assume. We're about 9% of exports, we're about 11% of imports globally, if you're around 10%, you don't always want to go me against the world, so we'll see how it plays out.
Sue Lee: Tell me how international small caps that you invest in differ from both international large caps and domestic small caps?
David Nadel: Well, they're completely different from domestic small caps for sure. This area of the equity markets is much higher quality than what US investors are used to with small caps. A much higher portion of the companies in international pay a dividend about twice the portion as in the US, about 85% versus about 40. This is just citing indices, not so much our strategy. In the case of US small cap, about a third of them lose money, only about 10% of international small caps lose money. It's an asset class that has outperformed, it's outperformed on absolute basis, it's outperformed dramatically on a risk adjusted basis because the volatility is lower. Everything that US investors are used to are small caps, they should put into a box. It really doesn't apply to international small caps, particularly, because these companies we were talking about this earlier, Clive.
David Nadel: A company that's $3 billion from abroad is not even viewed as a small cap, it's viewed as a mid cap. That's really an imposition of the US standard onto countries outside the US, which is meaningless. Versus international large, it's also a dramatic difference. The international small is much less correlated than international large is to, let's say, the S&P 500. At this point, a lot of people want diversification away from the S&P 500. So international small does offer a major advantage in terms of low levels of correlation.
Sue Lee: Conor, your thoughts on how dividends matter to you and your portfolio?
Conor Muldoon: Yeah, dividend is a key part of our investment process. One reason we like to talk to management is to really understand the capital allocation framework of a company and we love companies that return capital back to shareholders. It keeps them disciplined, it shows discipline in the industry, so it's a key part of our process.
Clive Gillmore: Yeah, if I may add as well that I think within the US market and it's been on a tear for a number of years as we know, some of that has been fueled by share buybacks as opposed to dividends. In the United States, why does the US use share buybacks rather than pay shareholders in dividends? Is because equity ownership amongst senior management is very large. If you pay a dividend, it's a net loss to you as an option holder. If you buy back your stock, it increases the price theoretically and therefore you get the value of it. You wouldn't go as far as to say it's a corrupt system and it certainly works when things are going up. But as we've seen recently, when things go down, you can quickly look foolish about the price that you bought back your stock. Because, seemingly, many US corporates have bought back their stock without looking at the price, and which type of investor amongst us or anyone else buys anything without looking at the price?
Sue Lee: A fair point. Tell me also Clive your thoughts on inflation and the impact it will have on asset prices?
Clive Gillmore: Yeah, that's a really good question and it overlays a lot of what we've been talking about so far. It really relates to this issue of are equity markets cheaper today than they were five years ago as Conor was saying? Absolutely and unambiguously, but if you were to go back to the 1980s, are they cheaper than they were then? A lot of that comes down to what you think about inflation and what you think about interest rates. Because as investors you have a choice of different investments so you can typically invest in monetary assets like bonds or you can invest in real assets or inflation adjusted assets like an equity, like a property. To think those two or the return on those two is totally unrelated would be folly at best. If inflation increases and/or interest rates increase, it has to have a deleterious impact on the value of equities.
Clive Gillmore: The problem is, for equities at the moment, because the price earnings ratios, for example, the equities trade at are directly linked to the fact that interest rates have declined for so many years and interest rates are so low in absolute terms, if interest rates go from one and a half or two to three and a half to four, that effectively changes the earnings yield by two times. Is it impossible in that scenario if interest rates get out of control or inflation gets out of control? The equities could fall by 30 or 35% despite the very fair points made about their relative cheapness. Sadly, that is true.
Sue Lee: Where are you positioning yourself? Do you think inflation and rates will both rise?
Clive Gillmore: I think most people accept the inflationary pressures are generally muted allowing the United States that has definitely been a pickup. What we do know, however, and this is where the real danger comes, is that interest rates have been set at an incorrect price for risk. They have been in the territory where they're effectively being below inflation. That's ridiculous on a long term basis. You have to correctly price risk. The real danger, and you saw a little bit of it in the second half of the year, is that even if inflation doesn't take off, interest rates need to normalize in real terms. Just that normalization is a fairly big pickup certainly at the short end in interest rates.
Sue Lee: David, there are bearish calls being made about the US. Some say a recession is looming. Do you think the markets will retest their lows?
David Nadel: I think it's anyone's guess, but we focus on the markets outside the US with this strategy so I'm not an expert on the US but there certainly could be some short term volatility. People's focus on topics like that tend to happen after the fact, so not a lot of people were asking that question three months ago about volatility and new lows, etc., etc. Which is, as you know to Conor's point, people entered that period too complacent. And really risks are, if anything, they're lower now. Valuations are lower, therefore, risks are lower, it's mathematical. There's always things to worry about, I don't know if the US will test new lows, it certainly could happen. I do think that the dollar is due for correction at some point. That has been many, many years of appreciation in a currency and currencies are mean reverting and over time, that should help all three of us to have less of a headwind of dollar strength.
Clive Gillmore: Yeah, we don't really want to beat up on the US and that's not the [crosstalk 00:30:20] but you have to say that what is IFA that the US isn't? It's IFA is not about technology stocks, which some people could argue are somewhat overpriced, especially as many of them are a de facto consumer discretionary stocks just by trade at a higher rate. It is not an investment, IFA is not an investment in the dollar in the same way the US is, and there's arguments to say the dollar is an overvalued currency. It is not, IFA, is not an intangible asset market is more of a tangible asset market. It's more of a dividend market than a buyback market. You have to say when you add up all these variables, you'd say for choice, if you're a value investor, IFA might look somewhat better than the US right now.
Sue Lee: In regards to geography, where do you think the strength will come from?
Clive Gillmore: Well, strength is I think it's perhaps a relative term but you have to imagine if you ... and certainly if you look at valuations outside the United States, there are raft of securities, probably ... I'm not an expert in the small end of the spectrum or the mid large end of the spectrum. But David and I were talking about this before, there's probably value in the full spectrum, certainly, in Europe after a multi-year period of relative underperformance. Japan is changing because it has a rapidly aging population and it needs return for shareholders. Historically, Japanese companies did not focus on return on equity, therefore, they traded at a much lower price to book value ratio and didn't care about paying dividends.
Clive Gillmore: Those things over the years have gradually unwound, and therefore, I think Japanese equities today whilst there are challenges are somewhat more interesting than they've been historically on a relative basis. The problem for Japan is its level of indebtedness is quite a lot higher than many other countries.
Conor Muldoon: Sovereign.
Clive Gillmore: Sovereign.
Conor Muldoon: Yeah.
Clive Gillmore: Yes, but the advantage, and this is the critical thing, is it's real advantage is that debt is primarily owned by its own citizens. If you want to, inverted commas, cancel that debt, it would be a very simplistic thing to do. It's difficult to imagine that the US can go, especially, now it can go to the Chinese government and say, "You know all that debt, how about you cancel part of the debt we owe you?" That's just not going to happen. We saw even in a relatively captive environment of Europe, with Greece and Germany, how difficult it was to make that or put that into operation. It's a challenge on an ongoing basis.
Sue Lee: David, you like Australia but where do you think the weakness will come from this year?
David Nadel: Well, by weakness, you mean GDP trends, I guess hard to say, we don't focus on it that much as heretical as that might seem like it to say. But equity returns are not heavily correlated with GDP trends, it's just a fact. Again, the type of businesses that our strategy is focused on are companies that can continue to execute through almost any type of economic environment. There could be weakness in any individual market but when you're invested in global leaders, you're exposed quite broadly and hopefully you're able to continue to compound.
Sue Lee: Conor, you like Europe, where do you find weakness?
Conor Muldoon: Yeah, we broadly like the non-US developed markets, and to add to the points made earlier, we've seen over the last five years these companies improve their return on equity by roughly about 110 basis points. And yet they're trading on a lower price to book multiple than they were five years ago. Where do we find weakness? It's not necessarily weakness, what gives us caution is some of the expensive parts of the US market. Technology was mentioned, a lot of these companies are quasi media companies and to the extent that we do see a slowdown that would impact their outlook for revenues. We just don't think that's reflected in the share prices.
Sue Lee: You mentioned technology earlier, and in terms of rise in technology, it's 2019, it's almost like we're living in a time of the Jetsons. What are some investable ideas?
Clive Gillmore: Yeah, so I think within the framework of technology, generally, you can obviously segment it into different component pieces. Going back to what I stated earlier and a belief that we have that dividends do matter, but you have to factor in predictable or as predictable as possible future growth rates. I think you have a whole range of stocks within the internet space that makes that equation very challenging. But if you look at what happened in the last four or five months of 2018, you can segment the market into three key pieces. A few stocks like Nvidia, Apple, etc. that had stopped specific issues that have fallen precipitously. Stocks that seemingly had fallen a lot but had risen so much in the first part of '18 haven't really fallen that much at all. Which is the majority of the big, the fact so called FANG stocks.
Clive Gillmore: And then you've got the whole list of stocks within the semiconductor chain, which have obviously fallen quite significantly. Internationally, those stocks might be in Korea Samsung, in Taiwan TSMC, and Micron and other stocks within the US. Perhaps that element of technology is the more interesting part of that equation for a value investor to focus on as opposed to the others where there are certainly some issues. The other one, and it's a sort of whisper this if you're a value investor, but is Apple cheap is always a question that value investors have. Because on the face of it, going back to everything we've discussed, it's crude multiples would make it look cheap. But any company that generates that amount of profitability from one product, the moment that product even gets a small hiccup, it's potentially a problem for the entire Corporation. I think going back to what I said-
David Nadel: Yeah, Nokia once ruled the world.
Clive Gillmore: Yes, exactly. But I think we do need semiconductors, production yields, the ability to operate efficiently in that space will always matter. I think if you're a value investor, at some point those companies are interesting. Whether they've fallen enough now, given what happened in the second elevating, not sure but again it's probably a toe in the water to consider them again.
Sue Lee: David, your thoughts on investable technology ideas?
David Nadel: Well, we really like software because it's embedded and its mission critical and it's very difficult to rip out. It's many of our CEOs use the phrase, "It's like open heart surgery to get rid of the software once it's in." We love that sticky customer relationship, particularly, software in the funds management area because funds management is growing, not all of it inactive unfortunately. But there is growth and funds management, and whether you're active or passive, being involved with the plumbing that makes that industry tick is very productive area to be. We have holdings in Australia and in Denmark in the funds management software area. These would be peers to let's say a Charles River that this audience would know or DST or SunGard.
Sue Lee: Conor?
Conor Muldoon: One of our favorite software business or technology companies is a company called Micro Focus. It's actually listed in UK but it's really more of $1 revenue business. This is a company that operates almost like a private equity business. It buys legacy enterprise software companies, it looks to remove costs, and ultimately return that cash back to shareholders. It did have a problem with one of its acquisitions it have made in 2017 integrating that and that caused the big dislocation in the stock price last year. We ultimately think that they're going to ride the ship and improve returns and margins, and it's actually one of our favorite technology stocks heading into 2019.
Sue Lee: Clive, what would you say is your philosophy for this year in today's markets?
Clive Gillmore: Well, as I said, I think the key if you're a fund manager is it's difficult enough to pick the right ideas to start with. If you start flip flopping on your philosophy or methodology, you're in very dangerous territory. The majority of us, when we start our careers, we learn the industry and then we focus on a particular methodology and philosophy that works for us. Then the key is to remain disciplined in its utilization. So I often say to the people that I work with in my office that even though there are vagaries in our system that means that things can go in and out of favor, the key is to stick with what you know and to focus on history, what you learn from that history, and you know what they always say, the sign of intelligence is never making the mistake ... Well, this is what I told my children, the sign of intelligence is never making the same mistake twice.
Sue Lee: David, it seems you like stocks that have pretty much a returning customer type of aspect.
David Nadel: Yes.
Sue Lee: What else is your philosophy?
David Nadel: Well, I couldn't agree more with what Clive said. If you focus, over the longer term, if you focus on process instead of outcome, you wind up doing a lot better. It's what Nick Saban says at University of Alabama, "Don't focus on the scoreboard." If you're sticking to a process, eventually, you're going to get the results that everyone likes. It's when you shift gears particularly when things go a little bit against you, you can really dig yourself a nasty hole. Yeah, we stick to that approach of these companies that have delighted customers. We really look for businesses that care more about their customers than care about shareholders, ironically, because if your customer is satisfied, you're going to do great as a shareholder. The businesses that take advantage of the customers to try to please shareholders, that's a short term play.
Sue Lee: Conor, also are you trying to manage the instant gratification of returns?
Conor Muldoon: Yeah, in terms of our process and philosophy, what we try to focus on is that second level order of thinking. Great companies, back to your point, they are not necessarily great stocks. We ultimately try to get back to the risk reward of every single security, and to the extent that it's price for disaster that we really like those opportunities.#
Sue Lee: I know you don't have, nobody here has a fortune globe to know what the future holds but we mentioned that the US dollar is set to pull back possibly.
Conor Muldoon: Possibly, yeah.
David Nadel: Possibly.
Sue Lee: With the upcoming Brexit vote, what do you think about the pound?
Conor Muldoon: Yeah, So what we've seen and it's quite interesting is that on the day now two and a half almost years ago that the Brexit vote occurred, Sterling fell against the dollar from about 150 just prior to the vote down to around 130 and then traded in the range of 122 to 130. Guess what, you know what two and a half years on and the currency is still around a very similar level, I think it's 129 or something in that order. The question is what is the fundamental value of a currency? And that's always a difficult thing to come to terms with, and particularly for people that need that instant gratification. Because the reality is most people would argue that predicting currencies in the short term is very speculative. The better way to focus on currencies is long term fundamental purchasing power.
Conor Muldoon: In those terms, variably depending on what currency you're looking at, the dollar is probably 15% overvalued. Sterling is the standout currency in most sensible scenarios that would be meaningfully undervalued. But as I said, and it's a dangerous place to go because if Sterling were to rise for example, export earners listed in the UK market would probably fall. What you need to look at, especially, if you're based in the United States as an investor is what is the dollar return you'll get. It's a combination of that local opportunity with the currency movement either up or down.
Sue Lee: David, is there a potential geopolitical event that the market's ignoring?
David Nadel: Yes. Do you want me to identify it?
Sue Lee: Yeah.
David Nadel: That's going to be a big no. The geopolitical event that will matter is, one, by definition that the market is ignoring. That's the nature of impact on equity markets. Everything that we've talked about today, if we've spoken about 10 issues, eight of them are going to recede and no one's even going to remember them six months from now, definitely, 12 months from now. Maybe two of them will be surviving, but they won't be that impactful because everyone's talking about them. The thing that will impact the market is something that we can't anticipate exactly.
Sue Lee: We talked about China, we talked about Brexit.
You're just going to try to get us to guess. I'm not going to guess, so let these gentlemen.
Sue Lee : Is anyone here investing in South America?
David Nadel: Yes.
Sue Lee:You find that area Of the world favorable at this point?
David Nadel: Well, I do. I mean, again, currency matters, the area in Latin America where we have focused our investments is Brazil. We have just two investments there, it's a 50 stock strategy so it's somewhat meaningful but no other areas of Latin America we invested in. Brazil is the broadest and probably the most mature of the equity markets in Latin America, at least in my opinion. The AI is near all time lows, so just recovered a little bit after Bolsonaro's victory. We're invested in the leading ERP software company serving the SME space, the small medium enterprise space, and then we're invested in the leading dental insurance in Brazil. Brazil has 275,000 or so dentists compared to about 160,000 in the US. It's the world's leading dental market by a long margin with a much smaller population and much less wealthy population. Being a dental insurance in Brazil is a very interesting business to have.
David Nadel: Their asset light don't take principal risk or have real typical insurance liabilities service provider. We like using our overvalued, I think we'd all agree, overvalued US dollars to buy assets in places like Brazil where the currency is just on its back and in businesses that are classic compounder type of businesses.
Clive Gillmore: David's mentioning that if you invest directly in those countries, remember your question was are we investing in Latin America? If you invest in developed markets and large cap space many of them are going to have exposure. In certain markets much more than others. If you invest in a Spanish security, there is a very low probability it will not have some significant exposure to Latin America. The danger is it's like you say are you investing in Asia? That means so many things, and likewise as we know, not all Latin American countries are created equal. There's a huge difference between what's happened historically in Argentina and Venezuela, and what's happened in Chile or what could happen in Brazil if things turn in the right direction.
David Nadel: Absolutely.
Sue Lee: I don't want to get in trouble again for looking into the future fortune, but so instead of asking what could boost the overall global markets around the table, what would you like to see happen this year that could boost the overall global market?
Clive Gillmore: I think a combination of a removal of the increasingly protectionist ideas which seem to have taken hold on a global basis would be a good thing for any investor, but particularly active investors. We haven't talked about it specifically but we know that quantitative easing is unwinding and I think that's going to begin happening outside the United States as well. I think that has to be a good thing for active investors and I think I would say for value active investors in particular.
Sue Lee: David.
Clive Gillmore: Yeah, I would agree some end to the tariff tantrum, some normalization of that in realizing that it's mutually advantageous to trade. Again, going back to those five best performing equity markets in history, they are all big trading societies. Your closed societies don't do well for equity investors.
Sue Lee: Conor, what would you like to see to boost the overall global market?
Conor Muldoon: I think a normalization of interest rates is very important, but one of the big risks that I would think that needs to be addressed in the next whether it's this year or next year is the fiscal position of the US. A lot of other countries come under tremendous pressure when they run budget deficits north of 3%. The US in boom times is running deficits that are approaching 6% and nobody seems to care. Ultimately, as a resident of the US, I think that as an investor in the US, given the impact that the US will have on global equity markets, I think that's one of the biggest challenges facing the world and global investors.
Sue Lee: Clive, is there anything else you'd like to add?
Clive Gillmore: Well, following on from Conor's point, I think one of the reasons why people historically have ignored these deficits on a relative basis in the United States is because the US has reserve currency status. The reason it's maintained its reserve currency status is not really based on it doing a great job in the last 15 years, it's because there's no viable alternative. The thing to watch perhaps over a 20 year period is the gradual and continuing opening of the Chinese capital account and investability in the fullness of time in the Renminbi as a potential reserve currency candidate.
Sue Lee: David, do you think that the US would ever lose its status as the reserve currency?
Clive Gillmore: 49:00 Ever, possibly, yes. But I'm certainly not going to predict it. The Euro is I guess the next biggest challenger, but the dollar has had that hegemony for so long. It is possible, I think for the time being people should assume that the dollar is the world's reserve currency. I think that's the time horizon that most people who are listening to this are dealing with I would say I would assume the dollar.
Sue Lee: Connor, your thoughts on the gold standard?
Conor Muldoon: I'm not a big believer in relics such as gold but so not a lot to add.
Sue Lee: Great. Thank you guys all for sharing your thoughts with us today. That was Clive Gillmore, he is the Group CIO and CEO of Mondrian Investment Partners. Also, with us was Conor Muldoon, a Portfolio Manager at Causeway Capital Management, and David Nadel, he is the Portfolio Manager at Royce Funds. Thank you all for watching Asset TV's Global Investing Masterclass.