Oldfield Partners’ global equities investor day conference transcript.
Oldfield Partners (OP): Richard Oldfield = RO, Andrew Goodwin = AG, Richard Garstang = RG, Robert White = RW, Juliet Marber = JM, Harry Fraser = HF,
Oldfield Partners – Transcript
Richard Oldfield: Good afternoon everyone.
As usual we will spend 40-45 minutes on the presentation and then 15-20 minutes on questions. We will stop at 5pm for a 10 minute tea break and then continue in the German AGM model image, where we’re not allowed to leave until you have decided you have finished asking your questions.
This is an afternoon devoted to the Global Funds we manage. We’ll begin with performance (pg. 2).
When we last met we were pretty optimistic and we remain optimistic, about the potential in the portfolio for returns over the next five or ten years. The upside in the portfolio was higher than at any time since March 09. The upside remains at a very high level, having in fact been even higher at the depths of the market on 11th February which I think we’re going to look back on as the turning point. We will see. We’re below for the year to date in sterling terms, just below breakeven and that is a little bit behind the World Index. That follows a few years in which we’ve had a pretty rough time. I will explain first of all in overview terms why we remain optimistic and then we’ll get into the specifics of the portfolio.
We’ve shown you this chart before, which shows the performance of the MSCI World Value Index relative to the MSCI World Growth Index (pg. 3). It’s the bottom half of the MSCI World Index in value terms (price to book value, earnings and cash flow) against the top half of the Index. We’ve had this extraordinary period in which growth has out-performed value for longer than any time in my experience. It’s also been about as severe as at the end of the 90s which was obviously a quite exceptional period in terms of the polarisation of markets. The elastic gets ever more stretched. At some point it has to snap back. Of course the credibility of those who are pointing to the stretched nature of the elastic diminishes the further it stretches but it doesn’t make it any less true that the snap back when it comes will be very powerful. We’ve had eight or nine years of relative famine, we’re due for an eight year feast in relative terms.
This next chart (pg. 4) presents basically the same thing in a slightly different way. It shows the ten year rolling performance of value versus growth is now almost as bad as it was in 2000. Value has under-performed growth by roughly 2% per annum over the last ten years and that has not been matched since 2000. Of course this time it came from an even higher peak and so this has been a more severe period than that one.
Why might it change? We came across a chart from Franklin Templeton (pg. 5) which shows that the average return in the three years following a Fed Funds increase. There have been six occasions since 1974 in which the Fed Funds has begun to rise. So in those six three year periods this is the pattern of the average return. It shows in green the MSCI World Growth Index, which has done pretty well on average after a Fed Funds rise, up 30% over the ensuing three years which is equivalent to about 8% a year, a little bit below long term nominal equity returns The Value Index is plus 50%. Why might that be so? I think one reason is that if interest rates go up then you have to apply a higher discount rate to earnings and cash flow that are long into the future in order to justify the valuation of a growth stock. So a higher discount rate is bad prima facie for growth stocks.
The second reason is that you tend to see higher interest rates associated with more normal economies and that favors cyclical stocks and it’s very often the more cyclical stocks which are in value territory. That is certainly so for us now. I would say that for us the major risk is one of recession. We do not believe and have not believed that we’re going to see a recession in the US in the short term. We don’t see the ingredients for it. We’ve got low interest rates, a very low energy price, the consumer is pretty strong, car sales are strong, housing is strong. Those are not the usual precursors to a recession. If there is a recession, if we’re wrong, then we’ve got a problem, but if there isn’t, it seems to us that recession is embedded in the valuations of many companies, certainly many of those we hold. Therefore if there is no recession the upside is huge.
The second major dislocation in markets has been the outperformance of the US market over the last several years (pg. 6). We’ve seen the US outperform to an unparalleled extent, going through these previous peaks of outperformance. Now there is no sacred law to say that this line can’t go up and up. The US has been a wonderful place with a very resilient economy, a very low price of energy and a quicker policy reaction after the financial crisis, but it does seem to us that strength has been reflected in the valuations of the stock market. So again this is a piece of elastic which has got too stretched and it needs to reverse.
This next chart (pg. 7) shows that when the Fed Funds rate begins to rise then non US markets tend to outperform the US. This is again the average pattern of performance in the nine major periods of Fed Funds increases since 1970.
The chart on page 8 shows returns on equity in different markets. The point about this is that the US return on equity which is in the top, the grey line, has been much higher in recent years than in Europe or Japan but this is not a permanent state of affairs, Europe has quite often had a higher return on equity than the US, there is no reason why it shouldn’t have it again in spite of the headwinds which Europe faces compared with the US. There is no permanent guarantee that the US will always have a higher return on equity.
Japan is the dark blue line and its return on equity has been on an increasing trend. You will hear more from my colleagues as to why we think we’re quite likely to see that trend continuing.
Turning to the portfolio at the aggregate level these are valuation figures for the portfolio (pg. 9). We tend to have lower valuation measures on average than the market, that may not be so for every measure at every point but generally across the board the valuations of stocks in the portfolio will be lower than the average for the market. That is so now with a price to earnings ratio of 12 versus 19 for the market, the price to book