Since 1990, the Orbis Global Equity Fund’s investment mandate has been to seek higher returns than the average of the world’s equity markets, without greater risk of loss. While the objective of producing higher returns is relatively self-explanatory, the goal of no greater risk of loss is much more nuanced. After all, the historical risk of loss cannot be accurately measured because most risks never materialise. As a result, clients tend to look at significant declines in the price of a fund as a proxy for historical risk of loss. Through that lens, one might conclude that we have successfully positioned the Fund to deliver on that objective by experiencing both smaller and much less enduring price declines than market averages in times of extreme stress. But simply looking back at these measures can be misleading, in that stock market environments are always different. Jeremie Teboul and William Gray from our offshore partner Orbis discuss Orbis’ perspective on the risk of loss in the current investment environment.
Historically, like Allan Gray, we have protected your capital by limiting our investments in the speculative, bubble-like areas of the global equity markets. For example, the Fund had minimal exposure to both Japanese equities in the early 1990s and to the technology, media and telecommunications (TMT) sector at the height of its bubble in 2000. The common experience in these periods was underperformance for investors who did not own some of the most rapidly rising shares, followed by meaningful outperformance for those who remained disciplined as those same shares fell sharply. Key to this experience was the fact that during each of these periods the attraction of the most rapidly rising parts of the market sapped the interest out of other large sectors of the stock market. As a result, valuations in those sectors became sufficiently low that we believed they offered both high prospective returns and lower risk of medium-term price declines. That opportunity, to invest in shares others had sold so they could own the most popular ones, is what allowed us to meet the Fund’s investment mandate in those periods.
Today, as we enter the ninth year of the bull market that started with 2009 lows, we are presented with a more challenging environment than the 1990 and TMT eras...
During the Global Financial Crisis, we were less successful at avoiding losses. Prior to the crisis, the Fund had some exposure to shares trading at low valuation measures, but when economies collapsed and credit markets ceased to function properly, those low valuations provided little protection given the magnitude of the deterioration in earnings most companies experienced. In fact many financial sector and highly-leveraged equities suffered very large, permanent capital impairments as they either became insolvent or sought rescue financing on highly dilutive terms. Students of markets might observe that, in response to their past experience, investors avoided participating in a valuation-driven bubble and instead were caught by a less discernible credit bubble.
Today, as we enter the ninth year of the bull market that started with 2009 lows, we are presented with a more challenging environment than the 1990 and TMT eras in that we don’t believe there are large sectors of the market which offer meaningfully lower risk of medium-term price declines. Governments and central banks have injected so much low-cost money into the global economy that investors don’t face a trade-off to sell shares to buy others. Combined with economic activity being brought forward through borrowing and stimulus, the majority of share prices, valuations and earnings are elevated.
Traditionally, shares of stable, predictable, and therefore less glamorous businesses tend to be the most attractive after long bull markets. But that is not the case this time. Faced with uncharacteristically low interest rates, investors have been attracted by the steady and predictable dividends offered by these shares as a good source of annual income, bidding the prices of these shares up so much that they could easily fall significantly and not recover for a long period of time.
On the other end of the spectrum, the shares of companies with heightened economic sensitivity, secular challenges, or dependency on credit markets are still risky as investors there are willing to pay high prices for their potential exposure to accelerating economic growth and protection against unexpected inflation. With no large sectors of the equity markets unpopular, there is very little opportunity to invest where current prices present low risk of short- to medium-term losses. Put simply, the areas of equity markets which have historically been attractive in the advanced innings of bull markets don’t presently offer meaningfully lower risk of loss, as they have in the past.
Key risk: paying too much for a share
The risk we are most concerned about is permanent impairment of capital - the risk that in time a share ends up being worth less than we paid for it. We believe we have limited exposure to that risk. The risk we are exposed to is that most share prices could fall meaningfully in the short or medium term. Considering the current market context, it would be naïve of us to think that our investments individually or collectively possess limited potential for such price declines given our Fund’s policy of remaining fully invested in and exposed to equities. By remaining focused on our disciplined investment process, however, we believe we can avoid permanent impairments of capital while producing well above-average long-term returns.
By remaining focused on our disciplined investment process, however, we believe we can avoid permanent impairments of capital while producing well above-average long-term returns.
Today, we are enthusiastic about both the long-term business prospects of the companies in the Fund and the prices at which many are trading. Many are led by outstanding management teams who we believe are capable of navigating through troubled times and taking advantage of distressed market conditions. The portfolio includes a number of shares of businesses that are protected by wide economic moats. Some – such as Air Products and Chemicals, and Berkshire Hathaway – possess large cash balances that can be readily deployed towards attractive investment opportunities in the event of large price declines. Investments such as Charter Communications, Rolls-Royce Holdings, and CDK Global, which makes software for car dealers, are undergoing transformations which should enhance their intrinsic value. Other investments such as Amazon.com, Priceline Group, Latin American online marketplace MercadoLibre and Chinese ecommerce company JD.com benefit from innovation and secular change. And lastly, some investments, such as the US health insurers and Sberbank of Russia are available at attractive valuations due to concerns about uncertain conditions in their industries or countries. The portfolio retains very little exposure to businesses that rely on ongoing access to capital and are therefore at greater risk of suffering permanent capital impairments. Overall, we believe the portfolio’s holdings possess strong economic characteristics and are well-positioned for a range of long-term outcomes.
Our investment process
Everything we do is focused on creating an environment that allows us to invest differently and thoughtfully. Our investment process is designed to produce alpha-generative insights and create the environment that allows them to be acted on. It leverages a deep and broad research-driven capability, encourages individual yet collaborative decision-making and empowers long-term thinking. Our aligned fee structures ensure that we are rewarded much more for superior performance than for increasing assets under management, and that we feel the pain when we underperform. All these factors enhance our ability to seek investments with a multi-year horizon and to have the staying power to see through market vagaries, which we see as a meaningful advantage.
Beyond the structural aspects, the softer parts of our process are enriched by the talent and diversity of our analysts. Whether they are predisposed to be contrarians, pessimists or optimists, demonstrate deep intellectual curiosity, or have the vision to see things through a different lens, collectively our analysts identify and select bottom-up investment opportunities that are aligned with your patient capital.
The best time to prepare for and to consider how one might react during a period of distress is before it happens rather than in the heat of the moment. As painful as short-term losses may be, they often present compelling opportunities for investors who can be patient and capitalise on temporary distress. As long-term investors, we would seek to do so on your behalf as we have in the past. And we would like nothing more than for you to also be in a good position to hold firm and do the same alongside us.