2020 has been quite a year and many of us are undoubtedly looking forward to putting it in the past. The pandemic, global lockdowns, US elections, one of the largest economic contractions in the past century, and a world stock market which crashed in March and is already back to all-time highs. The list goes on. 2020 has reminded us that we live in an unpredictable world. While this is uncomfortable, as contrarian investors, we embrace uncertainty as it can create attractive long-term investment opportunities, as Ben Preston from our offshore partner Orbis discusses in this 29-minute webinar; his key takeaways are summarised below.
A challenging market environment
Growth shares have trounced value shares over the past decade. As ‘intrinsic value’ investors, we can buy both growth and value companies, but we’ve often performed better in market environments where value shares are ascendant. In 2020, growth extended its already-extreme lead vs value. This is mainly because the growth cohort contains a lot of the ‘virtual economy’ companies which have benefited from lockdown and social distancing measures, while the value group contains a lot of ‘real economy’ companies like airlines, banks and physical retailers, whose fortunes have been quite the opposite.
Performance has been disappointing
While the Orbis Global Equity Fund has generated reasonable returns in absolute terms, after fees it has lagged the FTSE World Index over the last decade. Regardless of the market environment, we seek to outperform the Index, so we are extremely disappointed by this. That said, the large divergence in valuations across the market gives us enthusiasm today about the opportunity to buy decent companies for less than they are worth. Though the last decade has been disappointing, we are extremely excited today about the potential to generate strong relative returns over the next one.
What history tells us
Compared to their pre-pandemic levels, 65% of stocks across the world are still down, yet the market as a whole is up. How is that possible? Because the very biggest companies have led the market while many smaller companies have been left behind. In particular, a handful of stocks – Alphabet (Google), Amazon, Apple, Facebook, and Microsoft (collectively known as FAAMG) – have performed extremely well. So well in fact that they now represent around a quarter of the market capitalisation of the S&P 500.
While there is no doubt that these are excellent companies, they dominate the market even more thoroughly than the five biggest stocks at the height of the 1990s technology bubble. This has left many investors feeling that the FAAMGs are invincible, and concerned about the risk of missing out. The past five decades show that investors often feel that way. In 1980, investors thought gold was bulletproof, then its price fell by more than half. In 1990, the Japanese stock market looked unstoppable, then it fell by 60%. The same fate befell investors in the Nasdaq in 2000 and materials companies in 2008. At each peak, the prevailing theme appeared unbreakable, but from each peak, investors who overstayed their welcome were harshly punished. Investors in 2020 again seem to be betting that the hot theme of the next decade will be the same as the last.
The Orbis Global Equity Fund is not positioned for one view of the future
Our bottom-up, fundamental and contrarian investment philosophy does not restrict the ‘type’ of company that we can invest in. We are not exclusively value, nor are we exclusively growth. We are not exclusively large cap or small cap. Ultimately, we will invest where we see the greatest opportunity to buy companies for much less than they are truly worth. Today, the attractively valued businesses we have found happen to reside in different parts of the market. This has enabled us to build a diverse portfolio, which is not tied to any one particular catalyst.
For example, sentiment around BMW, the German automaker, and XPO Logistics, the US provider of transportation logistics services, is more likely to be driven by the economy. While NetEase, the Chinese gaming company, and Naspers, the global internet and entertainment company, stand to benefit from an increasingly virtual world. Other companies, such as British American Tobacco, produce revenue streams that are largely independent of the economic cycle, while sentiment for the US managed care organisations, Anthem and UnitedHealth Group, depends very much upon US politics. Danish wind turbine manufacturer, Vestas Wind Systems A/S, stands to benefit from increasing demand for renewable energy. While these are all very different companies, one thing they have in common is a price well below our assessment of intrinsic value.
On the flipside, the stock market is more concentrated than our portfolio in less economically sensitive businesses, which are at the more ‘expensive’ end of the valuation spectrum. It is not surprising that these stocks have done well – they don’t need a strong economy, and their valuations are pumped up by low bond yields.
We currently live in a bizarre lockdown world where only one type of company can grow profits, while the real economy has been forced to close. With no one in restaurants, on planes, in hotels, in offices, having drinks with friends, there are a number of businesses under pressure that would not be considered super risky in a normal environment. The stock market is betting heavily on this current set of circumstances persisting. This might well happen, but what if one of the recently announced vaccines is successful? This would help the real economy and cyclical businesses may outperform. What if the historically wide divergence between value shares and growth shares starts to narrow? Less expensive businesses that generate 10, 12, 15% of their market value in cash every year might start to attract lots of admirers. In the face of an uncertain future, we take a different view and believe more diversity may be appropriate.
Cautiously optimistic about the future
Normally in life, you get what you pay for. If you want to get a bargain you have to accept some kind of penalty for that: You have to accept a lower quality of what you’re buying, or take a bit of a risk. But in investing that’s sometimes not true. Sometimes investing actively gives you the opportunity to build a portfolio that offers higher rates of return but with less risk. We believe this is the case today. Stock market benchmarks seem quite risky as they are heavily concentrated in the types of stocks which have already produced fantastic returns. On the other hand, the diverse mix of companies we own in the Orbis Global Equity Fund have good fundamentals, yet trade at a much lower aggregate valuation than the FTSE World Index average. While you never know what is around the corner, this leaves us with a sense of cautious optimism for the future.