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Platinum’s Kerr Neilson: it’s all about the price

[This article was originally posted in Cuffelinks in 2015, and is reprised following Kerr Neilson’s decision to step down as Chief Executive of Platinum Asset management, to be replaced by long-time colleague, Andrew Clifford. Neilson will remain as an Executive Director and full-time investor, intending to spend more time mentoring the team].

Kerr Neilson was interviewed by Vincent O’Neill, Director of Private Wealth at Stanford Brown, on 24 April 2015 at the Stanford Brown Quarterly Investor Insight luncheon.

 

VO: What makes a good investment manager?

KN: You need to have some idea about what you bring to the game. You wouldn’t enter the Olympics without some ‘edge’, and it’s the same in the investing business. You have to define your ‘edge’ to yourself. One ‘edge’ you could bring is that which others find difficult, such as thinking in a contrarian manner. There’s a big problem with investments. Believe it or not, there’s no specific price for any asset. Some good companies are now worth 10 times the amount they got down to in the GFC. They haven’t become 10 times better companies. When you buy and sell in the stockmarket, you need to have a reference point against what other people think. Value can shift around massively. You need to be a contrarian to start looking for gaps. You need a way to distill out the confusion and noise.

VO: And what have you changed or learned over the years?

KN: Like all investors, you initially start looking for a bargain. But now we have the internet, it’s completely transformational. It’s as important as the railways and the automobile. On the one hand, you know what you’d pay for traditional companies, but then you’ve got this ginormous event which opens up the world to everyone. A company can be so much more valuable even though it started in a garage in Sydney. The value proposition is difficult to understand. With these changes, you need to change your own approach, at least at the margin.

VO: And you need a recognition that some are speculative.

KN: You need a high upside to justify the uncertainty and you need peripheral vision. A problem analysts have is that they spend a lot of time on a company, and they feel they need to be rewarded for that time. They still want to buy it, but you can’t do that if you’re running money.

VO: In what conditions does Platinum underperform?

KN: The times we are least effective are the times like the last six years, where there is little dispersion of valuations, and huge trending. The herd is going in one direction. The one market you had to be in was the US, and we have been progressively moving out of it.

VO: Does that make it difficult for you, as people question your stance?

KN: You need to build a team slowly over a long period of time because you have to think differently. To keep people of that nature is not easy, it’s a certain type of mentality.

VO: You’re a keen student of history. Can you share some of the key lessons from the past, including any insights for the current conditions of extreme monetary policy.

KN: You don’t need to be an historian, just start with the human condition. We are all slaves to our frailties, and we have little ability to suppress those animal instincts: fear, greed, jealousy, all these weaknesses we have. When you read the literature of the 1930’s, we had all this discussion about when to tighten monetary policy, and then you had some very volatile markets. So you can find precedents in history, but you must always look for the differences. We have a big change which is globalisation, and it is more powerful now. We have a transfer of capital and technology, and a massive pool of labour in China and India that is priced at $100 a week rather than $100 an hour. You need to be careful because we’ll have a lot of labour substitution which implies that growth in the West will be lower. The gap is so huge and the biggest problem we face is this arbitrage of labour costs. Through technology, you can quickly teach people how to do things, you can automate so much of this.

VO: Older people spend less on goods and services, they don’t have babies or buy houses, while they have higher health costs. What do you think about the drag on global growth from changing demographics over coming decades?

KN: In my view, technology is more disruptive than the ageing of the population. And India and Indonesia have the opposite problem of millions of young people entering the labour force, what do they do? The challenge is expectations. We’ve had 24 years of growth in this country. We’re not prepared to make these adjustments and it will come through the exchange rate. I don’t think the exchange rate will drop right now, but our labour costs are making us uncompetitive, so there must be more reduction in the currency. Our expectations have to be reined in.

VO: Can you talk us through your views on China.

KN: China will grow slower and in our view, India will outpace it by a factor of two. China might go down to 4½% to 5%. It was spending $4 out of $10 on building for the future, capital works like bridges and roads. In China, the locals are switching from property to shares, at the same time superannuation and insurance is growing, so there is more of a market economy going into financial assets. We can still buy companies at reasonable prices but they’ve moved very quickly.

Here’s a point I can never repeat often enough. This business is not about creativity and great dreaming. It’s all about price. When the price of something has collapsed by two-thirds, as the Chinese stockmarket did until a year ago, that’s not when you get worried. It’s when it’s gone up three-fold you should be worried. When it goes down you should be delighting in the prospect. Let me labour this point. If I offered you the car of your dreams, you’d be hounding me to tell you the price. I used to be in stockbroking, and as prices went up, our clients really lusted after shares as they became more expensive. But that’s not what they’d do with their Mercedes Benz S- Class.

VO: You’ve had a lot of exposure to Japan, can we expect Japanese companies to be managed to deliver shareholder value better?

KN: This is a remarkably introverted country, but we are seeing clear evidence of the leading companies changing in the way they select directors and the focus on profit. They don’t have bad returns on sales but they always over invest. They have such social cohesion that they’ll all fall into line. The market’s around 20,000 and it’s likely to get to 25,000 and then get into trouble at 30,000 – I think it’s got 50% to go over the next couple of years. When you have a currency that falls from 75 to 120, your cost competitiveness is spectacular.

VO: What are your views on the economic outlook for Europe?

KN: The central problem is the productivity gap between the north and the south. The south can’t close the gap. There’s no central exchequer, there’s no backing of a central bank. I suspect somewhere down the line we will get into trouble again.

VO: Are you still happy to be overweight in shares and not too much in cash at the moment?

KN: It depends on your time frame. In 1939 if you owned shares in Deutschland and your cities were flattened and industrial base destroyed, it took until 1954 to get your money back. The same is true in Japan. The only places that you did not retrieve your wealth was in China and Russia because there was a regime change. So you’re talking to a junkie here, we always see the benefit of shares because of the rewards over the long history. The trouble is, most of us go to water because we do not fully comprehend that it’s the very essence of our living, our whole structure, to own these companies. To lose faith in equities, you have to believe there’s a change in the entire structure. A fundamental change in the economic management of the system. So that’s why we say it is volatile but it is the underpinnings of our living standards. Even in the worst of times, capital will migrate to the best business opportunities. It’s a constant in our system, and to lose that, you must think we’re going back to some form of central control and ownership.

Please take away from this one critical message. Price is critical. What does the price say? It’s not about the headlines, it’s what is in the price.

 

Graham Hand is Managing Editor of Cuffelinks.

This information is commentary only (i.e. general thoughts). It is not intended to be, nor should it be construed as, investment advice. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

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