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Charles Dalziell on life as a contrarian investor

Charles Dalziell is an Investment Specialist at Orbis Investment Management. Orbis was founded in 1989 and manages over $50 billion in its Global Equity Fund from 10 offices around the world, including Australia.


GH: Orbis describes itself as ‘investing differently’, and in the article you wrote for Cuffelinks, you talked about the long game and the arduous process of investment research. But every investment involves some level of personal judgment. How do you make that final investment step between the empirical research and the subjective judgement in a concentrated portfolio?

CD: It is difficult, and can take months of work. Each analyst has to convince one of the five key stock pickers globally before a stock goes into the client portfolio. We have a formal policy group meeting where the analysts present their investment thesis to their peers, including to the global stock pickers. And the policy group will say, “Have you considered this? Have you considered that? What about these concerns?”

That isn’t a decision-making meeting, although everyone at the meeting votes on whether it’s a buy or a sell. But it’s not a vote on whether it goes into the portfolio. At the end of the meeting, there are only two decision-makers. One is the analyst, who can say, “I like the stock. We've been through the key points, there's nothing that's changed my mind so I want to buy this stock for my paper portfolio.” Their paper portfolio usually consists of about 10 stocks and analysts live and die based on the performance of that.

The second decision-maker is one of the five global stock pickers that direct capital into our Global Fund. One or more of those could say, “I think this is a really great idea. It fits well into our portfolio from a risk, return or uniqueness perspective. And I want to buy this in my slice of the portfolio.”

GH: This is the actual portfolio, the client portfolio.

CD: Yes. Or they may just say that it might be a good idea but it doesn't fit in. Or they may not be convinced by the thesis. We make final decision-making an individual activity because consensus decisions don't work well in a contrarian style. We want individuals to back themselves and their own ideas and be accountable. The analysts probably would like to see the stock go into the portfolio. But if it doesn't, they have still bought it in their paper portfolio and they are rewarded if the stock does well.

GH: Even though the results are not reflected in the external fund performance?

CD: Yes, they'll be paid a bonus based on the performance of their own paper portfolio but conversely, if the stock does poorly, they might miss a bonus. The performance of that 10 stock paper portfolio will be tracked over time. It’s designed for us to collect great data across the entire analyst team on who's got skill at picking stocks and who has the right temperament to be a contrarian investor. It's really not for everybody. And so we have higher number of analysts than we need because we know that there will be a high level of attrition in the early years. For some, it’s uncomfortable and they don't like this way of investing.

Every stock must go through this process. We've got 34 analysts globally, with theoretically 10 stocks each, that’s 340 stocks, but we only have 60 stocks in the portfolio. So most ideas don’t make it.

GH: And given that analyst has spent three months researching the stock, and it’s a big step for them to put it to this committee, do they often get talked out of it at that stage?

CD: They can do. It's intimidating, and they have to tick all the boxes and have a very strong investment thesis. We have divided the world geographically with a US team, Europe team, Japan team and emerging market team but we also have a global sector team, with a banking specialist, healthcare specialist, tech specialist, for example, which gives us the broadest possible coverage across the world. This means that we often have more than one analyst covering a particular stock or sector which leads to more productive discussions in meetings.

GH: How do Australian stocks fit into that structure?

CD: We have our association with Allan Gray in Australia, and the global team sees that research. We have one Australian stock in the global portfolio, Newcrest.

GH: In the article you said: “Stock pickers have to kiss a lot of frogs before they find the prince or princess.” It’s a great line. Are there common characteristics where companies fail to make the portfolio?

CD: Yes. First, we may do a lot of work and realise we just don’t have a unique insight or something that differentiates our view from the market. Second, history might not reflect well on what will happen in the future for this company. We have amazing data sources and excellent filtering tools and part of the analyst’s job is to establish that the stock looks good relative to history. But maybe we find questionable accounting practices, unusual executive remuneration, or strange depreciation schedules. Or the business may have changed, and while they used to earn 15% margins, now it’s 5% because somebody came up with a better mousetrap, and we don't think 15% margins can be achieved again.

GH: Some other public funds turnover 200% of their asset size each year, with adverse tax consequences. For a business like yours, a long-term contrarian, what do you think is an acceptable turnover level?

CD: At a basic level, if your investment horizon is four to five years, then 20% to 25% is theoretically about right. The reality is that stock prices move rapidly which can influence turnover. For example, when prices are moving down, you may be allocating more capital into those stocks. So I don't think there's any hard and fast rule. But if a fund manager's turnover is high, it’s usually because they are a trader. If a manager says they are long term, doing fundamental bottom-up research, and then portfolio turnover is 200%, you should ask some pretty hard questions.

I'm amazed nobody measures after-tax performance because it ensures fund managers have little incentive to think about the tax impact of turnover.

GH: The last five years have been difficult for ‘value’ versus ‘growth’ and a lot of stocks on high P/E ratios have just kept running. How has this played out for Orbis, and in particular, how have you managed your client relationships in that time? I’m wondering about patience for an explanation that goes for one or two years and how long that story can last?

CD: If you look at the last 12 years, we’ve outperformed even though value has underperformed growth. Yet 12 years ago, value was expensive. Everyone was a value manager and we were finding good growth names. Now there are very few value managers left and we are finding better opportunities in that space. We've gone through a once-off downward shift in interest rates that we've never seen before in history, and growth stocks are long duration stocks so they have benefitted.

We don't make big sector or macro calls, we tend to be focused on idiosyncratic single stock risks. We’ve owned all the big tech stocks over the last 10 years, but once our assessment of the intrinsic value has been realised, we tend to sell. When the margin of safety is gone, we move on because we think our competitive advantage has disappeared.

More recently, we added to a position in Facebook when it disappointed at the end of last year, because we think it's a terrific business. We haven't missed out on the tech side. The big tech companies have incredible cash balances and fantastic moats, with a lot of optionality, such as Facebook with Instagram and WhatsApp.

GH: And Apple has bought two dozen companies in the last quarter, so that's all about options.

CD: Options and plugins, things you can just plug into your infrastructure and your system and increase the value. So we're not dogmatic about being value managers and just looking for the lowest P/E or price-to-book ratio. We're thinking about discount to intrinsic value and growth has an important part to play in that estimate. The best stocks you can buy are growth stocks disguised as value, and we think we have a lot of those in the portfolio today.

For example, we own Naspers, a South African tech investment company that owns 31% of China’s Tencent. Through Naspers, you can buy Tencent at a 45% discount. We own Autohome, a Chinese marketplace for new cars, a bit like Carsales. And we also have Facebook in our top 10 positions.

GH: Can we come back to the question about managing clients.

CD: Orbis does an amazing job educating our clients and ensuring we only attract like-minded clients. We are upfront about our history, and we say contrarian investing is not for everybody. Look at our history, there have been many periods in the past where we’ve underperformed our benchmark by more than 10%.

GH: Under the market, or drawdown?

CD: Not a drawdown but actually under the market. But over 30 years, we’ve beaten the market by over 6% per annum. The long-term numbers are great but the price you pay is short-term underperformance. As a contrarian manager, things will just go against you. And in the last 12 months, we've certainly seen that.

It's been a bunch of different things that have happened to the portfolio at the same time, and a couple have been mistakes. The majority of the performance has been stock issues that haven't affected the assessment of intrinsic value. In fact, it's made us more excited about the opportunity and we've added more capital into those ideas.

To date the clients have been extraordinarily understanding. Clients are not blasé about our performance, they ask all the right questions, but they understand why we are not performing in this particular environment. They can also see the opportunity. It’s important to have the right clients because we will go through periods like this. And many are allocating more capital to us at this time.

I should also mention that we’re owned by the Allan and Gill Gray Foundation, which is a charitable organisation. And that ensures perpetuity of ownership and also that when we go through a period of underperformance, we don't have a big brother demanding we change our process at exactly the wrong time.

GH: Do you have a couple of names where you think the market doesn't realise how valuable the companies are.

CD: XPO Logistics is listed in the US. It’s a trucking and logistics company, but since mid-2018, its price is down around 50%. They downgraded revenue growth last year but to a level that is still above average for that industry, and they have economies of scale. There was also a short seller attack in 2018 and it got a lot of market coverage. We know this stock extremely well and we have a long relationship with the company. We hired a forensic accountant from New York University to examine the short report's claims and he did not see any cause for concern. XPO is one of only two US trucking companies that can execute on same day delivery and many retailers don’t want to outsource to the other, Amazon, as they are often a competitor as well.

GH: And an Australian stock?

CD: The Allan Gray Australian Fund holds Newcrest. Nobody’s investing in gold mines as the gold price is too low - we’re at the marginal end of the cost curve. Newcrest is one of the lowest cost gold miners in the world with long reserve life.

GH: Last question. Does Orbis have any plans for a Listed Investment Company or Active ETF, to make access easier for an SMSF trustee or retail investor.

CD: We’re on mFunds on the ASX, and on all the major platforms, or they can come to us direct. But no plans to list a vehicle at this stage.


Graham Hand is Managing Editor of Cuffelinks. Charles Dalziell is an Investment Specialist at Orbis Investments, a sponsor of Cuffelinks. This report constitutes general advice only and not personal financial or investment advice. It does not take into account the specific investment objectives, financial situation or individual needs of any particular person. Past performance is not a reliable indicator of future results. This interview represents Charlie’s views at a point in time and provides reasoning or rationale on why Orbis may have bought or sold a stock for the Orbis Funds. Views may and do change as facts or circumstances change. 

For more articles and papers from Orbis, please click here.


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