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Only one money fund is honoured in the annual City of London Wealth Management Awards – and this year that went to Pieter Fourie, a South African chartered accountant and CFA who relocated to the UK almost 20 years ago. In this insightful interview, Fourie takes us through his favourite shares – and how he has positioned his market-leading portfolio. A must-listen for anyone who is thinking of putting their money into the world’s leading stocks. – Alec Hogg
Pieter thanks for joining us, tell us about the award?
It was the City of London Wealth Management Awards. There’s only one fund award per year, it includes all asset classes, and this one was for the Sanlam Global High Quality Fund, and we’re quite proud because two years ago my colleague on the Fixed Income Global side also won the award, so Sanlam has actually won the award two out of the last three years.
How many competitors are there?
All the big asset management and wealth management firms essentially go for this award, it is quite a process, they look not only at the quant numbers alone, but they also look at downside risks and some other factors, so yes, we were up against the best, all the big players in London. We’re very proud that we got this award.
How long have you been with the Sanlam team?
It’s close to five years now. We’ve built out the team over those five years, we’ve seen our assets grown to three quarters of a billion Dollars, but we’re not focused on the assets, we’re really focused on giving a good outcome for our investors but I’m sure over time we’ll probably reach that magic $1bn.
Where were you before?
I was at part of a Stonehage subsidiary. Today’s Stonehage is still a big family office business in London, they’ve merged with Fleming, so that’s where I cut my teeth, in the high net worth space and the institutional space because the company was owned by Absa for quite some time, but that was the only company I joined when I first arrived here in 1999 and then I left Stonehage in 2012 to join Sanlam.
When you arrived in 1999, what was it for, a working holiday?
In 1998 we came here, I was a chartered accountant with Ernst & Young, we joined over here, me and my wife, my wife’s at KPMG still today and I was given the opportunity to be an equities analyst in March 1999, with the benefit of hindsight of course, very tough, evaluations were very high, it was a difficult period. Then I kicked on from there, in 2002, I started running as a fund manager, global equity funds and segregated mandates for clients, so I’ve really been in the global equity space for the last 18 years.
— Sanlam UK (@SanlamUK) March 31, 2017
In 1999 and then again you had the global financial crisis, so you’ve been through the fire.
That’s right, and it was terrible at the time as a youngster and then as someone with a few more grey hairs in 2008 because you saw the ugly side of downside. That’s so important in what we’re doing, is how you go through the downside cycles of the world. Even though the world is a terrible place, we knew, of course, in 2009, 2010 and even when I joined Sanlam in 2012, there are still relatively decent upside opportunities left post the GFC and the fact that investors could benefit from some great companies that have actually come through these crises, maybe in some cases even in better shape.
I guess people can take it as red that if you’ve won the Fund of the Year in London, that you know what you’re doing, but just having a look at the performance figures, you’ve gone from 12.5% in Sterling in 2014, similar in 2015, 28% 2016, up 7.5% again last year. Those are very impressive numbers against the benchmark, but I guess if you were to convert it into Rands, it’ll look even better.
Yes, having lived in London for 20 years, we are Dollar thinkers. I think in both Sterling terms and Rand terms, the Rand from memory in 2015 was pretty much a blowout year, in 2016 the Rand came back a little bit, but it’s really the Dollar performance that drives return for clients over the long-term and these numbers are a little bit better than what they appeared in Dollar terms of course. Sterling lost 20% against the Dollar last year and your Dollar returns were 8.5% versus say 7.5% for the market, but it was the compounding effect over the last few years. If you look at the fund today it’s close to 40% Dollar return versus 20% odd for the market and that’s really the number that we’re proud of. In Rand terms, I think the fund since inception is up about 80% over the last 3 and a half years.
I see you have Google or Alphabet in your fund, but no Amazon.
No, it’s interesting; Google was a bit of a journey for us. We were given a good opportunity. In November post the Trump election, what we saw was, many of the financials were heavily in favour and some of the growth stocks like Google for some reason seemed to be very much out of favour with the business not doing anything wrong operationally. So when it dropped to about $730, it became our biggest position, for the first time in three years. We thought at the time a 6% free cash per yield’s attractive for a business growing at 10-12%, its free cash flow over the next five years, you combine that with $90bn of cash, you actually have a very strong name that’s relatively undervalued against a market that’s pretty expensive at this point in time.
Now the business has kicked onto $930, so we didn’t trim the position, but we used inflows into the fund to effectively reduce that position from 4.5% to 3.7%, but we’re still very optimistic about the growth, certainly for the next five years in this business. If the rating remains at around 18 times earnings one year out, then the business could compound for us at that 8% to 9% level, which could be a reasonable opportunity in this market for us.
Have you ever been to the Berkshire Hathaway AGM?
No, I haven’t had the opportunity, but to me, whenever the AGM comes out, report from Buffett, I always go through all the things that he says. We like the fact that he’s so humble in terms of shortcomings, for any investor, including him as the most successful investor of all time and I think it was, again, quite significant that he admitted to the fact that companies like Amazon, which we also don’t own, but have certainly looked at and names like Alphabet, he missed those opportunities. It just shows you what a humble person he actually is to admit that he’s missed those companies. Of course, he’s been very successful with his two new lieutenants in picking up things like MasterCard, which is a name which we’ve favoured for the last four years, so it’s all about getting more right than wrong because of course, any investor including ourselves will be wrong about names individually over time.
The biggest holding that you have in your portfolio is a medical stock.
Medtronic was a position to buy more aggressively over the last few months. The market itself, as I said, is quite tricky at the moment, evaluation wise. For Medtronic, we look at that business; we calculate that they can generate $40bn in free cash flow over the next five years. If we compound that over five years, we get a free cash flow yield on average of 6.5%, they’re targeting 6% to 7%, they’ve just reduced their growth forecast 6 months ago and that caused the stock to come down from 90% to the mid-70% levels where we were starting to buy more aggressively.
— Sanlam UK (@SanlamUK) March 31, 2017
I don’t think it’s going to grow as quickly as say, a Google, but I think with them, cleaning up their portfolio, they did a big acquisition a couple of years ago in Covidien, which was the old Tyco Healthcare, they’re now selling off some of their divisions which are lower return on capital businesses and that’s exactly what we want our management teams to do. If we have a great business, they have the opportunity to modify that business even more and really get that 20% to 30% return on capital that ultimately results in a good compounding effect for our shareholders.
You have a broad spread in your portfolio, including Baidu in China, rather than a company that many South Africans know in Tencent, what attracted you to Baidu?
Well, the secret there really is that you don’t see it in the top ten, but Tencent is a 2.8% position for us. The local firm’s been following it for years of course, through their Naspers position, but we did build up our Tencent position again in November when Baidu, Google, and many names like Tencent, were for some strange reason out of favour, in the low 180s, we started building the position, we still have it today. We are now up 30% and we’re concerned that in the short-term Tencent’s actually fully valued.
In the case of Baidu, we just think that if you strip out some of their loss-making divisions where they’re investing heavily into growth areas like video streaming (and they’ve signed a good deal with Netflix just two weeks ago) if you strip that out, the call search business is actually on 14 times earnings. So for us it’s more of a value stock at this stage, but clearly the search business has to go back to the growth levels of 10% or more, they’ve gone through a very rough patch and until that happens we don’t think the stock might necessarily move. They showed about 6% growth in the last results, but as I said, we have to make sure that over time their new ventures are successful and that their core search business picks up some growth again and then we’ll hopefully see the stock move towards a level we think it’s worth.
It’s an interesting dichotomy between the US stocks and the ratings they have and their mirrors, if you like, in China and the ratings that they have. So Baidu, as a reflection of Google is relatively cheap.
Yes in the case of Baidu, the headline numbers don’t really suggest that. It’s actually on the headline numbers it’s a little bit more expensive but some good examples would for instance be if we look at the consumer staple side, a name like Proctor & Gamble is perhaps cheaper than L’Oréal, perhaps for reasons of scarcity. It’s the whole Europe, US argument which is very interesting because if you strip out certain sectors like financials, industrials and oil stocks, the premium that the US trade against Europe in particular, is not that high.
Yet you have businesses which we believe, businesses like Oracle, Google and Microsoft for that matter, which over time can continue to grow faster than the European equity market can grow its earnings with and therefore, we still think it’s worth paying up for those businesses, but we’re under no illusion that the, and I hate this quote, but it’s the easy money in those stocks have been made from. Here it’s more a question of the earnings growth itself will probably determine your stock market returns from those names.
Pieter you’ve shared with us, quite a few individual stocks that we can go out and do our own homework in because no one should blindly follow, even if you’ve won all these awards, but when you start, when you look at a clean slate and you start your portfolio, how do you begin, how do you construct it?
The balance sheet, funnily enough is our first port of call, so we want to make sure that the business generates free cash flow. I know this sounds very over simplified but if you look at our five indicators of financial health, we’re looking for businesses that are not that geared, we’re looking for businesses where the free cash flow is generated without the impact of gearing, so it’s a self-sustaining takeover target in effect because it doesn’t generate its own returns without the use of leverage. Also typically in terms of the businesses that we end up with, they have very good operating margins, 25% on average
They typically compound their earnings at a rate faster than GDP growth over time and typically our portfolio ends up with valuations as well, which are above the market, so it’s really a growth at the right price style of investment and we try and figure out, we try and spend all of our time figuring out the intrinsic value of the business and less about the business fundamentals itself, so we’re not very deep value investors, we’re not looking for turnaround scenarios, we’re just looking for great businesses with great margins and great positions in the market and making sure that if they come under short-term pressure, because all great businesses have operational issues from time to time. We make sure that we buy those positions in size when they offer value for us.
Intrinsic value is exactly what Buffett always focuses on and again over the weekend he was talking about it but I’d like to get your view on the two big stocks of his at the moment, the two big positions. The one he doesn’t like anymore, IBM, after really going big into it and the other which he really does love, Apple. And Apple’s already the second biggest holding in his portfolio. He says he might have struck out on IBM, but he’s pretty sure he’s going to win there, what’s your view on both of those?
Yes, IBM’s very interesting because we sold IBM three years ago, whereas we invested in the beginning thinking that some of their businesses can grow faster than the market, we ended up changing our view on the fundamentals of the business, and we sold and switched into a business called Cognisant. At that time, we also owned Accenture and we just thought they’re much better positioned in the digital age that we live in and since then it’s been absolutely the right decision for us to get out of IBM. Now of course, I can argue today that look how clever I am and Buffett got it wrong, but I don’t think that’s the point.
Clearly IBM is not such a bad business but the secular growth dynamics are quite against them for large parts of their business, including the hardware side. They’ve been trying to turn their portfolio around but I think it’s a classic case of, we don’t want to invest in a “Salmon”, so something that’s swimming upstream, we rather want to invest in the Accentures and the Cognisants, where we know they’re investing their portfolio in areas, which will grow with the market.
Apple became very interesting for us. Last year we started building a position in the fund at $95. My argument was that even if you factor in margin contraction from which, at that stage, in the mid-twenties to 15%, you use a required return of 12% and you forecast a terminal growth rate of 0% over the next five years after your fade period, that we saw an upside to $115. Unfortunately, that’s where we sold the stock and that to us, if you look at the stock today and it’s $150, it’s probably a mistake because the free cash flow yield’s probably still 7% or 8%, but you can’t catch all the winners. We will be aggressive when we see a large opportunity. That’s one where we made some money, but clearly, we should have had that one for the last five years.
If you had neither IBM nor Apple, would you be buying either of them now or selling if you had them in your portfolio?
I think Apple would be the one that we would, if a gun was put to our head, we’d rather be investing in Apple. What they have in their favour is the $235bn in offshore cash as well. If Trump does announce a tax holiday, there was an article today on Bloomberg that they could take all that cash and buy a business like Disney, which will then of course change their whole dynamic from being a hardware company to this sort of vision of some of their investors, which is to change them into more of a media consumer type business with that fantastic brand profile that they have behind them.
This is the advantage of having an extremely strong balance sheet, it allows you to use that cash and evolve the business over time while of course you’re generating massive amounts of free cash flow. IBM, on the other hand, I feel, will have to keep reinvesting to change some of their legacy positions in the market around and they wouldn’t be able to generate the type of free cash flow after capital expenditure that a business like Apple would.
Pieter your portfolio is fascinating, but one stock that we have to close off with, as fellow South Africans, is Tesla. Elon Musk has done amazing things with that business in the United States, but it’s also had an incredible run, the shares in the last three or four months. Is it something that you would look at, at these levels?
I went through a very large report from a buyer side analyst just two weeks ago and the analyst admitted he was wrong. The market cap today of course, bigger than General Motors. I think there are so many things that Tesla’s doing in terms of their distribution model, for instance. What they have in their advantage is this very good data that they have on their customer base. If you think about the fact that all their cars have analytical data on with their satellite network, they can for instance, target their charging points to areas where they know the cars are moving, so it’s becoming a very efficient model. What is the stock discount in the long term?
From memory, in the next three or four years, they will at least double their sales and the market’s probably saying that this business can sustain 18% operating margins, which is probably eight percentage points higher than a business like BMW or Mercedes. So, the short answer is, a fantastic story, an incredible success story, but at this point the stock is really discounting a very good outcome on the sales side and a very good operating margin story in five years from now to actually discount the current valuation of the market.
Like many stocks that are overhyped, maybe, and this is one to wait for a bit of a pullback.
Yes, our investment style would always miss the Tencents, the Teslas, and the Amazons for that matter, in the early stages of their evolvement, but once it’s a great business, we’re looking to get on board if we believe in the story long-term. Discovery, in the early stages of such a stock might look easy with the benefit of driving with a rear view mirror as Buffett says, but we try to focus on those businesses that are already very well established and where we can get a good sense of a sustainable operating margin growth profile for the future.
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