Investors need to go a long way to find sensibly priced stocks today, but Japan and the US still offer pockets of value, Simon Edelsten tells Merryn Somerset Webb.
I start all my interviews with small talk, not to make people comfortable but because I have recording paranoia. After one too many note-free interviews after which I have found that I have no recording at all, it now takes me a good five minutes of faffing with equipment to feel confident that all is well.
As I was going through this process with Simon Edelsten of Artemis, I mentioned that he was to be recording number five on this particular device and that Baillie Gifford’s James Anderson, co-manager of Scottish Mortgage (a trust that has made a lot of our readers a lot of money over the last decade), had been number four.
“That’s a coincidence,” Edelsten said. Only a few weeks before he had also spoken after Anderson at an investment conference. Their talks, he said, showed “quite an interesting contrast in styles” – something made more interesting than usual by the fact that Baillie Gifford also used to run Mid Wynd, the trust that Edelsten now manages (along with Alex Illingworth and Rosanna Burcheri).
How so? Anderson is very clear that he doesn’t buy and sell stocks such as Amazon: he hangs on to them, almost regardless of price and how much of the portfolio they end up making up, to give them time to fulfil their long-term potential. Edelsten, who considers his style to be more “balanced and valuation based”, had just sold Mid Wynd’s holding in Amazon.
Spotting and then buying and holding good companies isn’t enough for long-term success, reckons Edelsten: the second part of investing well has to involve looking at valuations – and taking action based on those valuations. So “the timing of when funds I run move into and out of themes and markets… is all about value for money”.
What “value” means
I ask what that means in practical terms (almost everyone refers to value for money as being a key part of their investment strategy). A stock offers value if it comes at a “huge discount on book value” – something that hasn’t happened much for the last five years – or it has “lots of after-tax free cash flow” – something which is “not that uncommon”.
Looking at Amazon in terms of “trying to be clear about how much free cash flow is left in the bank at the end of a period, I really don’t think you would end up with 8% of your money in [the stock], however much you think Amazon’s a great company” (Scottish Mortgage has 9% of its portfolio in Amazon). Instead, at a certain price and stage of development (getting into grocery in Australia is significantly lower-margin than selling CDs on the internet once was) you turn it over. Edelsten bought at around $400, sold at $1,000 and is unfazed that the price has now hit $1,500.
If you don’t turn over a fund for valuation reasons during a bull market as long as this one, “you will inevitably end up with a fund which is very unbalanced”. That’s fine as long as the market momentum is with you. But when it changes, a portfolio that is too heavily weighted towards bull-market favourites can turn into a “wipe out of people’s wealth” – as seen in 1987, 2003 and 2008.
So what’s he been buying as he has been selling out of internet stocks? Last year he was excited by automation stocks in Japan, which were trading at very low valuations given how thrilling the potential of robotics is (robots are cheap and clever, but also produce better outcomes than human workers in all sorts of situations). Japan has been sadly neglected by global fund managers, reckons Edelsten (I agree!), because so few of them know anything about it.
Ten years ago, everyone senior in the global equity business had done a stint in Japan at some point – so they never stopped looking at it. No more. Today they’ve all had a stint in emerging markets somewhere and know next to nothing about the world’s third-largest economy or its stockmarkets. But now others have picked up the theme, the stocks have moved from “modestly valued to really quite pricey”, so many had just been sold when we met.
What did he move the money into? “Cash, thank goodness” (we were talking during a nasty market drop a few weeks back). This brings us back to his main preoccupation – the provision of “balance” or proper diversification in the portfolio. This isn’t as easy as it was. You shouldn’t, for example, just buy Unilever as a way to diversify into the food sector for defensive reasons.
That’s because is it on 20 times earnings, but only growing profits slowly. That’s just not a good investment. The same goes for lots of the other “bolthole stocks”: note that when the market fell substantially last month many of them “led the market down” – as did some of the big banks into which people have been keen to diversify.
Hunting hard for growth
We move on to talk about the global economy a little. We are both convinced that it makes sense to invest as though there were a degree of wage inflation, general inflation and interest-rate rises on the way – and to assume that this means there will be considerable volatility in the markets over the next few years. It is hard, we agree, to imagine the US can see GDP growth at 4% and inflation at only 2% with its labour market as tight as it is. The good news, says Edelsten, is that there is still enough good corporate growth around that he can still find attractive propositions on “sensible ratings”. He just has to “travel a long way to find them”.
He has “practically nothing in the UK, and hardly anything in Europe”. Why nothing in the UK? The best firms are unlisted and too many of the rest have over-paid in dividends and under-invested as a result. That makes for a bleak future. But there are plenty of “decent American businesses” to buy – not cheap but growing enough to make up for it. And he couldn’t fill the portfolio without spending a lot of time in Japan (Japanese firms make up 15% of the fund).
His favourite holding is Daifuku (Tokyo: 6383), “world leaders in automated warehouses”. It has a huge order book, is growing fast and, at the time we spoke, had just fallen 15%. Perfect.