History tells us that when asset prices are high and we are worried about what will happen next, “defensive” stocks are the place to be. The usual advice is to take cover in boring blue-chips such as consumer staples and utilities.
While that has been a good call in the past, this time it is these same defensive names that have driven the market upwards. This makes sense: central banks suppressed the prospective returns on bonds by bidding up their prices, so investors who previously held bonds have been forced into equities. As reluctant equity investors, they have chosen the most bond-like stocks they could find – the defensives.
So where do you go?
In such a market environment, it is particularly important to focus on downside risk. Allan Gray and Orbis define risk as the permanent loss of capital. We position our portfolios to limit this risk. While this approach can lead to short-term underperformance, it is the best way to preserve and grow our clients’ wealth in the long term.
To achieve this, we look at every company we own in meticulous detail. We are wary of investing in companies with weak balance sheets that would not make it through a downcycle without raising capital or, worse, capitulating. While we pick the stocks we put into portfolios one by one, there are essentially four buckets of stocks that have emerged from our bottom-up decisions:
1. Stocks that are cheap because of company- or industry-specific concerns: These are classic Orbis stocks. Prices and investor sentiment are depressed due to country, industry or company concerns – or a combination of the three. Russia’s Sberbank is a good example. At a time when financial services and Russia have both been out of favour, many investors have overlooked what is otherwise a well-run bank with a dominant competitive position.
2. Stocks with large cash balances that can be deployed in attractive opportunities if asset prices decline significantly: Multinational conglomerate Berkshire Hathaway stands out as a good example. Warren Buffett has cash at the ready to snap up cheap assets as soon as they become available. We don’t think the value of that cash is reflected in the share price.
3. Stocks undergoing transformations that should enhance intrinsic value: An example is Charter Communications, one of Orbis’s largest holdings. The US cable telecom provider is leading the charge in consolidating the US broadband industry, with a savvy management team managing the acquisition process. We take a long-term perspective and don’t think the valuation the market assigns to Charter and other such companies is reflected in their share prices.
4. Beneficiaries of innovation and change: This final bucket is for companies changing the way we do things using technology and innovation. Once again, we think the market is underappreciating the value of profitable, long-term growth – something that is more evident when taking a long-term perspective. Orbis owns a number of e-commerce companies that fit this description, with Amazon being the best-known example.
Once you mix all these buckets together, you get a well-diversified group of companies that have been thoroughly analysed and have one thing in common: the price we have paid for their earnings and assets is well below what we think they are actually worth. We won’t be right every time – historically, our success ratio has been about 60% – but paying a low price relative to fundamental value creates a margin of safety in case we are wrong.
And that is the key point: we believe underpaying for assets not only leads to superior returns in the long term, but also reduces the risk of permanent capital loss. Similarly, it is also important to avoid areas of the market that look particularly expensive, as is the case with the so-called “defensive” shares in the current environment.
Orbis will be speaking about investing offshore and the opportunities it can find in the current global environment at the upcoming Allan Gray Investment Summit on August 31 2017. This new one-day event aims to help investors protect and grow their wealth. For more information and to book tickets, visit www.investmentsummit.co.za.
Matthew Spencer is head of institutional clients at Orbis.
This article was paid for by Allan Gray.