Offshore investing

Q&A: Understanding Orbis’ performance and potential

Market breadth has been very narrow offshore, with few winners and many losers. Among the losers have been emerging markets and select cyclicals. At the same time, value continues to underperform growth and entire yield curves in some countries are negative. This suggests there should be opportunities for contrarians with portfolios that look very different from the benchmark. Duncan Artus from Allan Gray and Edward Blain from our offshore partner, Orbis, answer some key questions about Orbis’ performance in this environment and discuss potential opportunities.

1. Why is Orbis underperforming?

Occasional periods of underperformance are an expected, but painful, aspect of contrarian, long-term investing. Quite simply, Orbis’ underperformance has been overwhelmingly driven by our stock picking. Over the long term, about four of every 10 stock picks have been losers and while we have had our share of mistakes in this recent period, the average performance of our losers has been consistent with the long term. For the most part, we still have high conviction in the stocks that have underperformed – and in many instances have added to these positions. However, while our losers haven’t done worse than the long-term history, the problem has really been our lack of winners.

Our approach tends to produce better results when cheap stocks are getting less cheap, and has a tougher time when expensive stocks are getting more expensive. In the decade since the trough of the financial crisis, we have seen more of the latter – expensive stocks getting more expensive. 

Higher prices for expensive stocks makes them riskier to us, so we are happy to continue hunting for opportunities among cheaper shares. Rather than overpaying for slowing, increasingly leveraged “safe” shares, we’d prefer to underpay for good businesses when investor expectations are nice and low. 

Encouragingly, today the stocks held in the Orbis Global Equity portfolio are significantly cheaper than the FTSE World Index on several measures of valuation, such as price-to-book and price-to-normalised-earnings. But as a reminder that low valuations don’t entail poor growth or quality, those same holdings, in aggregate, have historically delivered higher profitability (return on equity) and faster growth rates in book value and revenues than the average stock in the index. Though many of them have been painful to hold over the past several months, we believe this has left the portfolio looking attractive compared to its benchmark.

While losers can be painful, at times they provide us with the opportunity to buy even more stock at a much lower price. 

We can’t predict when expensive stocks will stop getting more expensive, or when our performance will turn, but we are determined to stick to our discipline. We remain convinced that buying quality on the cheap and passing on what’s highly valued by others remains a winning formula over the long term. That’s not to say all of our stock selections will turn out to be great investments. But it is fair to say that the individuals managing your capital – and our own – are feeling significantly more excited about the portfolio today than we have been for some time.

2. Is it true to say that Orbis is often not willing to pay a high enough price for quality businesses?

Our investment philosophy is simple: we aim to make money when underpriced assets get less cheap. This doesn’t mean we won’t pay for a quality business; but what we are looking for is not simply good growth in the present, we need to see signs that growth could continue for years in the future. Lately it has been uncomfortable to own unpopular companies rather than popular and well-behaved shares. But it doesn’t for one second make us think we should sell cheap stocks that have gotten cheaper to buy expensive stocks that have gotten more expensive. We can never know when markets will turn, but we remain confident that fundamentals will win out over the long term.

3. How do we think about holdings which are recommended by both Orbis and Allan Gray?

With the US market (60% of the world index) looking expensive overall, Orbis is finding more opportunities in developing markets. This has led to some crossover in the holdings between Orbis and Allan Gray – specifically holdings in Naspers and British American Tobacco. NetEase, a competitor to Tencent, is also a large position for Orbis, increasing the aggregate Allan Gray and Orbis exposure to the Chinese gaming and internet sector. While both firms follow the same investment philosophy, they make investment decisions independently. Despite Orbis’ broader global mandate, there have been rare instances where both Allan Gray and Orbis have independently identified the same opportunities. The Chinese internet sector contains some of the biggest shares in the developing market universe, so it makes for a compelling area to comb through on a bottom-up basis, looking for potential value. The Allan Gray investment team is in regular contact with Orbis and when looking through the combined portfolios at the aggregated positions as a percentage of the fund, Allan Gray is comfortable with the exposure relative to the attractiveness of the opportunities.

4. Is Brexit a good opportunity for Britain and for investing?

The main question for us is not what will happen to European politics or the UK economy, but whether individual companies look like good long-term investments at the prices the market is offering us and whether the current environment is creating more opportunities that can fall into that bucket. We believe the best tool to answer that question is bottom-up, fundamental research. For some shares, assessing the political and economic risks of Brexit forms part of that research.

We cannot control how the market reacts to major events, but we can control how we respond. Aware that opportunities can emerge if Britain does leave the European Union, we have reviewed our investment ideas and re-affirmed our estimates of intrinsic value so that we are able to take advantage of any dislocations. For the overwhelming majority of our favoured securities, we do not see a clear impairment to long-term intrinsic value as a result of Brexit, though the resulting uncertainty may make for uncomfortable share price movements in the short term.

While the human side of Brexit creates unnecessary mess and complications, which will be painful to deal with, the UK’s proximity to Europe means it will continue to be a key trading partner to the European Union. The ongoing uncertainty is making people understandably uncomfortable, but we believe the outcomes won’t be as bad as the market is insisting.

We are global investors and we specifically look for investment opportunities created by market pessimism. So if there are challenges in a market, we weigh up whether there is enough pessimism to create an attractive opportunity. Often the answer is “yes”, but if not, or if we don’t have enough conviction in any of the opportunities we find, we can always look elsewhere. We are both global and “bottom up”, which means that first and foremost, we look for great companies. Being bottom up gives us the extraordinarily valuable luxury of ignoring almost every stock in the universe. We only need to find a handful of attractive ones.

5. Why is it a good idea to invest in Orbis funds?

Managing global equities is a challenging job and there are very few managers out there that look at the full spectrum. While Orbis has been punished over the last few years as the cheap shares we have identified and chosen have continued to get cheaper, we are confident and excited about our share selections.

When assessing how we feel about our Funds’ positioning, we consider the price we are paying for the earnings, assets and growth of the companies in the portfolio and compare these to the benchmark. We also look at what we don’t own and question how we feel about this. We are equally excited on both fronts. Of course, there is no guarantee that the market will come to share our view of the businesses we have invested in. But importantly, we don’t own the stocks just because they’re cheap. We own them because we believe their low valuations are unwarranted.

Many market players claim that value investing is dead. While we aren’t textbook value investors, there are many similarities between a value philosophy and our fundamental, long-term and contrarian philosophy. While value investing has taken a pretty tough knock more recently, it has also taken its fair share of knocks in the past, and subsequently recovered. We believe today is no different and that a value approach will work in future for the same reason that it has worked so well over the long-term past – at its core, its efficacy is driven by thousands of years of basic human nature, specifically the survival instinct that causes humans to respond to greed and fear. These primal drivers of human emotion lead investors to run with winners and from losers. In markets, investors habitually expect the winners to forever thrive and the losers to forever struggle, and they price the companies accordingly. History has shown that investors tend to overshoot. Growth fades and struggles subside. Whether through the power of incentives, the levelling gravity of capitalism, or even luck, great and bad companies alike often prove their adjectives wrong.

Going against the herd comes with its share of volatility, but in our experience it is often uncertainty itself that creates opportunity. We are willing to trade the near-term comfort of the herd for the potential to earn considerably more attractive future returns while protecting our clients’ capital over the long term.

During the tough times, the performance numbers of a good manager experiencing temporary adversity can look identical to those of an unskilled manager. It is then even more important to look at the firm’s overall philosophy to distinguish between them, rather than recent returns. We have a cohesive set of principles that underpins the firm and everything we do. For example, our private ownership structure enables us to pursue a long-term philosophy, and our individual accountability enables us to be contrarian. Importantly, we work tirelessly to make sure our interests are aligned with those of our clients.

The financial services, products or investments referred to on this website are not available to persons resident in jurisdictions where their availability or distribution would contravene local laws or regulations and the information on this website is not intended for use by these persons. This website is for information only and does not in any way constitute a solicitation or offer by Allan Gray Proprietary Limited or any of its associates or subsidiaries (collectively “Allan Gray”) to buy or sell any financial instruments or to provide any investment advice or service.

By selecting one of the countries below I confirm that I have read and understood the above and that:

(a) I am not a South African citizen; or 
(b) I do not reside in the Republic of South Africa; or 
(c) I am not otherwise a person to whom the communication of the information contained in this website is prohibited by the laws of my home jurisdiction; and 
(d) I am not acting for the benefit of any such persons mentioned in (a),(b) and (c) and 
(e) I confirm that any investment with Allan Gray is based on my own initiative and not due to any offer or solicitation by Allan Gray.