Written by Philip Baker & Vesna Poljak, Australian Financial Review, 5 October 2015
“It’s like one plus one equals one-point-five,” says John Abernethy. The fund manager, who founded Clime Investment Management and is a former head of equities at NRMA Investments, is trying to piece together what he argues has been almost a lost decade for the Australian sharemarket.
“The stockmarket is the same level today as it was nine years ago,” he says, referencing its index points value. “The valuation’s up by $300 billion but we can track probably 50 per cent more than that, say $400 billion, has gone in new issues, or reinvestment or retained earnings. There’s been destruction at a great rate.”
Part of the problem he believes, is there’s too much “pure equity”, and the tide of money flowing into the hands of asset managers through superannuation contributions has undermined the value of hard capital. On the other side, the people running Australian businesses – with few exceptions – are struggling to take that capital and create growth.
“That’s a great criticism of capital markets today which I think is destroying value in Australia. There’s no thought processes to capital structures and that’s why the sharemarket is pretty appalling at present.
“We give too much credibility to people managing businesses who really haven’t proven anything, they just happen to flop into the job.”
Abernethy comes from the Warren Buffett-style school of value investing; a friend who worked in equities advised him to seek a career in the market out of university because of Abernethy’s willingness to think “outside the box”.
“He said ‘Look, any chance you get you’ve got to move into the stockmarket because it will suit you: you’re a bit of an entrepreneur, you’re good with numbers.'”
By “entrepreneur”, he meant Abernethy’s eye for a winner at the races.
“I had a pretty good track record,” he admits of his days running books at school. “Percentages and returns, risk management and risk assessment. It’s all basic stuff, you don’t know where you’re going to take it in life. But during university I used to go to the races every day during university holidays.”
His big break in markets came when he joined NRMA as a trainee back when the investment team was run by Sam Kaplan. Kaplan is also close to Chris Corrigan, who used to run ports group Patrick.
“I got [the job] on honesty because most of the questions I couldn’t answer, rather than guessing, I said ‘I can’t answer that.’ At the end of it he said, ‘You’ve got the job'” he recalls.
This was before demutualisation, when NRMA, AMP and National Mutual (now Axa) dominated Australian equity markets because of their access to the balance sheet reserves the mutuals commanded.
“It was Buffett-type methodology, value investing, index-unaware, buy value, structure deals, use the balance sheet where appropriate for underwriting. Sam was a very hard fund manager.”
The discipline instilled around the treatment of capital back then and “member-first” ideology is something he carries with him today at Clime.
The other twist was that brokers relied on mutuals to get deals done and equally, assume underwriting risk. “Today they’re just managing flows,” Abernethy argues. “It’s almost like there’s so much money coming up, the capital managers, they just get rid of it.”
In typically outspoken fashion, he is scathing of some of the deals that find their way into the hands of investors, and ultimately, individuals who are counting on a return in retirement.
“Some of these asset managers, asset consultants, industry funds need to have a wake-up call and the investment banks in this country need to be shaken up a bit because some of the deals they’re bringing to market are disgraceful the way they’re structured.”
He reserves some of his most scathing comments for index funds – “brain-dead” – and hedge funds.
“Does the guy in the street who’s putting 9 per cent of his salary each fortnight into those funds actually know what’s going on? Would he actually be happy that there’s a clown buying an index on one side and another clown shorting it on the other side with his money, and he’s paying them. On the hope that in 20 or 30 years time he might get enough money to live off?”
Today, Clime is watching market volatility provide some entry points into stocks that look compelling. Even though returns are low, he still thinks 10 per cent is the right target for equities and “if you can’t see that, don’t do it: just wait”.
The fund manager picked up The Reject Shop when it was dumped in heavy selling at around $5 a share. It’s now back at $8.58.
Credit Corp Group, which has also been savaged, looks interesting, he says. “That looks interesting. We think it’s worth about 15 per cent more than it’s current share price. But is it a mad rush into it? No, it’s an accumulate because just as the de-rating is unpredictable the re-rating is unpredictable.”
There’s Qube Holdings – “back to $2, not a bargain but interesting if you take a five year-view”.
In the banks, Abernethy finds National Australia Bank the most attractive but that’s only relative to its peers. “The banking sector is going to pay dividends plus a very small capital gain for a couple of years. In the world of low returns that’s not too bad.”
Woolworths looks oversold and “pretty attractive” on a five-year view, but “it’s now become a market game for hedge funds”.
Abernethy says Woolworths’ franchise value is enormous and its national footprint cannot be replicated. Naturally, “One wonders why the big shareholders let the board away with what it got away with, and what the board let management get away with.”
He is hugely cautious on energy but in resources, “I do like BHP out of the whole lot. They’ve got themselves into a complete pickle with the dividend policy. Again that’s poor capital management. They bought shares back at the high of the market and threw away franking credits and then they started on the dividend policy which didn’t reward shareholders for good performance by the company.”
Abernethy sees the chain of events as management “arrogance”. “What did they do with the money they retained? They bought highly priced assets in inflated resource markets. Here we are now, they can’t even develop them. They all seem to extrapolate the present into the future as if there’s no cycle.”
The wasting of the resources boom bounty troubles him, so he is hoping the Turnbull government will push sectors such as tourism hard and chart a more purposeful course for the Australian economy.
“Australia’s going to get what, 1 million Chinese tourists this year? We should have aspirations to double that or triple that.
“The reason why China is the second-biggest economy in the world isn’t by market forces,” – far from it, he jests – “it’s got direction. It mobilises capital. It’s pretty basic stuff.”
Original source: Financial Review