By Alan Kohler
Geoff Wilson AO is the Chairman and Chief Investment Officer of Wilson Asset Management which he started in 1997; so 23 years ago and in the middle of the Asian crisis.
Geoff has been around a long time; he obviously was around a long time before that as well and so I think he is about as old as I am, which is quite old. He is one of the more experienced people in the market, he went into this crisis with a fair bit of cash because he’s a value investor and he hasn’t been able to find much value in the last 12 months or so, so he hasn’t been buying a lot and therefore he is in a reasonable position, I think he’s up to more than 40 per cent cash now. It’s very interesting to talk to Geoff.
Here he is, Geoff Wilson AO, Chairman and Chief Investment Officer of Wilson Asset Management.
Geoff, I want to talk to you about your views on the market in a moment but let’s just focus on your business. You did a presentation a couple of weeks ago, a conference call and a PowerPoint in which you showed that the cash weighting of your flagship fund, WAM Capital, was 33.8 per cent, that’s pretty high. Did you see this coming in some way?
[laughs] For the last probably two or three years I personally have been nervous. We have all been around the market for quite a period of time and we know we had bull markets and bear markets and I actually thought the bear market was going to start when quantitative tightening started a year and a half ago, we had the sell off in 2018, in the last quarter 2018, I actually thought that was the start of the bear market. Probably in retrospect, it was good that the fed did a U-turn and pumped money into the system again because of the pain that we’re going through now because of COVID-19.
We tend to hold reasonable levels of cash in WAM Capital and that’s because of how we invest the money, we’re looking for undervalued growth companies, we’ll buy them when we see a catalyst, if we can’t see a catalyst then we’ll sit on cash or if we can’t find the undervalued growth companies so we tend to have a bit of cash. Actually, how we were positioned when the markets started to fracture is we actually had a very low cash level by historical measures because it was the middle of the reporting season, this is in WAM Capital, and we’d actually done very well in terms of picking a number of companies that actually ended up having upgrades through that period even though it wasn’t a great reporting season.
I think our cash level got down to the low teens, this is in sort of mid-February and then when it became clear, it was really that Monday when it became clear that the virus was starting to spread in the western world, then we looked at our portfolio and lifted our cash levels up significantly and as of I think last night I think we’re 43 per cent cash. It’s actually increased since that period.
Obviously, this gives you a fair bit of firepower when you decided to buy but in the meantime, I presume it also means that your funds under management don’t shrink as much as perhaps those who are fully invested.
Assuming the market is going down the difficult part is if the market is going down even though you might have 40 per cent cash you’ve still got 60 per cent equity, so you still feel the pain, not to the same degree as everybody else, but obviously feel the pain.
Looking at the funds management industry this is a crisis in a way because the market has shrunk 35 per cent or whatever, that means that those who are fully invested, their funds under management are down 35 per cent and presumably their cost base is geared towards a much higher level of income.
It is. I suppose one of the good things about the funds management industry, it’s a high margin business and it’s interesting you say that – in theory, even though revenue will drop significantly, assuming everyone is 100 per cent invested then revenue is going to drop by 35 per cent, there would still be a very healthy margin and it’s interesting you say that because one of the early things when we’re looking at the companies we had in our portfolio obviously when you make a decision on revenue you know there’s a multiplier effect on revenue with most companies because they’ll have a – say they’ve got a 10 per cent gross margin and so for $100 of revenue there’s $90 of cost, so they’re making $10. If they can’t adjust their costs and their revenue drops by say 5 per cent then all of a sudden your profit has gone from $10 to $5 so there’s enormous leverage both ways and that’s what we’re going to see.
What we did do, we obviously went through all of the companies in our portfolio making sure that we had companies that would survive, particularly some of the early ones to be sold out were the ones that had small margins because if there was any impact on revenue then effectively they’re loss-making and also companies that had debt levels – and we saw that in the GFC. Effectively, if you had current debt that was due to be paid in the next 12 months then there was a question mark whether you’d survive, and we did that very early.
Can you tell me which stocks you sold?
I’d prefer not to because we thought there were five companies in our portfolio that might go under, so I’d prefer not to.
That’s fair enough. Are you seeing redemptions from clients, are people pulling their money out?
The positive thing about listed investment companies is the pool of capital doesn’t change – well, it changes by how you perform as a manager if the assets – in terms of go up or down. Because it’s a closed pool of capital people can buy and sell their shares but we don’t have redemptions so I’m aware that various other managers had redemptions and these are the ones that had the open ended FUMs and I’m aware of one manager that’s actually put a gate on their fund just to stop people from redeeming because it would force them to sell. There’s definitely been some dislocation there and I’d assume the interesting thing is in these cycles of bear markets the early stage has just ballooned. I think we’re probably just through that period and I’d say we’re probably – we’re sort of between fear and panic now.
I think redemptions will be coming but the tough thing is the average investor tends to buy at the top of the market and sell at the bottom so they’ll be selling in a period of time.
Do you think there will have to be a shake out in the funds management industry, that a number of funds will possibly go under?
I don’t think you’ll see necessarily funds going under, I’m aware of another fund that’s a global fund and what they have done is their mandate allowed them only to have a certain per cent of the portfolio in cash and as they were very nervous or very bearish about the market they have decided to wind up their business and they had to go 100 per cent cash. You definitely will see a number of fund managers that don’t make it through this period, you’d assume that over the next six to 12 months there’ll be a lot of redemptions and like I suppose all industries everyone is now looking at their costs. It’s effectively survival, any expansion plans have been put on hold and everyone will be making sure they get their costs under control.
Unfortunately, the terrible thing is with the virtual lockdown how many people have lost their job over the last little period. That will happen in funds management land as well, not to the same degree though.
I guess the thing with the listed investment companies like yours is the question of whether it’s a premium or discount to NTA but the problem is figuring out what NTA is because it’s moving so fast, isn’t it?
Yeah, it is very dynamic and a number of brokers model the listed investment company so you can get effectively live NTAs and when we’re looking at other listed investment companies – if other listed investment companies trade and get big discounts to NTA then we’ll buy them as well. If we believe that they can get the share price back to NTA and what we do is you either … holdings and work out how they performed or some people very broadly can just use a proxy for the market and just adjust the NTA by what the market has done. Obviously, knowing that someone has X amount of cash in their portfolio then obviously you’d assume the cash stays the same and the equity is in decline by that so it’s not that hard to get a guestimate of what the NTA is, particularly with a market that is jumping around significantly.
Are your funds now trading at a discount and what sort? I noticed that according to my IRESS screen WAM is at a discount of 16 per cent, is that right?
That was last month’s NTA.
That’s right, I don’t have a live NTA for WAM.
Okay, so the market is down 24 per cent this month so if you assumed we did better than that you’d assume we’re still at a premium to NTA, WAM, but not a great premium to NTA. Actually, we’re at a reasonable premium to NTA you’d assume.
WAM and your other funds have all underperformed the market a little bit, not much but the one that’s underperformed the most is your microcap fund which has underperformed, I think, since February the 20th anyway by about 12 per cent.
Yeah, and the reason there is when they move from premium to discounts and you’ve got to remember with microcaps that actually has a – we’ve moved that cash level up to over 40 as well. There’s a lot of risk there and the interesting thing is last year I think that was up 35 per cent, so the microcaps is really the whip end of the market where when things are going well you do extremely well and when things are going poorly it’s very challenging but we’re incredibly well-positioned so with all of this shake out, what makes me excited is it’s actually back to fundamental investing, it’s not buying companies on PEs of revenue and it’s back to old fashioned investing, trying to work out what a company is worth and being prepared to pay that.
Perhaps rather than asking you which stocks you sold I should ask you which ones you’ve hung onto 100 per cent of, or your entire holding, are there any?
Because we’ve got midcaps, large caps, small caps, micro caps and global. There’s six listed investment companies so there’s a number of portfolios and with each portfolio we’ve got, there’s a portfolio manager that manages each of those portfolios so it’s their decision. The interesting thing is because we’re remote and we normally sit in an open plan office so we’re going to have a conversation all the time, now we’re on Skype Business each morning at nine o’clock and we’ve got the other 12 phases, we sort of go through our macro and then any of the micro details about what’s happening in the market at the moment. In terms of individual stocks I’d have to check with those guys. I’d assume there would be some.
What’s in your mind? I get the portfolio managers are doing their own thing but if I asked you what stocks would you hang onto through this what’s the answer?
First of all, you want to buy a stock that’s going to survive.
I’m asking you what you’re hanging onto, what you wouldn’t sell, actually, possibly a slightly different question.
Rather than what you’d buy what you’d keep – well, similar I’d say, a similar answer. In theory you want a good franchise, you want a really good business, but you want someone that’s quite dominant in their industries and ideally you’d have other players in those industries that are geared up that won’t survive. For them, they’ll actually benefit from that but really it’s good quality companies that have good balance sheets and well managed. An example of one of those is if you look the GFC for an example, say you’re looking at the banking sector which most Australians are invested in. I remember we were talking internally about this last week and I think NAB was back to the price it had been during the GFC and I think Commonwealth Bank was still more than 200 per cent above that price.
That shows you the difference in picking a quality company that you believe will continue to perform, even though things might go through a difficult period and each of the portfolio managers in terms of the various stocks we have actually put together what we want to be exposed to when we think we’re towards the bottom of the market. Always the first leg of the market coming out is financials. Obviously, I remember during the GFC you end up having a number of false dawns where you think the market has bottomed and you sort of up weight into the financials and then you weren’t correct.
The most leveraged financial is Macquarie Bank, it’s leveraged both ways, if things get worse then it’ll perform poorly but when things pick up – to me, if you wanted to try to be a bit more selective and wait until you believe that there’s blood on the streets, as Baron Rothchild once said, then you’d be looking at the leverage play there, Macquarie on the banks and then the other banks and obviously going for the ones that you think are better say, Commbank down. Then also because this has been a sort of really sudden economic shock then assuming – and one area that’s been decimated obviously is travel, if companies in that area survive like the Flight Centres or the Qantas’s, quality in that area, then when things do pick up you’ll get a leverage play on those. The tough thing at the moment is, the million dollar question is, how long will the duration of this virtual lockdown be. You have to have a view on that before you sort of decide to commit to that strategy.
Do you think the market bottom will depend on the virus bottom entirely?
Sorry, I just missed that, the market bottom will depend on?
The virus bottom.
The virus peak, yeah that’s right.
Yeah, what we saw effectively there’s three areas, there’s credit, there’s the virus and there’s GDP and we saw in ’87 effectively the credit markets just froze up. What we have seen this time is there has been dislocation in credit and what we have seen is the monetary authorities have been incredibly responsive on that area and I’m not sure if you noticed last night that the Federal Reserve was not only buying … but they were buying corporate debt, they’re prepared to buy that, and really an infinite amount of it. That sort of gives you confidence on the credit so then obviously the impacts on the GDP us the virtual lockdowns which are the virus and what we did see is in China when they went to their first lockdown when their cases peaked the Chinese market actually – even though it sold off significantly while they were growing when it peaked the Chinese market actually rallied, and they actually rallied quite strongly.
Since then, obviously globally, we have had significant growth in the virus globally so the Chinese market has fallen like all of the other markets. To me, it’s really peak pessimism and whether it could be the decline of the virus because all of the studies, all of the things I’ve read, it looks like a vaccine will be 12 months and the various studies – I was reading one by the Imperial College in the UK that I think helped turn Trump around from being sort of quite jovial about this to being a little more serious. Their view is it will take a period of time, it’s not a one-month lookout problem but to me the peak in the numbers will be definitely important.
The GDP situation, you rightly singled that out and a lot of people now are starting to call for a depression which is a GDP decline of 10 per cent or more. The last time we had a depression obviously was 1930 and what we saw then was the market – I’ve just been looking at it this morning – the US market, the Dow Jones fell initially after the crash of October 29, the Dow fell 34 per cent and then rallied 20 per cent in 1930 and eventually it ended up falling about 85 per cent. I wonder whether a depression actually causes a much more significant fall in the stock market than the virus itself would cause, if you know what I mean.
Yeah, the economic impact, that’s right. People are talking about GDP numbers for a quarter of a drop of a lot more than that. I think Goldman Sachs are talking about a 30 per cent drop in GDP in the US so it is very serious and really the question is the duration, how long will that be for. The interesting thing is if you superimpose the graph of the market now over 2009, the current market is fractionally steeper but very similar to the first period. If you’re looking at 2009 it looks like we’ve got a little bit to go further on the downside. I think the difference between 2009 and now is effectively the various strategies that they came in with were quite draconian and I think that led to the 85 per cent fall. I don’t disagree that this is worse than the GFC, and I think in 2009 there were tariffs and they were doing all of the wrong things.
Yes, by draconian you mean that they were tightening rather than loosening, or at least fiscally as well.
Yeah, correct, they weren’t anywhere near as proactive. The interesting thing is how accommodating the Federal Reserve has been this time, I suppose they learnt from the GFC. I wouldn’t expect it to be as extreme as that. We know that this will be dealt with, there will either be a vaccine or there could be some herd immunity, but at some point in time – it might take a year, 18 months – I think between 350,000 to 650,000 people die a year of the flu and there will be a number of people that die each year from Covid-19, or coronavirus, or what was it called? SARS, I think it’s a SARS derivative.
Yeah, that’s right.
At some point in time, it’ll just be part of life and people will be normalised. It doesn’t feel like that at the moment because the fear level and the panic is very high and I think it’s incredibly unsettling for everyone whether you’re in the financial markets or not in terms of the dislocation and what’s occurring. We will get through it and the bounce back will probably be very strong but the tough thing is we just don’t know exactly when.
Do you think it’s possible to kind of simplify the effect of the monetary policy and the fiscal stimulus and so on that’s going on, in a sort of where do you think the PE might end up bottoming? Obviously, the market PE is back now to roughly average, about 14 times, and the GFC it got to 10 times and I think in 2012 during the European crisis it got to 10 as well. I wonder whether we’re looking at 10 this time or back to the sort of depression times of 5 times PE instead, I don’t know, is that an oversimplification?
It is a little bit. To me the difficult part is of the price-earnings ratio, the difficult part is the E part, as in the earnings. We’re of the view that the market is on 14 times and when I was talking earlier I mentioned about the leverage to revenue and we really – the big unknown is just how long all of the lockdown, which is going to create an incredible increase in unemployment, lost consumption, etcetera – the impact that will have on revenue which really those earnings, maybe the market is not really on a PE of 14, maybe the market is on a PE of close to 20 currently. I’m just picking a figure out of the sky.
It’s really difficult to try to work out where they will finish, PE is a combination of interest rates and expected future growth, current earnings and prospective future growth, and to me, all the risk is on current earnings and when the future growth comes because I’d say if you look two or three years out then life will be back to normal, we just don’t know exactly when.
Are you starting to think about what does normal look like after this and how the world might change after this pandemic?
Yeah, and it will definitely change. We have been talking about that in terms of change in behaviour. Alan, you’d probably be similar to me in terms of age, and I am sure your dad would have been similar to my dad who was around in the depression and when we were growing up, or when I was growing up, dad spent all of his time turning off the lights. That was just something drilled into them, to be very frugal and don’t waste any money. To me in terms of what you’ll find is from what’s happened and what will happen with the lockdown, that people will change how they purchase. In the old days maybe if we wanted something we’d purchase one, now we’ll probably purchase three or four and always have a bit of a stock just in case.
There’s no doubt that communications, working from home – if you had a business that just relied on company rentals, companies renting space, to me I’d say the growth trajectory going forward would be less than it has been historically because I think people will work out how to work at home efficiently, and on the artificial intelligence side – there will be a lot of growth in a lot of different areas. The world will change permanently but that will more be around the edges rather than significantly.
Do you think the stock market will change, do you think investors’ attitudes will change?
For the short term they will because we all know that markets are – the big drivers are fear and greed and that’s why markets go to ridiculous heights, because unfortunately people get greedy and that’s why during difficult times they go to significant lows. Whether the market falls 35 per cent, whether it falls 50 per cent, whether it falls 60 per cent or 70 per cent there will be a bull market after this bear market. Historically even since 1900, I think the average bear market goes for about a year and a half and one of the positive things is bull markets run a lot longer than bear markets. There will be a bull market if you buy shares now and look in ten years’ time because people are fearful at the moment, even though it mightn’t be a bottom you’ll look back and say actually I bought reasonably well.
You’ve been generous with your time, Geoff, I appreciate it. Thanks.
Good man. Thanks, Alan.
That was Geoff Wilson AO, Chairman and Chief Investment Officer of Wilson Asset Management.