Ned Bell on why there’s a generational step change underway
Ned Bell is Chief Investment Officer and Portfolio Manager at Bell Asset Management, a global partner of Channel Capital.
GH: The Bell Global Equities Fund was launched in 2007, that’s 15 years ago, and you were recently awarded the Undiscovered Manager award in the 2022 Morningstar Fund Manager of the Year awards. What’s been happening?
NB: We’ve been managing institutional money, building the team and focussing on distribution via platforms and advisers with more retail exposure recently. We believe company quality drives share prices but markets have not always rewarded fundamental analysis in recent years.
GH: How have markets changed in the last 15 years?
NB: Passive investing has had a massive impact, especially in the way they buy more as the market rises. Both active and passive buyers of the large FAANG stocks created an almost corkscrew impact pushing up the market. This is unravelling as we speak, and we are seeing very sharp drawdowns in massive companies like Netflix and Meta.
So the market composition has changed a lot but there’s also been a generational shift. When markets are so good for so long, and many of the more experienced participants have retired, they are replaced by younger participants, whether investors or investment consultants, and many have never seen a falling market. It’s a different dynamic.
GH: The market delivers surprises every year, but are you seeing something more significant now, a sort of generational step change?
NB: I am. If you think about the environment, what’s on the whiteboard for this year … the highest inflation since the 70s, a raging war in Europe, a rapidly decelerating China which has accounted for a large proportion of global GDP growth in the last 10 years. The gap between GDP growth expectations for emerging markets (EM) versus developed markets has shrunk to the smallest in 20 years plus. It’s a monumental turning point. Investors in EM markets must ask themselves, if the whole reason for being there in the first place is to capture a growth premium and it’s no longer there, then why are we still there?
GH: Yes, and EM is one of those markets that is always about to happen, but it never quite delivers.
NB: Yes, but no matter what markets you invest in, it comes down to the companies. And in EM, we’ve not seen the earnings growth in the companies over 10 years. The phenomenal GDP growth is disconnected from the earnings growth of locally-domiciled companies, yet we’ve seen the likes of Apple and LVMH and countless terrifically-managed global companies prosper from a revenue perspective.
GH: Your emerging companies fund invests in the global small and mid (SMID) cap space in a universe of thousands of companies. How do you filter that vast choice?
NB: The first point is we’re only investing in developed markets and companies with a minimum market cap of US$1 billion. We screen for a return on equity above 15% for three consecutive years and that gives us about 700 names as a starting point. After some bottom up fundamental analysis, we end up with around 150 names in this SMID sector, then it’s a matter of the right price.
GH: Running an investment business from Australia, do you have good access to talk to the CEOs and management of those companies?
NB: We absolutely do. I start every meeting saying I’m not a hedge fund and that usually gets an extra 10 minutes. The fact that we are long-term shareholders endears us to them, we’re not trading them, our average holding period is well over five years. In a normal year, we do 500 research engagements a year and this is our 20th year.
GH: I heard you speak recently about looking for companies with earnings resilience, but to what extent do major macro themes play into your investment decisions and that resilience?
NB: It does play into how we define quality. We look for great management, strong business franchises, consistently high levels of profitability, balance sheet strength, sound ESG principles. But also strong business drivers, and that’s when macro comes in. Our investment meetings at the moment are dominated by the effects of inflation plus China and supply chain disruptions.
GH: Are there a couple of examples of companies in your portfolios with strong pricing power that can be resilient in the face of this inflation?
NB: Sure. Among the large cap names, the luxury goods are hard to go past, LVMH and Hermes, which have phenomenal pricing power and exposure to an economically-insensitive market …
GH: … the more expensive a handbag, the more desirable it becomes.
NB: Exactly, and that’s a good spot to be in. Companies like Moody’s and S&P, terrific businesses and essentially service providers but not subject to inflation such as rising labour costs. Costco is a brilliant retailer with pricing power. In the small and mid cap side, someone like Poolcorp, the biggest pool company in the US, has no problems putting up prices. And Estee Lauder in the consumer space. There are lots of great companies to own at the right price.
GH: How do you feel about the tech stocks that seem to be forming two tiers, with names like Microsoft and Apple in the top tier and Netflix and Zoom without the same quality?
NB: We are underweight the big FAANG stocks by about 8% versus the index, and that hurt a lot until about September last year. We do have exposure to the likes of Alphabet and Amazon and Microsoft but not Apple although we owned it for about 16 years from when the first iPhone came out. We sold that due to its stretched valuation in 2020. Those first three are terrific businesses with longevity but growth is slowing. Stocks like Meta and Netflix on high multiples of 50 in growth manager portfolios can quickly derate and the prices keep falling because the value managers are waiting at 18 times earnings. Rising interest rates means one thing … multiples compress.
GH: Do you feel there are pocket of stocks, either expensive or cheap, where your team has noticed something that the market is completely missed?
NB: Yes, absolutely. I always make this point, but the global small and mid cap universe is extraordinarily inexpensive for an asset class that’s consistently added value over 20 years. It’s less risky than emerging markets as an asset class and the fundamentals are better. They didn’t keep up in the so-called ‘growth rally’ until September last year, and the valuation differential is huge. If you compare the SMID MSCI index with the World Growth MSCI index, it’s a 40% discount. Just buying the index is 17 times earnings versus 27.
GH: Where is it historically?
NB: It’s the biggest discount in 10 years, historically, SMID has traded at a premium to large cap value. Why is this? Through COVID, many companies had to tighten their belts quickly, and smaller companies were efficient and fast and more nimble, with a lot of family ownership. They took a lot of costs out of their businesses. The earnings estimates for this year versus 2019 pre-COVID for the SMID index are 70% higher, yet prices are only marginally up. The value for money is exceptional in businesses you can own for 10 to 15 years.
GH: Every fund manager has its winners and losers. Is there a stock that you’ve sold recently that didn’t do well and it taught you something about your investment process that caused a rethink?
NB: Yes, a Danish company called Ambu, a leader in medtech equipment, and it had been one of our better performers. We sold some when the thesis was moderating, growth was slowing, change of management, but we should have sold the whole position. The lesson is that when the thesis changes, you need to take a really hard look at it and we should have done better.
GH: Your portfolios are unhedged. Do you have any advice for how an Australian investor should think about the currency?
NB: The main point is there’s a degree of inbuilt currency hedging in the portfolio. If we’re buying US dollars to buy Nike, then their revenue exposure is very diverse across currencies. In fact, if you invest in a hedged product, you may be inadvertently taking more of a currency view.
GH: Are you considering a listed version of your funds, particularly with the development of Active ETFs?
NB: Not immediately but it’s not out of the question. At the moment, we’re working diligently on getting the funds onto platforms. We don’t want to go down the LIC path which is fraught with danger and can be a distraction from what we should be spending time on.
GH: What’s your pitch for active over index in your sector?
NB: The environment we’re going into now will be brilliant for active management, the best for 20 years. If you think about capturing alpha (outperforming the market), it’s when we see these market dislocation events, we see irrational behaviour by investors who are not used to the environment. That’s what bottom-up stock pickers want. In the last five years, our disciplines of only investing in quality companies and not paying too much has done us no favours. Ironically, this is when many super funds have moved more to passive.
The last five years have been upside-upside-upside … now let’s see who can manage the downside risk. Investors have become frustrated by active managers but this environment will suit skilled stock picking and portfolio construction.
GH: You’re making the case for a particular type of active management, because some active managers have backed the growth story of the last five years and done well, although they’ve given a lot back in the last six months. Sounds like you expect league table positions to change a lot.
NB: Yes, but it’s about quality. History demonstrates that quality does well in inflationary environments. There’s still a lot of valuation risk in the growth end of the market and lot of poor companies at the value end. In an economic slowdown with inflation, you want to own companies where earnings are dictated by the quality of their franchise, not the direction of the economy.
Graham Hand is Editor-at-Large for Firstlinks. Ned Bell is Chief Investment Officer and Portfolio Manager at Bell Asset Management, a Channel Capital partner. Channel Capital is a sponsor of Firstlinks. This information is not advice or a recommendation in relation to purchasing or selling any assets. It does not take into account individual investment objectives or needs.
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