The BlueAlpha BCI Global Equity fund was only launched towards the end of 2014. Its performance over this period has however been so eye-catching that it has quickly become one of the most favoured global equity unit trusts used in South African fund of fund portfolios.
Since inception, it returned 18.6% per annum to the end of September. Over the past five years, it has delivered a total return of 124.5% in rand terms, against a category average for global equity funds available in South Africa of 76.7%.
The fund aims to invest in ‘dominant, high quality businesses’, and currently that is expressed through significant holdings in the likes of Facebook, Amazon, Microsoft, PayPal and Mastercard.
There is little argument that these are great businesses, but there is also a fair amount of concern about their current valuations. According to Bloomberg, Facebook is trading on a PE multiple of 34 times. PayPal is on a PE of 95, and Mastercard 48.
Co-manager of the BlueAlpha BCI Global Equity fund, Citywire A-rated Richard Pitt, is not oblivious to the risks inherent in those kinds of valuations. That is part of the reason that the fund also carries a fair amount of cash. At the end of September, 11% of the portfolio was in cash, although that has been reduced slightly after the quarter end.
‘We have quite a lot of “sexy” companies in the fund that have high ratings, for lack of a better word, and although you could argue that there are good reasons why they have those ratings, the markets have run a lot, and there is a lot to be worried about,’ said Pitt. ‘It’s is nice to have powder when things sell off a bit.’
The fund is also looking to invest in that most rare kind of asset at the moment – out-of-favour quality. Pitt acknowledges that there isn’t much out that that fits this description, since the market has been chasing the quality theme, but there are still some counters that the market is shy on.
The case for Intel
One example is Intel, which Pitt sees as a company with high returns, but with growth metrics that are in debate.
Currently, Intel is trading on a PE multiple of 11, according to Bloomberg. Its competitors Nvidia and AMD are on 93 and 123 respectively.
‘The market is saying that, between them, Nvidia and AMD are going to eat Intel’s lunch,’ said Pitt. ‘And it’s true that Intel is a bit behind in the chip space. But what is interesting is that the business is also transitioning.’
Increasingly, Intel is providing chips for data centres, and in the next few years Pitt believes this will be the majority of its business. The market could be mispricing this opportunity.
What the market is pricing
‘What many people don’t know is that if you compare a business like Apple to Intel, Intel has beaten Apple on almost every single metric, including revenue growth and operating income growth,’ said Pitt. ‘But in terms of price performance, they parted ways a lot in the last year.
‘Apple does have higher returns and slightly higher growth, but basically what the market currently implies for Intel on current pricing, which is an interesting way of looking at things, is that in the next five to eight years, Intel’s cash flow return on invested capital is going to go to zero. Now, it may do that. Nothing is impossible. But that seems to me like a very unlikely outcome. And therein lies the opportunity in an out-of-favour quality business.’
As Pitt points out, Microsoft was highly out of favour just over a decade ago. Apple was out of favour as recently as five years ago.
‘It’s hard to explain why these things happen, but it’s usually because people are very focused on short-term issues,’ said Pitt.
He is, however, reluctant to see seeking out these kinds of out-of-favour quality companies as value investing.
‘Investors and fund managers are stuck on this value notion,’ said Pitt. ‘They think that if you buy on low PE or low price-to-book, you are buying value. But you might just be buying rubbish businesses.
‘Value is not a statement of cheapness. It is a statement of what you get versus what you pay. Students of value should study Warren Buffett’s writings on this. He talks about value as what you are paying versus the likely cash stream that you will get.
‘So, if you buy something that appears very cheap at a point in time, but it is going to have very bad economic value creation, or even negative value creation, then it’s not cheap. If you pay up for a business that turns out to deliver a lot of value, that may turn out to be value.’
Words like ‘growth’ and ‘value’, Pitt points out, are used to simplify things. But, he argues, ‘every investor should be a value investor’.
‘Why would you pay more than you think you are going to get?’ said Pitt ‘Even if you are someone who buys growth, you are still theoretically buying value, because you are assuming this is going to be a growth story, and there is going to be economic value.’