In a presentation to advisers and clients via Zoom webinar, Matthew Spencer, from our offshore partner Orbis, discusses the disappointing recent performance of the Orbis Global Equity Fund (the Fund). While reflecting on this period is sobering, the fact that the Fund’s underperformance has been driven in large part by widening dislocations within stock markets, has made Orbis more enthusiastic about its absolute and relative return potential at the end of March than it has been for some time. Watch the 17-minute recording here and key points are summarised below.
Embracing volatility and uncertainty during the first quarter of 2020
The COVID-19 pandemic has been, and will continue to be, a very challenging and stressful time for societies across the world. As investors and stewards of your hard-earned savings, we’ve seen stock markets suffer extreme declines, trillions and trillions of dollars of fiscal stimulus, massive spikes in unemployment, and strange phenomena in the oil market – just to mention a few! If anything, we believe this period has seen the dislocations within the market widen even further.
In such turbulent times, our investment team remains focused on making high-quality investment decisions amid rapidly changing market conditions. In fact, we embrace these periods of extreme market uncertainty as they often present us with compelling investment opportunities.
We started the year with a portfolio we felt was attractive in absolute and relative terms. That certainly raised the bar for new ideas, but the huge volatility of late February and March yielded a number of very attractive opportunities for patient long-term investors. These included:
- Some stable businesses that we felt should see little impact from COVID-19, yet their share prices fell sharply. These included British American Tobacco, Newcrest Mining and US internet and media company Comcast.
- More cyclical businesses whose revenues, earnings and cash flow are likely to fall sharply due to the economic disruption caused by COVID-19, but which we expected to be resilient in the event of a prolonged downturn. In some cases, seemingly indiscriminate selling resulted in their share prices falling by much more than our estimate of their true value – BMW and Howmet Aerospace being examples.
- Businesses we expect to benefit from structural change and were able to purchase at lower prices. These included Chinese e-commerce giant Alibaba and Danish wind turbine manufacturer Vestas.
We funded most of these purchases by selling shares that had held up well in the downturn and outperformed prior to that.
Testing the resilience of our holdings
As the magnitude of COVID-19’s impact on economic activity became clear, our analysts’ top priority was to re-examine the existing investments in the portfolio. This meant stress testing these businesses, particularly those we expected to be more sensitive to the economic cycle.
Automakers BMW and Honda are great examples. Today is clearly a tough time to be selling cars. Fortunately, BMW and Honda are much stronger than many of their peers. Each has >US$10bn of net cash on its balance sheet, while most of their competitors are indebted — some with junk credit ratings. To test their resilience, we ran a worst-case scenario where Honda and BMW don’t sell any cars for the rest of the year. In that scenario, their balance sheets at the end of the period would look like their competitors’ do at the start, so you can only imagine the sort of pain their competitors would face. With shares in BMW and Honda trading at around half of their book value, the market appeared much more pessimistic than our rational assessment of their long-term prospects would suggest.
US transportation and logistics company XPO Logistics is another business that we put through the stress test gauntlet. In this case, we believed it would prove to be less economically sensitive than the market fears. There are parts of the business that are cyclical and experiencing lower demand, but we believe other divisions (such as those exposed to e-commerce and the transportation of food and beverages) may experience a meaningful boost – especially as COVID-19 may accelerate the transition to e-commerce, where XPO is a logistics leader.
In other cases, our rigorous stress tests resulted in us eliminating some small positions in tourism-related stocks. We redeployed that capital in businesses that we felt offered greater resilience, and thus better downside protection, yet had suffered similar share price declines.
Comparing the current crisis to previous market extremes
It is interesting to compare the characteristics of the portfolio and market to previous market crises. The aggregate valuations of the Orbis Global Equity portfolio at 31 March 2020 weren’t too dissimilar to what they were during the global financial crisis (GFC) in 2009 or the tech bubble in 2000. By contrast, it is striking how different the market’s valuations looked across these periods. While not trading at nearly as extreme a valuation as in the tech bubble, the market was a lot more expensive at 31 March 2020 than it was during the GFC. This is consistent with our view that the outlook for relative returns looked a lot more promising at the end of March than for quite some time.
We appreciate that this has been a challenging time for our clients — as it has been for ourselves as co-investors in the Orbis funds — but we are increasingly excited by the value that we believe is embedded in the portfolio at today’s prices. Importantly, we don’t own the stocks just because they are cheap; we own them because we believe their low valuations are unwarranted given our view of the likely future outcomes for each business over the long term.
By maintaining a long-term focus at times when it is unusually difficult to be thoughtful and calm, our fundamental, long-term, and contrarian investment philosophy can be a source of both clarity and opportunity.
To view the Q&A session from this webinar, click here.