Offshore investing - Allan Gray
Offshore investing

The benefits of neglect

When investors are scarce and investments are plentiful, investors pay low prices and investments offer high returns. When investors are plentiful and investments are scarce, investors pay high prices and investments offer low returns. A look at valuations today suggests that markets are in the latter camp. Ropafadzo Shoko, from our offshore partner, Orbis, explains why exceptional valuation gaps make us excited about the relative return potential of the portfolios.

Stock markets trade near record valuations on multiple metrics, and corporate bond yields are at record lows. Rising valuations, not growth in expected earnings, drove all of the return for stock markets last year. 

Those rich prices come despite the best efforts of issuers to take advantage of investor demand. In 2020, issuance of government bonds, corporate bonds, and equity all hit post-war records, and the party has continued in 2021, with the most indebted and least profitable businesses enjoying their best funding conditions and share price performance in decades. 

In short, there are plenty of signs of too much money chasing too few deals. But one vehicle deserves special mention – Special Purpose Acquisition Companies, or SPACs. A SPAC is a shell company that raises money for the sole purpose of acquiring another business – essentially a box of cash looking for a deal. Their popularity has exploded. In the 10 years to 2019, 226 SPACs raised US$47bn in total. In 2020, 248 SPACs raised almost twice as much money as all prior years combined, and the first few months of 2021 are on track to exceed that record-breaking year in both number and size! 

At the time of writing, Bloomberg data showed there were 300 SPACs holding more than US$90bn in total that were still searching for deals. Almost all of them trade at premiums – in other words, people are paying more than US$10 for a box with US$10 in it. Some trade at premiums of 30% or more! And many of these companies are competing for similar deals. Of the US$90bn raised, fully US$30bn is earmarked for technology businesses, with much of the rest targeting fintech or biotech firms. Not wanting to miss out, celebrities such as Shaquille O’Neal, Alex Rodriguez, and Jay-Z have joined the SPAC party. Celebrity involvement seldom heralds a market bottom. 

If a handful of SPACs with a few billion dollars were hunting for deals, they might find bargains, and paying a premium might make sense. But with investors backing hundreds of SPACs in a US$90bn money-throwing contest, many are likely to overpay. 

We have always feared losing money more than we fear missing out, so we remain focused on finding companies trading at a discount to our assessment of their long-term fundamental value

Remaining disciplined in an environment like this isn’t easy. To butcher the Keynes line, the market can remain irrational longer than you can stand watching your neighbours get rich. 

We have always feared losing money more than we fear missing out, so we remain focused on finding companies trading at a discount to our assessment of their long-term fundamental value. From that perspective, the good news is that the exuberance is far from universal. The US market has grown to represent 61% of the FTSE World Index (and probably even more of the froth) but only 29% of our Global Equity Fund. While we have found some attractive opportunities in the US, most of our best ideas are elsewhere. Globally, valuation spreads remain exceptionally wide, even after the rotation in markets we’ve seen since November, leaving many shares trading at attractive valuations. 

Here, we take comfort from a pattern common to periods of speculative excess. As hot investments draw ever more interest, perfectly good companies are left selling at attractive prices out of sheer neglect. This has let us find a number of solid businesses which, chiefly through growth and dividends, should offer double-digit long-term returns. In an expensive market, that looks like a compelling proposition. 

Some examples are literally and figuratively on the opposite side of the world from the excitement in the US. Though not conversation starters like today’s hot stocks, we have found several time-tested Japanese businesses with undemanding valuations, decent growth prospects, and chunky dividend yields. The Japanese trading company Mitsubishi has grown book value per share by 7% per annum for decades, and today offers a dividend yield of 4.5%. Similarly, we expect Nippon Telegraph and Telephone, Japan’s largest telecoms operator, to grow earnings per share by 8-10% per annum over our horizon, and it yields 3.5%. Brewer Asahi Group, which also owns brands like Peroni, is in normal times a predictable business, but sold off when COVID-19 closed bars. A return to its normal steady growth combined with its 2.3% dividend yield suggest double-digit long-term return potential. 

Asahi’s pattern is similar to that of Comcast, whose main business (broadband) is predictable, but where recent sentiment has fixated on short-term challenges (COVID-19 shutting Universal theme parks). South of the US border, Fomento Económico Mexicano owns a convenience store chain as well as stakes in Heineken and a Coca-Cola bottler. All three are classic consumer staples businesses that have seen temporary uncertainty from COVID-19. We could go on – many solid businesses across the Orbis Funds offer a similar combination of refuge and return potential. 

With an active share of 93%, the overlap between the Orbis Global Equity Fund and the FTSE World Index is just 7%

Opportunities like these give us some comfort about the Funds’ long-term absolute return potential, just as the exceptional valuation gaps we see make us excited about the relative return potential of the Funds. And at a time when concerns about market valuations are rising, it is worth remembering that an active investment is not the same as an investment in “the market”. With an active share of 93%, the overlap between the Orbis Global Equity Fund and the FTSE World Index is just 7%.

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