Taking a 10 year view

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  • 12 mins 45 secs
Andy Headley, Fund Manager & Head of Global, Veritas Asset Management, runs a twenty stock global equity portfolio on behalf of Alliance Trust. Here he shares his 10 year view and discusses the economic cycle.


Alliance Trust
Alliance Trust PLC


Alliance Trust PLC
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Phone: 01382 321 010

PRESENTER: I’m joined now by Andy Headley of Veritas. He runs a 20-stock global equity portfolio on behalf of the Alliance Trust. Well, Andy, thank you very much for joining us. First of all, can you give us a bit of background on your specific approach to investing?

ANDY HEADLEY: Yes, no problem. So we look to invest in high quality companies wherever they may be based. Obviously we’re looking for quite large companies, so typically they’re above US$5 billion. And we’re very value disciplined. So whilst we’re looking for good quality companies, we’re not prepared to overpay for those companies. And we’re very long-term investors, so typically we’re looking for invest for five to 10 years in any investment that we make.

PRESENTER: How can you be confident that you can take a genuine 10-year view on a stock?

ANDY HEADLEY: It’s really difficult, and that means effectively that we limit ourselves to certain sectors and companies where we have confidence that we can understand the company over a five to 10-year horizon, which really rules out things where the environment for those companies may be changing very quickly, so we won’t invest in areas where the change is very quick. We’re looking for companies that have very strong barriers to entry that we think will be really enduring.

PRESENTER: Now 2018 was a really tough year for active fund managers, how did you do?

ANDY HEADLEY: We did OK in 2018. The results were that we were quite well ahead of the market, so in relative terms we did well. In absolute terms it was OK rather than great. I mean generally speaking because we’re long-term investors it’s quite hard to segregate performance into a single year. So whilst our performance was good in 2018, obviously we look over much longer time horizons than just a single year. So when we look forward obviously we’re looking, we’d certainly expect to deliver better absolute performance and continue with good relative performance. I think 2018 interestingly was, whilst the performance was OK, it was quite a difficult year in terms of markets. So obviously markets rallied quite strongly during the year, and typically in strongly rising markets, which we saw earlier in the year, we find it difficult to keep up.

So we look to, if we can keep up with a strongly rising market we’re doing quite well. But when markets decline, then we would typically expect to perform quite well in that environment. And that’s exactly what happened in 2018 with a lot of our performance, our relative performance coming when markets started to decline.

PRESENTER: So what is a fair period to judge performance then?

ANDY HEADLEY: We would generally say that five years is a good period to assess a manager over. I mean realistically you should probably assess a manager over full cycle, so including a bull and a bear market. But that might be such a long time. I mean in this particular instance we’re looking at 11 years or so. So I think five years is fair. The shortest I would ever assess a manager over really would be three years, and less than that it’s very random. So people can perform well or badly over a single year, but it doesn’t necessarily indicate skill.

PRESENTER: So what’s the stock picking environment like in 2019?

ANDY HEADLEY: So the end of 2018 saw a lot of volatility. So we saw volatility increase. And for stock pickers that’s a really good thing. So whilst market decline and obviously that’s negative, seeing a change in correlation. So in 2018 we saw correlations of all assets and a lot of equities increase. So everything was moving together. When we saw markets decline, we start to see that share prices move differently. And so we get more disparity between share prices, and for active stock pickers that gives us much more opportunity to identify things that we can buy, and also identify things that we can sell that have performed well, so we really like increased volatility and lower correlation, which is what we’re starting to see. So hopefully in 2019 we see quite a lot more volatility both upside and downside, which will give active stock pickers a good opportunity to perform well.

PRESENTER: So can we expect greater turnover in the portfolio this year?

ANDY HEADLEY: That’s a good question. So generally speaking if we have more volatility we do see greater turnover. We actually increased our turnover in 2018 relative to where we would normally expect, and that was largely because of Q4 where we saw markets move around rapidly. So we were selling a few things and actually we bought a few new positions in Q4. And if that continues, so if that increased volatility continues we will probably continue to have quite a high level of turnover relative to what we would normally expect. And as you might imagine as long-term investors our turnover tends to be pretty low anyway.

PRESENTER: Now, you’ve mentioned you’re a stock picker, but there are all these big themes swirling round in the markets, Brexit, whatever Donald Trump’s up to, the retreat from QE, can you see any of these big themes impacting on returns and how you invest as a stock picker this year?

ANDY HEADLEY: Yes, I think it probably will impact on returns in 2019. But bear in mind we’re very long term. So we’re looking out five to 10 years. And actually these factors tend to have less influence over the longer term than they do in the shorter term. And so we don’t pay too much attention to these issues in the short term. I think what we’ve noticed in the last few years, and is continuing, is an increasing interference from governments. So that is having an impact on some of our positions, where we’re seeing that governments want to get more involved, and that can have an impact of there’s a sudden change in policy on the companies that we either own or are analysing.

PRESENTER: Have you got an example of that?

ANDY HEADLEY: Yes, within healthcare we’re healthcare we’re seeing a lot of changes in healthcare. So you’ve probably seen in the US that there’s a lot of political movement to lower drug prices. Now we’re not invested in any of the pharmaceutical companies, so we’re not directly exposed, but we do own companies in the supply chain. And the politicians are looking at those companies in the supply chain to see if they’re making supernormal profits. Now we believe that those companies are very valuable within the supply chain and actually perform a very important role. And so we think that they will actually be protected. But of course in the short what we see is a lot of political rhetoric and potential legislative changes that could impact those companies. And perhaps as a side point, one of the things we’ve noticed again in the last couple of years is the increasing importance of narrative in the equity market. So companies that have either a positive story or a negative story see very high impact on their share price as a consequent of that, even if the underlying fundamentals are not really affected.

PRESENTER: So do you think it’s important to meet management of companies, or do you try and keep well away from that and just look at the numbers?

ANDY HEADLEY: We do both. So we do actually think it’s important to meet the management of a company. We’re long-term investors. So the companies we invest in generally have high returns on capital, they’re generally very highly cash generative. And as a consequence of that the management team are going to be deploying a lot of shareholders’ capital over our investment holding period. So if we’re holding something for five, six, seven, eight years, that management team might be deploying 50% of the market capitalisation of the company in M&A or reinvesting in the business, or paying back to shareholders. And so we really need to understand what management are going to do with our shareholders’ capital. And so we think it’s really important to meet them, really to understand in particular how well they are, how good they are at allocating capital.

PRESENTER: A lot of people say that the economic cycle’s pretty long in the tooth now. As you talk to company managements, how positive are they feeling?

ANDY HEADLEY: It’s mixed actually. So we find in some sectors that the management teams are very positive. So interestingly in aerospace where we have some holdings the management teams that we meet seem to be very happy. The aerospace cycle is strong, the aftermarket cycle remains strong. So we’re seeing that there are pockets where there is definitely strength. There seem to be pockets where there is also increased competition. So consumer staples would be an area where there does seem to have been increased competition. What we’re seeing has been a reduction in barriers to entry over the past five or six years in that sector, which has been driven by digital and the internet, so it’s obviously much easier to build a brand in a world of social media. It’s easier to distribute in a world of Amazon. So it’s clearly easier for some of these new companies to build a market position. And that’s taking a bit of share from the major consumer staples companies. And so I think that consumer staples are finding it harder. But equally we think that with the derating that that sector has seen over the last five years that some of that is now reflected in share prices.

PRESENTER: What was your best performing stock of 2018?

ANDY HEADLEY: So our best performing stock was actually a very long-term holding of ours, which was Microsoft. So Microsoft was up nearly 30% last year, so pretty good performance. And we think that really what that’s showing is just the fruits of Satya Nadella’s strategy, which has been to be very much more open as a company. Invest very much in the cloud, move to a subscription model, and that’s really beginning to bear fruit now for the company. And they’re seeing substantial cashflow coming from really that strategy that was started to be implemented four or five years ago, so it’s taken time, but the performance is now coming through.

PRESENTER: Stock goes up 30%: do you sell it, hang onto it, cut it back?

ANDY HEADLEY: That’s a really good question. So for every company that we have, when we invest we have a targeted rate of return that we think we will achieve. So let’s say that’s 15% a year in that company. And as the share price moves up, and earnings and cashflows move up, that will be a moving target. But when the share price moves to a point that we think is fair value, which might be a 5, 6% rate of return for a company going forwards, then we will sell, but only at that point. So we’re happy to hold. Microsoft is not at that 5, 6% annualised rate of return at this point. It’s still higher than that, so we’re happy to hold. But clearly it’s more expensive than it was a couple of years ago.

PRESENTER: So tell us finally a couple of stocks that you’ve got high hopes for for 2019.

ANDY HEADLEY: Yes, it’s interesting. So I think 2019 could be interesting in the healthcare field. So we have a couple of stocks that I mentioned earlier in the supply chain. And we think that issues in the supply chain in the US healthcare market will be resolved in 2019. And these companies are extremely cheap. So they’re on typically 9, 10, 11% free cashflow yields. So they look extremely cheap to us. We think that these companies are going to become pillars of the health solution that we need to see in the US. And so they will be instrumental in delivering US healthcare. And so we’re pretty confident over certainly a two, three-year horizon that these companies will perform well from here.

PRESENTER: What are they called?

ANDY HEADLEY: So one of them is CVS, which is a retail pharmacy together with what’s called the purchasing benefits manager. So they buy a lot of drugs. They’ve just recently acquired a very large insurance company. So they’ve become vertically integrated with insurance, retail pharmacy and purchasing benefit management. And what they’re going to do is they’re going to develop a strategy whereby a lot of healthcare moves into the pharmacy. So that the first point of call for somebody who’s ill isn’t necessarily their GP or their physician, it’s to go to the pharmacy. And a lot of drugs and treatment can be given at the pharmacy, and it will make a huge cost saving for the whole healthcare system if they can do that. So we think over time that that will be a very successful strategy.

And the other one that we think will perform well is a company called Cigna, which is a US health insurer. It too has just become more vertically integrated by buying a purchasing benefits manager. And so we think actually the US healthcare, that supply chain and delivery to the healthcare services part, will end up maybe four or five very large vertically integrated companies, of which CVS and Cigna will be two.

PRESENTER: We have to leave it there. Andy Headley, thank you very much.