By Andrew Clifford, Platinum’s CIO
Calendar year 2017 was a strong year for performance of the Platinum Funds. This was driven by a large exposure to Asian stocks, dominated by China and our cyclical stocks in areas such as commodities, banks and semi-conductors that benefitted from synchronous global growth.
2018 to date could be described as more of a grind. By the end of June, the flagship Platinum International Fund was flat calendar year-to-date. Across our range of Platinum Trust Funds, five year returns to June of 13-17% pa are ahead of our long-term averages, and the 10 year returns of 11-15% pa1 include the 2008 GFC.
In both March and June quarterly reports, we talked of the three fears that have started to permeate markets this year. I will address these later, but each of trade wars, Chinese financial system reform, and rising US rates have led to market outcomes affecting Fund performance.
It is worth noting that we were proactive in this regard, bringing market exposure in the Fund down from the mid-80s to mid-70s in March cognisant of the need to be more cautious while the market digested these issues. As you know, we do not manage to a benchmark or index, and the Platinum International Fund remains more weighted towards Asia.
Indeed, as investors have tried to appraise their fears, there has been a broad exodus from emerging markets. At its most extreme in the June quarter, the tech-heavy Nasdaq was up 9% while the Shanghai Composite was down 23%2.
Let’s look more closely at China, which I would reiterate, we still believe presents us with the investment opportunity of a generation. Local investors have been particularly concerned with the tightness in credit availability as a result of the financial reforms. The topic has been part of daily news and commentary in China for the last six months and the fear has been well and truly expressed for some time. It has, however, only recently been reported in the foreign financial press. Similarly, with China the prime target of President Trump’s trade war and with no sign of a negotiated outcome, these tensions have weighed heavily too.
Currently the Shanghai A share index is back to the lows reached in January 20162. As you may recall, at that point the country had just been through a period of capital flight, heavy industry was plagued by excess capacity and there loomed the possibility of non-performing loans triggering a banking crisis.
Today, while the economy may be experiencing some slowdown as a result of changes in the financial system, supply side reforms have resolved the issue of excess capacity, profitability of heavy industry is much improved, and while some problem loans still need to be worked through, the likelihood of a full blown banking crisis is much lower.
Risks have been reduced substantially, profits are higher, yet stock prices in aggregate are at the same level as they were two years ago. At an individual stock level, we see extraordinary value in a wide range of companies.
Of course, it is hard to know when these various fears will subside, allowing the market to move higher. We talked in 2016 about the coiled spring that was building up in the valuation discrepancies between cyclicals and Asian stocks, and the much-loved growth stocks. Recent moves suggest that spring is tightening again, with the torrent of money flowing out of emerging markets and rushing back into certainty.
We would expect the credit tightness created by the financial reforms to recede in time and the PBOC has started to take measures to ease the problem. The impact of tariffs at a company level should start to become obvious in the weeks ahead, although one can’t predict future moves by the US administration. Overall, a combination of negative sentiment and attractive valuations are indicative of strong future returns from any market, at the moment this particularly applies to China and its neighbours in North Asia such as Korea and Japan.
Joseph Lai, our Asia portfolio manager and his team came back from China recently having enjoyed five consecutive days of blue sky, suggesting that the administrations focus on the environment may be starting to pay dividends. They saw how ambitious the local electric car makers are, a theme we are exposed to in a meaningful way across the Funds today. They also reaffirmed our positive view towards life insurance leaders, Ping An and AIA, who dominate an industry with a great runway of growth. Visiting India also provided increasing evidence that we are seeing signs that we are at the start of a private sector capex cycle, with reform measures such as the GST and Bankruptcy Laws starting to have a major impact.
In Japan, females are driving workforce participation rates to record highs, corporate profitability is above the previous range, and politics is stable. Currently at half the market level of 1989, and after a 30-year bear market, the biggest problem may be mobilising the domestic investor, but with only 11% of Japanese household’s $16 trillion of financial assets in the stock market, a small shift in asset allocation could have a large impact on the market! The most stark market observation is in the dispersion of valuations. It has been evident for several years and may continue testing our resolve, but as an extreme example, we recently saw an artificial intelligence company IPO on a valuation of 500 times sales, while we can buy Itochu, which is hitting record earnings, is on a PE below 7x with a high-teens return on equity.
The European economy remains in rude health. Economic indicators have stabilised at robust levels, and two million jobs were added last year. Wages, retail sales and credit are growing, inflation is contained, and monetary policy remains accommodative. Near-term the Euro has been pressured by the rate differential with the US and political developments, which once again are reducing investor enthusiasm, but leading to opportunities at a stock level.
Bear markets tend to be caused by either extreme valuation, or by an economic slowdown. In that regard we think the reactions to trade wars and Chinese financial system reform have re-calibrated prices and adjusted to the new news.
The US market is the only one where we see valuation acting as a major headwind, but are not of the view that we are yet heading for a dramatic economic slowdown. There appears to be enough slack in the labour market to keep inflationary pressures in check for now. The flatter yield curve suggests markets believe we are nearing the end of this expansion, but economic indicators suggest robust growth, buoyed by tax cuts and we expect infrastructure initiatives from Trump to add further fuel to the economy, though this will reinforce upward pressure on rates. In any case, from a Fund perspective, we have been progressively reducing exposure to what we believe is an expensive market for around five years and currently it is hovering close to zero at a net level.
We have been active while these market ructions have been occurring. Having added Kasikornbank from Thailand, Suruga Bank from Japan, and Canadian shale gas producer 7 Generations last quarter. As discussed in the quarterly report, we have been adding to our Autos exposure, Daimler and BMW are our favourites, Chinese Insurers, healthcare leader Roche, and India’s Reliance Industries. We have also been reducing some positions that have played out such as AstraZeneca, Intel and Shell.
Myself and Clay Smolinski are the co-portfolio managers of the Platinum International Fund from 1 July 2018 and the transition from Kerr’s portion of the Fund has been smooth, and something we have done in a number of Funds over time as we have brought portfolio managers through. Kerr in his role as an analyst, is engaging in debate and bringing new ideas to the group.
In summary, the last quarter was uncomfortable as investors fled to safety, but we are excited by the valuations and the prospects of the companies that we own, and with slightly higher levels of protection being carried than in recent years, we are ready to deploy capital into new ideas as they present themselves.
Source: Platinum Asset Management