How the legendary Kerr Neilson invests now

For all his success, Kerr Neilson surprisingly comes across without ego. He is undeniably warm, profusely philosophical and wonderfully humorous, pausing at the outset of our interview to declare he had been hit smack-bang in the eye by an "unidentified flying object" (likely an insect); "free botox," he chuckled.

Having left Bankers Trust on a high in 1993 (after famously helping to steer investors through Black Monday; the market crash of 1987), Neilson and several other former colleagues established Platinum Asset Management, with its first funds launched to market in June 1994. 

After more than two decades at the helm of the now $23 billion funds management empire, Neilson has a few notches on his belt. He is widely regarded as bringing global investing down under, while his uncanny ability to consistently pick winning stocks has garnered him a reputation as Australia's answer to Warren Buffett. 

Now, three years on from handing over the reins to co-founder Andrew Clifford, Neilson is managing his own money; researching and investing in asset classes that previously may have been off-limits. 

"I'm prepared to take more risks. I'm not trying to protect against the downside," Neilson said. 

He continues to actively invest in Asia, a region which he believes Australian investors still underestimate. He is fascinated by artificial intelligence, quantum computing, and data storage, and continues to hunt for "priceless companies" that can grow exponentially over the coming decade.

In this profile, Neilson shares his take on inflation - informed by his own investigation of his ancestry. He also outlines where he believes we are in the market cycle, shares his experience investing in cryptocurrencies from earlier this year, and points to several interesting companies that have recently caught his eye. 

Note: This interview took place over Zoom on Tuesday 17th August 2021. 

The making of Australia's great contrarian investor 

South African-born Neilson bought his first stock at just 13 and argues his interest was spiked as, even at that age, he understood that wealth was and is created by companies; not governments. 

He believes that if investors understand what makes companies unique, they too can participate in the wealth created by these businesses.

"I'm not talking about hired guns who take over as CEO, who have never taken a risk in their lives and then help themselves to a hundred million dollars worth of stock. I'm talking about real entrepreneurs," Neilson said. 

"If you understand the drive in those people and what they can create you've got something really valuable. And they exist." 

Now, nearly six decades later and after leaving the top role at Platinum Asset Management, Neilson is still on the hunt for "priceless companies".

"I'm prepared to take more risks ... It's really about being less concerned about inter-month and inter-year variances in the value of the portfolio and simply looking very, very hard for companies that are either opportunistic or alternatively are what I call priceless companies," Neilson said. 

These include companies like Facebook (NASDAQ: FB), Microsoft (NASDAQ: MSFT), Alphabet (NASDAQ: GOOGL) and Amazon (NASDAQ: AMZN). 

"I've held Microsoft since it was US$22. It's now US$290. So that's 14 times," Neilson said. 

"Facebook keeps morphing and even in the face of fresh legislation, it will continue to morph. And you think of Amazon, which was initially a retail business and is now an advertising business and a filmmaking business and a subscription business. These businesses will continue to be bigger and stronger in the future."

He argues that due to the FAANGs power and commercial reach, as well as solid leadership, they can continue to transform and dominate the market.  

"At the outset, one might have misconstrued their true opportunity, as the market did with Amazon and the like," he said. 

"The power of these enterprises is an accident of a confluence of social, technological and financial change; they are very rare." 

While alternatives exist, Neilson believes they often display fewer of the "seven powers" when compared to the tech giants. These "seven powers" can be described as:

1. Holding a cornered resource
2. Enjoying economies of scale
3. Benefitting from network effects
4. Offering a product that has high costs of switching 
5. Is a powerful brand, enhancing its ‘spread’ above costs
6. Having a persistent process enhancement path
7. Nurturing innovative opportunism

He points to other examples of "priceless companies" as the likes of Disney (NYSE: DIS), Beiersdorf (ETR: BEI), and Diageo (LON: DGE), as well as similar consumer franchises. 

However, "as Orwell explained, some are more ‘priceless’ than others!" Neilson added. 

Neilson has also recently identified Cloudflare (NYSE: NET) and Fastly (NYSE: FSLY) as opportunities, the latter of which he believes to still look quite reasonably priced.

"Online gambling is also really interesting. It's facilitated by new law changes," he said.

"We are pretty interested in Flutter Entertainment (LON: FLTR) which is quite intriguing from an ESG point of view because you actually know who each and every one of your users is, which you didn't know when they'd walk into the TAB because they were faceless, really.

"We now know exactly what the predilections of that person is. And if they are overusing gambling apps, we can actually determine how extreme the habit is." 

An interest in ancestry and the life-long lessons learnt from it 

The biggest mistake Neilson believes he has made in his career is not being cynical enough - both of governments and "non-risk taking" management of public companies. 

This desire for deeper distrust is likely inspired by Neilson's truly impressive ancestry and the decay of wealth that followed with each changing regulatory regime facing the Neilson family. 

This started with James Beaumont Neilson, born in 1792 in Shettleston, Scotland, who realised hot air was more effective in the smelting of iron ore; a discovery which would triple output per ton of coal and make him the family's first very rich man. 

"From that, the family did quite nicely for a while. His son went into steel and then locomotive. By the turn of the 19th century, they were perhaps among the very biggest locomotive producers in the world," Nielson said. 

This was the leading technology of the age, Neilson added, and yet, his forebears refused to innovate and were ultimately left behind by their competitors. 

"The first thing I learnt from the family was intellectual property has huge value. The next thing I learnt was that you've got to look at problems not from within, but from without," he said. 

"If only someone had said to them, you're just focusing on what you're good at, but does that have any bearing on what the market wants?" 

These were very valuable lessons for a young investor, Neilson said, and have helped him to build the investment strategy that he still uses today. 

"I like teams who stand back and express some self-doubt. I love the idea that there's always another game," he said. 

"Don't worry about inflation, worry about tax" 

In the current market environment, in which every investor and his neighbour are scratching their heads about inflation, Neilson believes it's taxation that they should be worried about. 

"My ancestors bought land on the other side of the river from the city of London and they sat on it for 125 years. Then Harold Wilson comes along and he imposes what was called a windfall land tax," Neilson explained. 

"When my grandmother died, the marginal rate of capital gains tax was 84% and it was even higher on unearned income and investments ... It was a complete disaster. So wealth is much more readily destroyed by changing regimes than inflation."

Neilson on his mother's lap in the 1950s. Source: Supplied.

He urged investors to remember that while there have always been spurts of inflation, in general, equities have had a very high propensity to deliver real returns. 

"Only in two major economies have you not seen your wealth improve, or at least be held at a certain level by being in equities. And that is when you've had a regime change," he explained. 

"You had that in China in '49, and you had it after the Bolshevik revolution. This is very relevant because over the last 50 years you've had something like 6% to 9% real returns from equities; it's been huge."

The discussion then is not so much whether we have general prices rising, but whether it persists at a higher level for several years, resulting in aggressive wage increases and ultimately a regime change. 

"It feels to me as though the factors that have been suppressing inflation over the last 14 years - which was the new supply from China, unemployment, and the lack of aggregate demand - are now moving away," Neilson said.  

"We're more prone to inflation than we've been for quite a long time. So my guess is that we will have higher levels of price increases than we're thinking about right now."

He believes these price increases will be more evident in some countries than others, such as Britain and Australia - both of which have experienced labour shortages during the pandemic. 

"The very idea that central banks should be debasing money; the very fact that they should be removing the market mechanism for the pricing of credits is an incredible interference with our system. And we can't know what's going to really happen in the future," Neilson said. 

One thing we can know, however, is that the behaviour of central banks has been "immoral", he said. 

"This is dishonest. There's actually an obligation out there that central banks are eroding through their printing of money," Neilson said. 

While that may sound high and mighty to some, Neilson believes it is a conversation worthy of philosophical consideration. 

"You are playing with a lot of variables that will work through the system for many years and there will be consequences that we haven't yet considered," he said. 

The world's economies are "discordant," he said, and yet the cost of money has not yet adjusted for this discordance. 

"Ultimately, savings pools could shrink. And in that case, you do have a repricing upwards in the cost of money because the magician can only produce so many rabbits. They do run out," Neilson added.  

The party is nearly over, but there is no reason to be "miserable" just yet 

Neilson believes there are quite a few "telltale signs" that the market is getting a bit "extravagant" or in the later stage of a bull market. 

"Why I'm not particularly miserable is we are seeing parts of the market already being sold off 25-30%," he said. 

"If interest rates shot up quite a lot, then you'd have to adjust what you thought was fair value. And if I'm getting a 4% free cash flow earnings yield, that's probably okay if the company is growing at 10% or more; it's probably more than adequate." 

Despite there being clear overpriced patches across the market, Neilson said he is surprised at the way profits are coming through.  

"If you look at profit growth across the world - Emerging Markets, East, West - they're all way above what was expected a couple of years ago. And even Europe, which has had more setbacks, is looking extremely good," he explained. 

"So is part of this misallocation, potentially, or is it something else that's taking place? Because there's a paradox here... There's been this lack of productivity growth."  

We have seen what Neilson believes to be "many bubbles" across the market; in biotech, SaaS companies, battery material producers and EVs - most of which have sold down from highs in February this year. 

"You've had these very strange circumstances, which you typically get in very extended markets," Neilson said. 

"You had it back in the Tulip Bubble and in the South Sea Bubble in 1720. And it was all about creating money - that was the common factor in each of these market booms. It was easy money in every single case."

There is no "exciting" bull market without cheap money, Neilson said. 

"We may well be experiencing that now. So that's the trick to identify what edge you have as an investor. You've got to know what you're buying pretty carefully," he said.

Neilson also adds that economies around the world are being "augmented" by what he dubs "the super-highway," or as most people call it, the internet. 

"This super-highway is absolutely starting to rev up. And with that, there's massive productivity shifts and changes in the way we're using our workdays," he said. 

"I think we're living in the most exciting period. And as an investor, one needs to play both sides. I think if you simply play the old world, because it's quite cheap, you'll deny yourself some of the most exciting new aspects of the market."

How is Neilson reacting to fresh regime changes in China?

Neilson points to the newly stoked fire in the Chinese regulatory environment as a regime change to keep on investors' radars and agrees the corporate sector may very well be obstructed by some of these new changes. 

"However, I do not believe the CCP will reverse what has been the very cornerstone of their success, which has been the unleashing of requirements from allowing people to share in the profits they make," he said. 

"This move in China does reduce the optionality of some of those companies, but I do not believe they are ready to say capitalism is forlorn and they don't need that system."

This added rigmarole is unlikely to deter Neilson from investing in the region, noting there are still several interesting opportunities within the Chinese market. 

"There is a company called Kingsoft (HKG: 3888), which has a cloud business, a software business - which is a bit like Windows 360, and it's also got a gaming business," he said. 

"Companies like Tencent (HKG: 0700) are interesting because it has this incredible games platform, as well as a payment platform, as well as a social platform. The business isn't going to disappear. And what's more, I think they will expand globally, particularly throughout Asia - where you've got three billion people."

In addition to the two stocks above, Neilson also privately invests in Baidu (HKG: 9888) and Alibaba (HKG: 9988). 

"These businesses will continue to grow at 10-15% for several years, and the surpluses they create will largely be free for distribution," he said. 

A short foray into the world of cryptocurrencies

Having written about cryptocurrencies back at Platinum in 2014, Neilson said he was initially excited by the potential of blockchain. 

"The shortcoming of a lot of these tokens is they've become speculative," he said. 

"When Bitcoin (BTC) sold down to US$30,000, I thought it was broken and I'm still not clear that it isn't. I think it's highly tied up with cheap money and I don't think all this transacting in these coins is going to go away."

He notes that for an asset to become a currency, it needs a relatively predictable rate of exchange - something that proponents of Bitcoin believe the cryptocurrency boasts as "it doesn't go down in value". 

Neilson also believes that a currency should be scarce, but not so scarce as to promote widespread hoarding, as "such behaviour is self-defeating to the extent that it discourages exchange". 

"You can call it a store of value, but it only has a store of value if it is a currency; if it has mediums of exchange. So there's a fundamental conflict there," he said.

Nonetheless, at the beginning of the year, Neilson decided to invest in altcoins (which are alternative cryptocurrencies to Bitcoin - hence the name). 

"We loved Polkadot (DOT) because its originator had been Ethereum's CTO and we figured that he would actually improve or repair what he had overestimated or underestimated in his work on the previous coin," Neilson said. 

In a bid to dive headfirst into the cryptocurrency, Neilson enlisted the help of "some Ukrainians to assemble a whole lot of data". 

"We were trying to see whether this was becoming a more virile coin. And we got so far and then gave up. We sold out of our position completely and we ended up with a nice return," he said.

While he is no longer actively playing in the cryptocurrency arena, Neilson is still looking into altcoins for his portfolio. However, he notes that he had some difficulty in unwinding his position in Polkadot; the liquidity and ease of transaction were just not there.  

A final word of advice

Neilson's advice to investors is to write a little note with headlines of what you want to achieve. These could include: 

• Why am I not selling? 
• Why am I buying? 
• What would I do in the event of there being a significant repricing? 
• Is this business a franchise that will be bigger and stronger in the future? 

"You've got to be honest with yourself. You can't just say, 'If the market was down 40% I'd buy more,' because you've actually got to be held to this," Neilson explained. 

"If you then prepared your mind for a possibility of that, you are likely to be a little more cautious, and you will probably keep some money on the side to really take advantage of the next opportunity." 

By "franchise", Neilson means a business whose products or services have a scarcity value as well as pricing power, helping to set it apart from other providers.

"That's the question I'd ask someone when they talk about a really great investment. That's quite distinct from the opportunity of buying a cyclical stock just because it's hit its bottom and you can see why it can turn around," he said. 

"It's a different type of investment because that cyclical company can make a lot of money, but it's not the same as investing as a long-term investor should consider things."

One thing for investors to remember, Neilson said, is there's always part of the market that is out of fashion. 

"Right now, you and I might not wish to touch oil companies, but 10-15 years ago, any investor who didn't have some energy-related stocks would be regarded as bonkers," he said. 

"So it's gone the full 360. And I suspect you'll make some quite nice money by having some of these petroleum-based producers where they've got some interesting prospects because the world's not going to suddenly go to wind and solar; these things take huge time to adjust." 

Companies such as Royal Dutch Shell (AMS: RDSA) have recently caught Neilson's attention, which is currently trading on seven or eight times earnings, he said. 

"There are a lot of interesting stocks out there that have been treated like pariahs," Neilson explained. 

"There's always somewhere you can go when everyone's hot and steamy, you don't have to join them. You can go somewhere else. And that's perhaps the best lesson. 

"The giveaway in the market is very plain. On the way up there are a whole lot of cross views. There's a lot of arguments about the problems, about why this thing is looking extreme. It is when there's a total concurrence of views - that is when you're at the tipping point." 

Right now, ironically, there is still quite a lot of debate within markets about economic growth, corporate profits and valuation, Neilson said. 

And while he can't categorically say that everything is pointing to the certainty of a setback, there are measures that he has used in the past, like return on valuations in relation to market capitalization and the size of economies, that are flashing red. 

"The fact is now with the internet, you as a small trader can access the entire world. That's why I'm ambivalent. That's why I'm not prepared to say you won't make some money if you're smart," he said. 

"I don't believe the game's over yet. But equally, I can see why you could lose a lot of money in certain areas." 

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