Meet the fundie built to outperform when others don't

For about a decade, value investing sat in the naughty corner. It consistently ran a distant second to the growth/momentum dynamic that saw global markets climb to heights never seen before.

To say the growth-value dynamic has evolved recently would be an understatement. Evolution is something that typically happens gradually, over time. The growth to value shift has been more akin to a high-speed collision on a racetrack. It has been abrupt and violent. For most investors, it has also been pretty scary.

Not so for Reece Birtles, Chief Investment Officer at Martin Currie Australia. Reece essentially built the value investing strategy at MCA. He has worked with some of the best value investors worldwide, and he has a wealth of experience across all market cycles. He was made for the current market conditions. 

So, where are we now? Where do things sit on the growth-value continuum? Those are the questions I posed to Reece in our recent chat. For what it’s worth, he thinks the current conditions are good for the Martin Currie approach to investing on a three-year outlook.

"The last decade of the 2010s to 2020, post to GFC, was really an abnormal period where the central banks printing money and interest rates going to zero caused such disparity in valuations and yields from where they should be on a normal basis," says Birtles. 

He goes on to say that with interest rates heading back to levels that they were closer to pre-GFC, conditions are becoming more favourable for value investors. That's because rather than prices surging and becoming increasingly disconnected from valuations, the ability to buy something that's truly cheap, with a margin of safety, is emerging again. 

Reece and I also discussed the use of forward-looking indicators, what emotions he is seeing in markets right now, how he is spending his risk budget, and two cracking pieces of advice for investors. Spoiler alert, they are absolute belters. 

TOPICS DISCUSSED

• 0:36 - A value approach built over time
• 2:41 - The current market environment
• 4:39: The shifting value-growth dynamic and what happens next?
• 5:58 - Why the big picture is so important
• 7:30 - The importance of being forward-looking
• 9:26 - The Martin Currie edge
• 11:00 - The emotions in the market
• 12:01 - How market complacency provides opportunities
• 12:44 - The Martin Currie risk budget and how it is being spent
• 14:03 - Energy transition and the opportunities it will provide 
• 15:24 - Two cracking pieces of advice for investors

Note: This interview was filmed on October 12th, 2022. To access the interview please click on the player or read an edited transcript below.

Edited Transcript

Chris Conway: Hello and welcome to Livewire Markets. My name is Chris Conway. And today, I'm joined by Reece Birtle's from Martin Currie. Reece joined the firm in 1995 and has worked his way up to become CIO, a position which he has held since 2006. He has supreme market knowledge and insights, and no doubt he's going to share a lot of those insights with you today. So without further ado, welcome Reece.

Reece Birtles:

Thanks, Chris.

We'll get straight into it, because we've got plenty to cover. I just wanted to start by asking you if you could explain to me your approach to investing and how you've built that approach over the years?

My approach to investing is really about intrinsic value, so it's really about understanding the true value of a security, estimating that value and going through all those challenges of understanding what true value looks like and then looking for undervalued securities. The premise, I guess, my family started in self-managed super fund investing in the 80s, so I always had an interest in investing, as well as in small business and what really drives companies. And then at uni, I was really looking at Fama and French, undervalued securities, market anomalies, try and understand the broader benefits of investing in a value approach. And then, I've had obviously just some fantastic opportunities with the firm I've been at and the predecessor firms over time. So we were, at one stage, J.P. Morgan Investment Management, one of the real founders of the dividend and discount model, and value investing right back from the 70s. Worked with City Asset Management, where they took both a fundamental, but also a quantitative approach to really look for how to improve the way you invest, look for biases, combining some of those fundamental and quantitative signals.

And then just some great people that I've worked with over time, just true value investors in London and in New York with the firm. So, that's really just given me that broad approach of really believing that the true insight is your fundamental insight that you can have on a company, where you can see the future that can be quite different than the past, understanding where the market can have that wrong, but also the importance of, especially when you run a portfolio, of improving the odds on your decision making. So bringing in different decision-making processes, alternative sources of information, having the right team dynamics to ensure that we get all the right perspectives to make the right decisions.

You've been doing this for about 25 years, how challenging are the current market environments compared to what you've seen over the journey?

In many ways, we like the current market. As a value investor, we are really looking for, what is the normal state of the world, when are conditions in the right balance? 

Be it in terms of growth, inflation, bond yields, market valuations, and it's when things are moving well away from that sort of normal approach. It's when we really find it tougher. But when things are heading back to that normal state, we think it's a lot easier. 

So the last decade of the 2010s to 2020, post to GFC, was really an abnormal period where just the central banks printing money and the interest rates going to zero, just caused such disparity in valuations and yields from where they should be on a normal basis. And so today obviously just, we're in a different condition, we... Interest rates of heading back to more like what they were pre-GFC, inflation obviously emerged as an issue again, whereas it had been forgotten about. And so that, we feel conditions are heading in our direction. 

And then the other aspect is when you're a value investor, you know, you want a margin of safety, you really want to buy something that's truly cheap and that the market's mispricing. 

And when we look at the dispersion of valuations across the market, it's still extremely large. So it provides a very good opportunity for us. But obviously, the macro conditions and the slowing of the cycle does present some challenges, but we think on a three-year out basis, conditions are very good for our approach to investing.

In April, you wrote a paper called, The Tide Continues to Turn for the Value-Growth Dynamic, and one of the things that you said in that paper was that, "The time is now to capitalise on this thematic." How have you put that into action and you think those conditions will persist?

Yeah, as I was saying, if you look at the PE ratio of, for example, the MSCI Growth Index in Australia versus the MSCI Value Index, the growth index is on about 25 times earnings, the value index is on about 12. You're paying double the multiple for growth stocks to value at the moment, so there's a big margin of safety. The normal spread is normally only a couple of points. So for us, depending on the portfolios that we run, we've done that in different ways. In our select opportunities value strategy, we're always looking for the balance of value, versus quality and momentum characteristics.

And we will take more active share, when the opportunities are larger. So, we've got bigger active positions in the portfolio than usual. In our more multi-asset type funds where we have broader decision capabilities, we've done things like move away from index-aware strategies or core like strategies, towards much more value or income-orientated strategies. So, we're far further away from the index than we would be in market conditions that were not as favourable.

I understand that the big picture is a large element of your investment process. Has that become an increasing focus over the last 12 months, again, with the macro conditions that we've been faced with?

So for us, the big picture is like when we're doing bottom-up analysis on companies, and we're looking for what the fair value is on normalised earnings power or sustainable earnings a few years out, we need to see, understand that we are doing that based on a balanced world. And so, for us, the big picture is all about how far away are we from those conditions and when are we going to get there? So that's important, in terms of setting those portfolio dynamics, in terms of how much active share we're taking or how much risk we're willing to take. In the last 12 months, we would say things are heading towards us, so growth is slowing towards probably more normal levels from extreme, inflation has obviously been excessive, so we wouldn't say there's a bigger picture today, bigger emphasis on it today, we'd say, it's really just come to the fore in the recent period. 

The hard time, from big picture for us point of view, was in the middle of that last decade, when it was like bond yields are going to zero and they're never ever going up, and therefore you can pay any price you like for a growth stock. 

Clearly, that dynamic's broken. And you can see how it has broken now and we are heading back to a more normal world.

That's a nice segue, Reece, because you've been on record talking about the quality filter that you employ and that you try and always to be as forward looking as you possibly can be. Can you give me an idea of some of those filters that you use and how the forward looking assessment has changed more recently?

Yeah, so clearly, if you go back to Fama and French, in terms of the anomalies are in the market and the four-factor model, value or price-to-book in their context, and beta and risk are obviously really important factors. And, you can understand those from a quantitative perspective. What we really try and do with our fundamental analyst team is do better than those market-based factors, so rather than looking at a price-to-book, we're doing a forward-looking discounted cash flow model. 

We want to understand where normal earnings are going in the future, in order to get a much better estimation of value, than a book value might be. 

And when it comes to beta, the equivalent for us on that is our quality assessment. So we're really looking at the business strength of each company, what is its market position, its barriers to entry, its pricing power and sustainability, as well as management and governance and sustainability issues.

So our quality rating, we find on average over time, does a much better job of predicting where future beta is going to go, as opposed to just using an historic beta measure. So they are the the prime fundamental, forward-looking indicators that we do. Where we are today, clearly I've talked about valuation spreads are quite wide and very attractive. On the quality and beta side, we're actually seeing lower beta, higher quality companies are actually looking quite attractive. The market has been risk-seeking in recent years. 

And so, we are finding this unique balance of quite cheap companies that are actually lower risk than the market. So they're the main positions today.

Obviously, you've got incredible research capabilities here at Martin Currie. Reece, what else sets Martin Currie apart? What are you doing differently to your competitors?

Well, I mean clearly, that fundamental approach is quite... there's plenty of firms that do it. I think one of the things that's quite different about us is that combining those quantitative or broader insights with our fundamental data, so we have valuations and quality assessments on basically all the stocks in the ASX 200 and that allows us to look for how the collective is behaving. In terms of efficient market hypothesis and the like, you need a complex system to have a lot of diversity. And so, you need to understand how the colony of ants is behaving, in terms of behaviour and how dispersed it is, rather than just look at the individual agents all the time.

So because we cover that broader market and we have that understanding from a quantitative perspective, we can see where the system is out of balance, so it allows us to see things like valuation spreads or how high beta stocks are expensive, which really helps us understand portfolio positioning and that allows us to move the portfolio over time, in terms of how much risk are we willing to take, in order to get a value exposure or do we need to be more defensive and more hugging the market. And we do that on quite a systematic basis, in terms of forward-looking return expectations.

I understand, Reece, that behavioural finance plays a large part in your team dynamic, as well as the way that you look at the market. From a market perspective, what are some of the emotions that you're seeing in the market right now?

I really, when I think about that, I think recency bias or anchoring on recent years is the big thing. So everyone's obviously very focused about how much the Fed's going to raise rates or the RBAs going to raise rates and what that peak cash rate is. And I think you only have to go back to 2007. And before that time, U.S. cash rates were always over 4%. Australian cash rates were well over 5%, so we've really become quite complacent, I'd say, even over the last 30 years on falling yields, falling inflation. So there's a big, big, there's just ignoring the inflation dynamic and I think that's going to be very important going forward.

Just a follow-up question on that, so you talked about complacency more broadly. Does that provide opportunities for you? Is that what you were talking about earlier, in terms of getting excited about the environment now, that complacency throws up opportunities for you to get after?

Yeah, I mean, we can clearly see there's a disconnect between observed inflation, where interest rates are and where, for example, value versus gross valuations, dynamics are. There's normally quite a tight correlation between the dispersion of value and growth stocks linked to what bond yields are doing. That sort of link is broken down now, so we're getting a market signal from something like bond yields that is quite strong, but we're not getting it in the equity market. So, that's definitely an anomaly we're seeing in the market.

Talk to me about your risk budget, Reece. Obviously, all fund managers have one. Where is it now? Where are you spending it and what does it look like?

Yeah, we would say we're not taking too much risk at this point. I mean clearly, the economy is slowing, rates are rising and there's going to be speed bumps. The world hasn't seen quantitative tightening before and the interest rate rises are very significant. And we think things like the supply chain, pressures that creating the inflation dynamic will persist. 

But as I said earlier, we're finding that some of the high-quality names are actually quite well-valued at the moment, so we don't have to be seeking risk to get value opportunities. 

So our risk budget, we would say, is certainly not an extreme. We definitely, at times like in 2020 with COVID, we'll do way more portfolio turnover. We might have a year of 45% turnover, where normally we're a 20% or sub 20% turnover portfolio. So, turnover's been quite low and we've got a lot of dry powder for probably what we think is going to happen over the next 12, 18 months.

In terms of where you are spending that risk budget, Reece, where you are in the market, what's your highest conviction at the moment, in terms of a theme or even some stocks?

Yeah, I think our strongest convictions really around the amount of money that needs to be spent on energy transition and the implications that throws up, be it for energy stocks as in oil, or electricity or gas stocks, in terms of the underinvestment that's likely in there, but also the companies that are going to benefit from energy transition spend. So the new infrastructure that has to be built. And what we saying in the most simple terms, we think the world probably, depends on how you define it, but powered itself on about $500 billion a year on fossil fuels over the next 20 years. It needs to spend two to $3 trillion a year to transition the economy.

And that's because they're replacing the whole capital fleet, as well as more capital intensity of renewable type projects, so the companies that are going to benefit from that. And so, in our portfolio, you'll see that those energy names, the industrial type names that will benefit from that spend, but also in the non-bank financial space, where companies are going to benefit from higher rates, so that's really where the majority of our positioning is at the moment.

And finally, Reece, what is the number one piece of advice you would have for the listeners out there or the watchers out there, in terms of portfolio construction?

I'd say never be all-in in investing, so you always can't over commit yourself. When you think it's a great opportunity, there's always a little bit more to come tomorrow and there's always another opportunity. So I always think, clearly, we're are willing to really back a position when we have faith, but you really need to hold something back. And I say certainly at a total portfolio level, that's very important. And then I'd just say the other one is for an Australian retiree, just to make sure you take advantage of franking credits. It's one of the few free lunches in finance.

And, one of the things you guys do very well here at Martin Currie.

Thank you.

Reece Birtles, thanks very much for spending the time today. Appreciate it.

Thanks, Chris.

Well, there you have it, ladies and gentlemen, lots of great insights as promised. If you enjoyed this interview as much as I did, make sure to give it a like. And don't forget to subscribe to our YouTube channel, because we're adding great new content every week.

Learn more

Managed Fund

Martin Currie Equity Income Fund

Australian Shares

View