Portfolio strategy: 4 ways to win in a changing world

The lyrics “turn and face the strange” from David Bowie’s 1971 hit song “Changes” could not be a more fitting way to describe the challenges investors are facing today. COVID-19 has raised doubts about themes that many considered structural and sound such as the desire (or need) to travel, the use of office space and the pain befalling banks and insurers as a result of low interest rates and a global economy veering into recession.

In this extended interview, Charlie Aitken of Aitken Investment Management and Nick Griffin from Munro Partners join Matthew Kidman to discuss the big changes occurring in consumer behaviour and markets as well as “dead-end streets” – as Bowie put it - to avoid. They also share 4 stock ideas; companies with “fortress balance sheets” set to emerge even stronger on the other side.

Notes: You can access the video, podcast or edited transcript for this Buy Hold Sell episode below. This episode was filmed on 7 April 2020. 

Edited Transcript

Matthew Kidman: Welcome to our thematic discussion brought to you by Livewire Markets. I'm Matthew Kidman and today we're talking about change. In 1971, David Bowie wrote the song Changes. “Turn around and face the strange" and boy is it strange at the moment. I've got a couple of great gentlemen here to talk about what is reshaping the market and how we apply it and where we go from here. Charlie Aitken from Aitken Investment Management and Nick Griffin from Monro Partners. Welcome gentlemen.

Well, things have changed haven't they? Changed in the sense of how we're living, but also zero interest rates, a lot of money being pumped around the globe, but businesses are shut down. Charlie, I'll start with you. Kind of a wartime situation here that we haven't experienced before, but what's your view on the impact and how it will play out? Will the governments win? Central banks win? Or are we in for a long recession?

Predicting the future 

Charlie Aitken: Well, I see it, Matthew, really as disaster relief. This has completely come out of left field and I don't call it stimulus, I think it's disaster relief. It's trying to buy us time to get through the virus. I think it will effectively buy us some time. It won't stop people having high unemployment levels and the effect on business, but I think what government and central banks have done has been absolutely appropriate and we just need time. So let's see what happens, but I see it as disaster relief.

Matthew Kidman: Nick, got a view on that? Are the governments going to get us there or is this just a long valley that's going to take a long time and we need to adjust now?

Nick Griffin: Yeah, I'm going with Charlie here. We think it's not stimulus, we call it compensation for lost earnings while you solve a healthcare crisis. And unfortunately, that gets you across the valley. But when you get across the valley, there's still a pretty nasty recession on the other side. And there's really not a lot you can do about that. And so from our point of view, it's a deep recession early, but it's still just a recession. And we just need to play that how we would play any other recession.

What to be aware of 

Matthew Kidman: Okay. Nick, sticking with you. Good players change with the environment and that's what we have to do here. What are some of the structural shifts, the thematics that you're identifying that are going to come out of this, and that we have to be aware of going forward?

Nick Griffin: Yeah, it's interesting. We were actually going through the S&P 500 the other day, the top 20 companies that make up about 40%, and trying to work out how much their earnings would go down in this crisis. And it's actually not that much. It's important to stress that unfortunately, this really is a Main Street crisis, not necessarily a Wall Street crisis. And so if you look at just the top five companies in the world being Amazon, Apple, Microsoft, Google, and I've missed the last one, but if you look at those guys, they're going to come through this okay.

And so the big structural shift for us is we've always had the portfolio positioned towards e-commerce and software, and always had a position towards healthcare. And all we've done through this crisis has probably pushed the portfolio further that way. It's pretty clear that digitalisation will accelerate off the back of this.

We're doing this video with Zoom, my kids are going to do their education over the cloud, so the cloud is going to accelerate here. E-commerce is going to accelerate here. And then to a certain extent, digital advertising, while it'll get hurt this year, will probably accelerate this year as well. So all of those big guys, unfortunately, come out of this as winners in the long run, but maybe not in the short run.

Matthew Kidman: Charlie, the world's changing but from what Nick's saying, the strong get stronger and the rest have to deal with what's left. Do you have the same view or have we got to be a bit more nimble than that and look a bit further in some of the knock on effects?

Charlie Aitken: No, I absolutely believe the strong get stronger. The strong were strong before this in terms of balance sheets, that's what we really focus on. So this is really a liquidity issue at the moment, too. And remember, the world's largest tech stocks, many of which Nick mentioned, have the strongest balance sheets in the world. But they're also some of the least effective. I think this just entrenches some of the structural trends that were already underway.

I think I'm far more in favour of ‘business to business’ exposure, than ‘business to consumer’ coming out the other side of this. I really think there'll be a mindset change from consumers coming out of this, these are the ones, the people obviously losing their jobs, unfortunately. But most consumers and smaller businesses and SMEs were caught completely off guard with no cash and no liquidity for a rainy day. And I think that'll change their mindset permanently in terms of behaviourally, coming out the other side of this. I think there'll be far more conservative settings in SMEs, far more conservative settings in households, and I think consumer spending will take some time to pick up on this.

I also think most people who lost a job will not instantly get it back as well. So I think we'll be dealing with high unemployment for some time. I think the other big change will be in dividend payout ratios and buybacks. I think that will be restricted. I think that you need to be aware of companies with organic growth and sustainable dividend payout ratios.

And I also think the other side of this will be much higher tax rates eventually, too. We have to think about that. So while we've got stimulus at the moment and an aggressive fiscal side of things as well, I think the tax rates are something to think about.

But look, really, I actually think the strong get stronger. It's as simple as that. And not many people have noticed, but Microsoft shares are actually up this year. And if you want an example of something that's the strong getting stronger, $134 billion of cash on its balance sheets. So my view is, just be a little bit careful on the consumer. I think that their mindset will change, but business to business looks all right and the strong are taking market share.

Leaving the worst behind 

Matthew Kidman: All right, Charlie. You're on a roll, let's stick with you. What's going to be worse off? What's going to really suffer from now on into the back end of this crisis?

Charlie Aitken: It's blatantly obvious but I really struggle to see how international travel gets back to pre-crisis levels quickly. It would be a pretty big call to say, "I'm getting on a cruise ship tomorrow." I don't think anyone's going to do that. So I think there's going to be much tougher visa restrictions in the world. Travelling is going to be harder, travelling is going to be more expensive. So I think it's going to take a long time for international travel to pick up. So we're not looking at casinos or airlines or airports or anything like that at the moment.

But I also think that another thing to be careful of is if this working from home trend, i.e. what we're doing right now, really picks off, then I think you've got to be careful in landlords. I think that's something that's being forgotten out there. Commercial landlords that could actually face much higher vacancies, rental pressure. And does anyone really want to work in a shared office going forward? I don't.

So I think there are some quite big structural changes. So what I'm avoiding is commercial landlords. I'm also avoiding international tourism. But a bit like Nick, all we've done is increase our investments in what we think are the strong and who have fortress balance sheets.

Matthew Kidman: We may never sit next to each other again, Charlie. Now Nick, let's take that same question with you. You've told us where you're narrowing your portfolio down. Where don't you want to be or where do you want to be light on in terms of portfolio going forward?

Nick Griffin: Yeah. Look, I agree with what Charlie said about the travel industry, obviously. I'd just point out that in every crisis there's a sector that sort of gets in trouble and doesn't come back. And last time it was the banks and I'd just be mindful of people looking at that area because there are big solvency issues here, not just liquidity issues, solvency issues. And they will need to do big diluted capital raisings. The bridge that's there will not get them through.

Matthew Kidman: You're talking about the banks or companies with big clients?

Nick Griffin: Yeah, that's the companies. And so moving on, on to what Charlie said, is then think about that small business and where that ends up. So where we see that ending up is clearly with banks. So banks are on the hook at the end for that small business who doesn't get across the bridge, unfortunately.

The other people that are also there that are probably a bit left field is things like restaurants. So a lot of restaurants are franchise models. The franchisees, as Charlie pointed out before, are probably having to do this completely unprepared, probably quite highly geared. And also autos. We really don't like autos here. We haven't liked them for ages and we still don't like them. The dealerships, the dealerships are in financial trouble now, the auto players will have to incentivise the dealerships to sell their cars. People will give cars back rather than pay off the loan. So you end up with a subprime problem on the lease book.

These are the sorts of guys that are really exposed to that mass market that, unfortunately, the workout just doesn't get solved in a week or two. It takes probably a couple of years. And so from that point of view, they're the areas we're avoiding.

Charlie Aitken: I might just make one more point, Matthew. So you ought to be very careful in any company, particularly a U.S. company that takes money from the government in any form. That is going to have ramifications, if you accept government bailout money in terms of permanent dividend payout caps, buyback caps, and also some sort of equity dilution from the government.

So when you look at our portfolio and Nick's portfolio I'm sure is the same, we haven't got anyone who will end up taking government money implicitly, I don't believe. But that's where the banks, I think you've got to be very careful in financials globally, and those who are on the other side of this risk because eventually they may end up taking government money.

Are we at the bottom yet?

Matthew Kidman: Okay, I'm going to come back to stocks, but just a general question before we get to a couple of picks to get us through this. Have markets bottomed? Or is there something worse to come?

Charlie Aitken: I don't know the answer to that. I am uncertain, Matthew. I think you can't make any unequivocal statements at the moment. I hope they have. I think mid-March there was rampant panic and bond markets were in trouble and credit markets were in trouble and even gold was being sold because it had liquidity problems.

I think the interesting bit is the equity market, rightly or wrongly, is the first thing that gets hit because it's the most liquid. You get your money back in two days in terms of settlements. So let's hope they have. I can't be certain of that. Sometimes in these occasions, they go and retest the lows. But what I am certain of is I own fortress balance sheets. So that's the one thing you cannot do as a fund manager. You cannot own anything that ever goes broke and that won't happen on my watch.

Stock picks for the recovery 

Matthew Kidman: Okay. Nick, you gave us a bit of an idea on where to be. Let's take it down to two names. Where do you want to be as we reshape the economy and we go forward?

Nick Griffin: Yeah. Look, if you want to keep this really simple, you can just own the biggest e-commerce company and the biggest cloud company in each region of the world. So that's Amazon for the U.S. or for the developed world. So our biggest e-commerce company in the world, biggest cloud computing company in the world. Cloud infrastructure, as a service, is effectively the weapons manufacturer in the whole cloud game. And so from that point of view, every Netflix movie you watch, most of the software you're running, and most of the fitness apps you're using, are using Amazon web services. So, that's Amazon. It's also up in the March quarter. And I think, as Charlie pointed out before, it's pretty rare that the S&P goes down 20% in the March quarter, yet the second and the third biggest stock in the world are up. That just shows you how strong, how unique these companies are.

And the second one, just do the same thing for China, so you own Alibaba. China, in theory, could get through this easier than the rest of the world. Alibaba is the biggest e-commerce company in China. It's also the biggest cloud computing company in China. That just keeps it really simple. I can give you some smaller ideas apart from that, but those have been the two big ones.

Matthew Kidman: Charlie, same question to you. Two to get us through.

Charlie Aitken: Yeah, I totally agree with Nick on the large e-commerce and cloud plays. We obviously have large exposure to those two and they've done well for us.

I still believe in the payment systems, in MasterCard and Visa, even though they're going to take a little bit of a short-term hit on transactional volumes being down. Remember, they take no credit risk. They're not lending anyone any money, unlike other payment systems. I still think this accelerates a move to the cashless society away from cash. Obviously cash is unhygienic in the current environment and not many people actually want to accept cash. But also with a big move to e-commerce, the payment systems are very well placed to benefit from that. So I still like those. They're seen as IT exposures globally (where they're really financials in funny way), but I still think that the payment systems look really good and that's something I'm increasing our investment in.

Matthew Kidman: When it comes to markets, COVID-19 is code for rapid change and the bigger are just going to get a lot, lot bigger.

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