Buenos días a todos. Comenzamos la conference call de Sextant Grand Large, contamos con la presencia del gestor-coordinador del fondo. Louis responderá a todas las preguntas que nos habéis hecho llegar a través del correo electrónico.
Vamos a dividir la conferencia en tres bloques diferenciados: allocation, performance y perspectivas de futuro.
We switch to English, if you don’t mind.
Q: We’re here today with you to discuss Sextant Grand Large, our most well-known fund. Let’s start talking about allocation, something key on a fund like Sextant Grand Large. Louis, could you tell us what’s the current exposure of the fund?
Louis: The current exposure of the fund is as follows: a 33% net equity, with close to 50% gross equity. We have around 15% bonds and 35% in cash. The main message is that we have around 1/3 of the fund in net equity exposure. We are cautious but still well invested reflecting overall expensive markets worldwide, with USA very expensive and rest of the world trading at a fairer level.
Q: So far, 2020 has been a very intense year. Could you tell us how has the exposure changed during the year, pre and post COVID-19 crisis?
Louis: Indeed, this year was a crash-test for the process of the fund. What happened was similar to the events of late 2018, when the market went down quite significantly and rapidly. We were at 25-30% net equity exposure at the beginning of the year, which was ok for us. We were able to increase the equity exposure during the drawdown of the market to 50% net equity at the bottom in March and we’ve progressively decreased the exposure down to 35% now. We can say that Shiller’s PE worked quite well. It helped us be very reactive in March, obviously with this model it was easy to increase the equity exposure. Without it, it would have been very hard to buy so aggressively during march.
Q: Could you explain us in more detail how does the CAPE system work? It’s a proprietary model of Amiral Gestion and sometimes clients don’t fully understand the mechanism.
Louis: The Shiller’s PE is market PE ratio, taking into account the last 10 years of earnings adjusted for inflation, taking into account a full cycle of earnings and it’s a good valuation tool for markets and that’s what Nobel Laureate Robert Shiller proved that it’s a very relevant allocation tool on a 5 year and more time horizon. We look at the worldwide market Shiller’s PE and the more expensive they are, the least equity exposure we have and vice versa. It’s a very fundamental approach. It’s a very relevant and comfortable system for us: on the long run, valuation always works. It’s something that currently we tend to forget, investors prefer to momentum-driven allocation processes or stock-market or economic scenarios. A famous investor said on Barron’s that valuation was useless to invest in the stock market. When investors say these things, I think we’re close to a turning point. We’re confident and disciplined in terms of our process on this topic.
Q: A question many investors ask is regarding the US exposure of the equity portfolio. This has been something Sextant Grand Large has done for quite some time. Could you explain the reasoning behind this decision?
Louis: Sure. In addition to my previous point, the geographical exposure of the portfolio is not linked to Shiller’s PE model. Shiller’s PE is just for determining the optimal equity exposure overall. The geographical exposure of the equity part of Sextant Grand Large is just the result of the pure bottom-up stock picking process, so no link between both. Secondly, we must mention that we dedicate a lot of time on US equity stocks, we have a dedicated portfolio manager and even today, Berkshire Hathaway is a good example: #2 position in the fund despite being a US company. We have little exposure to the US and much lower than the worldwide benchmark because valuations are very high, both in absolute and relative terms. On top of that, on average US companies have much more debt levels than in the rest of the world, which is something less relevant when interest rates are close to zero and people not look too much at risk but it’s important. The positioning has cost the fund in the recent years because US stocks have outperformed. Why? Because of higher earnings growth. What is really interesting is to look at where did the growth come from. On average, and this is very interesting, growth came from several unsustainable factors, which are quite unique to the US in the last 15 years. First is wages compression, only in the US. Not in Europe or Japan. Salaries as a percentage of the value added came down a lot in the US to benefit the capital share of the value added. Additionally, you’ve had much lower taxes thanks to Trump measures especially, which is also quite unique to the US. And finally, you’ve had a huge wave of debt-financed buybacks, which is something that happened to a much lesser extent in the rest of the developed world. Those are factors which in our view explain most of the higher earnings growth in US companies in recent years. This is obviously something that might revert to the mean in the next 10 years compared to Europe and Japan in which case the US equity market would dramatically underperform. But even without a reversion to the mean, what we can say is that it will be tough to reiterate. It’s tough to imagine wages could go down even more, taxes could go down even more, debt-financed buybacks could increase much from the levels we reached in 2019. This means that the higher valuations in the US overall don’t seem justified and we find much better risk-reward elsewhere.
Q: Some critics regarding Shiller’s PE say that the negative interest rate scenario has changed everything. What would you say to them?
Louis: That’s maybe the most interesting discussion point currently because there is this narrative in the market which is kind of a mathematical reality that if you use a 0% discount rate, because interest rates are at zero levels and will stay there for very long, then obviously valuations are infinite in a discounted cash flow model. I guess what most people forget is that, yes, zero interest rates mean zero inflation anticipation and so you can lower your discount rate. All things being equal, that raises your valuation. But what people forget is that zero interest rates also mean zero economic growth for the next years. Interest rates reflect not only inflation but also growth. So, if you have zero growth for the next years, that offsets the fact that you have a lower discount rate. Both things can offset each other. So, I guess, for a lower discount rate, you have also to take into account lower growth, so both things in my view are quite offset. That’s why basically I think you have in Europe and Japan much lower valuations than in the US despite having lower rates in recent years. And even today you have somewhat lower rates in Europe and Japan. Despite of that, you have lower valuations and I think that it’s correct.
I think the reason why you have higher valuations in the US is not linked to lower interest rates but to higher realized eps growth linked to elements (wage compression, lower tax rates, debt-financed buybacks) which in my view are unsustainable”
Q: The fund has traditionally held a small percentage in gold stocks and gold-related assets, normally 1-2%. But this year, the exposure has increased significantly. Can you tell us how much gold does the fund hold, the distribution of that exposure and the reasoning behind the investment? It seems that Warren Buffett read your mind, since he invested a few months after this move on Sextant Grand Large, so it´s a good thing to know.
Louis: Basically, we’ve been owning some mining stocks for a while for macro reasons, when gold mining stocks were at a huge bottom compared to gold prices. That happened in 2013 and 2016, if I’m not wrong. It was an opportunistic move. In march, when gold mining stocks went down a lot, we invested again in those stocks but we increased the weighting of the fund for two reasons. First, there is microeconomic reason. We’re very interested about the sector and we’ve been seeing very low supply of new gold mines, no discoveries and a huge change in the way companies in the sector are running their operations. Historically, the gold sector was the least disciplined of all the mining sectors, which translated into a much more fragmented sector compared to other mining sectors. It also translated into much lower return on equity and return on capital employed. This is really changing, companies in the last years have been very disciplined in terms of costs CAPEX, etc. New management has been coming in, a lot of shareholder pressure to improve return on equities. It’s a virtuous circle because you’re sure you won’t have a huge CAPEX boom and huge discovers coming in to the market. Specially, because it takes at least 10 years for a new project before coming into production. So, you have a very favourable sector context, plus huge free cash flows given the current gold prices and very low valuations. In 2020, the gold mining sector in terms of free cash flow valuation might be the least expensive of all the market. Plus, you also have an interesting macroeconomic setup where the debt and budget dynamics which has been amplified by the COVID-19 crisis obviously negative interest rates are necessary for countries for a long time. That’s very positive for gold, the opportunity cost on gold vs. bonds is disappearing. That’s why we’ve been holding a position between 6 and 8% since march, with a mix between long-life assets which we think have the better returns on equities in the industry. So low-cost, long life and some well managed funds to diversify our exposure.
Q: To finish on the allocation part of the discussion, could you tell us about the long-short part of the fund. How much shorts do we have right now and what’s the reasoning behind it?
Louis: As you may know, on top of net equity exposure in the fund, which currently stands at 33%. We have a flexibility between 0 and 20% to have an equity hedge exposure. This is something that contributed to the good performance of the fund until 2017. During the last 3 years we decreased the size of this hedge portion to 11% because we were thinking that at the end of the bull market becomes less fundamental, our stock picking had less opportunities to outperform. That was correct. We’ve been increasing again this part since March back to 15-20% again, to take into account the extreme market polarization that we currently see taking growth parts of the market and the rest of the market, not only deep value. The second market polarization we’re seeing is US vs. the rest of the world. And the third one, which we did not mention yet is the big caps vs. small caps valuation polarization which is also back to high levels. We may be still early but we want to profit from those discrepancies in terms of valuations, so we have a portfolio which is more and more small & midcap oriented, much less US and we avoid trendy stocks. We think it’s a good way to outperform with a 3 to 5-year time horizon.
Q: What has happened in the last few years with the performance of the fund? Some investors are surprise of the recent underperformance but the investment team seems very confident about this. What can you tell us regarding performance?
Louis: Obviously, we share this disappointment. But we have to look at it on two aspects: the exposure management of the fund and stock picking, what has changed and how we envision the future. So first, on the exposure part, as mentioned, since the beginning of 2018, we’re coming to the end of this bull market. Momentum is stronger than fundamentals, which is quite usual at this stage. We have a more cautious equity exposure and we try to avoid trendy stocks. It’s normal that we underperform at the end of the rising market, but the good side is that we were quite stand correctly end of 2018 or in the COVID-19 crisis in march. Obviously, what was unexpected was that COVID-19 accelerated this outperformance of momentum stocks and growth stocks in general. This was a throwback for positioning. We think this doesn’t change the overall picture.
Q: That was our next question. What can you tell us about stock picking performance contribution?
Louis: Basically, equity selection in the fund, as you may know, is based on picking the most defensive stocks of our pure equity fund in a global basis, regardless of sector or size. This is a selection which normally outperforms our pure equity funds. This has normally worked well and one could have expected the same would have in 2020 and obviously this is where we’ve been disappointed. Our equity selection in Sextant Grand Large hasn’t outperformed our pure equity funds, it was the contrary. The reason why is because we had a few COVID-19 exposed stocks at the beginning of the year in the travel area, in the property area, trade fairs and we sold some of them but we were slow to do it. It will be the first time in 10 years that the equity selection within Sextant Grand Large underperforms our pure equity funds, which have done very well this year, like Sextant PEA or PME, up 10% this year. I think there’s no reason why the process should be less efficient and we’re quite confident this will not happen again; we will be much better as it has happened in the previous 10 years.
Q: If we study a more general performance, of say 5 years, the fund is still on the top quartile. What’s your feeling when seeing a bigger picture?
Louis: Again, it was somehow expected to underperform at the end of the bull cycle with our process where we lower our exposure when the markets are up and we have a contrarian style of stock picking but, obviously, COVID-19 made it worse. The good thing of Shiller’s PE is that it works the more you hold the strategy across the cycles and is something which is really interesting for the long term. If you take a step back, you may remind that we were 70-75% exposed to equity in 2010 and 2011 especially, and now we’re more around 30%. So, it makes sense to be less exposed at the end of the bull market but tougher times can come and we have to be ready to be able to outperform. This allocation method is very robust over the long term across the cycle. Then, we’re also confident in terms of stock picking despite the setbacks we had this year because we have a strong confidence on valuation, we’re pretty sure that if you buy good companies at reasonable prices something good will happen. In our equity funds, we have increased our part of small and midcaps and we’re less invested in the US. And then we have a mix of some GARP stocks and some value names. What makes us confident on performance going forward is what happens inside of the companies. If you look at the expensive part of the market, you have seen record amounts of IPO’s in the tech and biotech sector. You’ve also seen a record amount of convertible bond emissions and a lot of insider sells. In our portfolio, you’ve seen the opposite: you have lots of companies which are owned by entrepreneurs and you’ve seen lots of buybacks from those companies and lots of insiders trading, managers buying their own stocks. Just to put a few examples in the fund, with huge amounts: Vivendi, Aimia, Jacques Metal, Econocom or even Haw Par in Japan, so it’s something happening across the portfolio currently. We really think that insiders, on average, are normally very right about the value of their own businesses. If we look at Iliad, which is a French telecom company, it has been a bad performance in the fund in 2019 but we kept and increased our position because the owner and manager bought more shares, he did a tender offer on part of the float. After this, the stock price doubled and it was one of the best performers of the fund this year. So, just to share that insider behaviour is kind of external validation of the confidence of the portfolio positions. So, we’re confident that we’re not crazy and valuations are still something to look at.
Q: Finally, regarding bonds, what could you tell us about the recent performance this basket has done on Sextant Grand Large?
Louis: In terms of bonds, it was 15% exposure at the beginning of the year. Now we’re in a situation with very low levels of inflation, interest rates are also at very low levels. The structuring is also a very good indicator of the risks being taken by the market. Currently, structuring is super risky and the governments are extremely light. This means that for the companies that went bankrupt this year you’ve had record low recovery levels for the bondholders. So, this is a very risky situation because obviously central banks have been a huge support for the bond market but if your company can still go bankrupt, it’s still very binary and you could lose everything. So, again, we have very little duration, little interest rate risk and only 15% exposure. Just to give you some context on how we managed that part this year, we increased our exposure while increasing our equity exposure to 20% of the fund thanks to our previous cash position. We had some decent quality names with good management on 3-4 year bonds with a yield around 4-5%, sometimes more, which we sold during the rebound. What we’ve also sold is our subordinated financial bonds which are more risk in our opinion. So currently we’re focused on our biggest convictions: companies like Econocom (we own the shares and also the bonds, a company which will be net debt very soon), Kloeckner (which is a very good risk profile, you have a lot of working capital coming back, they’re deleveraging very easily) and other companies which are reducing debt with asset sales. So, we feel very safe regarding the payment of the debt, like ThyssenKrupp in Germany or Casino in France. To give a good example, they have been selling a lot of assets at prices which are generally higher than expected. They’re currently buying debt back at discounts, which is extremely healthy, so we’re quite confident on the quality credit of the company, but the bond didn’t rebound. In terms of exposure, we managed it quite well during the year. In terms of picking, it has underperformed even though on the bond part we’re more confident than even on the quality of our bonds, so we’re very confident it will have a contribution to performance in the next months.
Q: Now, let’s speak about the future. As Buffett says, if investing was all about the past, librarians would be rich. From now onwards, two scenarios are possible for the fund: 1) the market goes up 2) the market crashes. What can we expect in either one of those scenarios and how would the fund behave?
Louis: We don’t do any kind of scenarios, neither macro or stock market one’s. It’s a waste of time. But we can anticipate how the fund could react. Our view is that if markets generally speaking go up, there is a huge catch up potential we think in terms of equities in the fund compared to the trendiest parts of the market. We have many names, like I mentioned, like Econocom and others, which are valued at bottom-cycle prices in terms of economic cycle. There is a huge catch-up effect on that part, even though we only have a 33% equity exposure. We have a 50% gross equity exposure plus the hedged part would also contribute a lot, I think. On the contrary, if the market is going down, then it’s even more obvious that we’re interestingly positioned. We have cash, 30-35% equity exposure and within that, our companies are at very low valuations, the one’s which are not easily owned by institutional and retail investors. And remember that in Grand Large we have a defensive approach. Our companies have little to no debt, which is extremely important when things are wrong and compared to the market averages the difference is huge. Also, in terms of the bond portfolio, we think that we also have a cautious position with short durations. We also have a significant cash position, which we think is key to seize opportunities.