Interview: The investor's guide to global equities

Published Nov 7, 2021, 5:30 PM

Global share markets are soaring right now, and it's easier than ever to buy international equities. So when you're looking to diversify your portfolio, what should you look for? Hugh Selby-Smith, co-CIO at Talaria Capital, takes us through the risks and opportunities of global investing, as well as some of his favourite stocks.

Welcome to the Fear and Greed Daily Interview. I'm Sean Aylmer. We talk a fair bit here about global equities for a couple of reasons. The first is that whatever happens on overseas markets often has an impact on the local market too. The second is that it's never been easier to buy shares in international companies. And it's not a bad idea either. That's why I like talking to experts about what we should be looking for, what trends to keep an eye on, and where the opportunities might be. Hugh Selby- Smith is the Co- Chief Investment Officer at Talaria Capital, which specialises in investing in large cap global stocks with around $ 500 million in funds under management. Hugh, welcome to Fear and Greed.

Sean, lovely to be here. Thank you.

Let's start with the basics. If I want to buy overseas, what are the things I should be thinking about?

Well, I think there's a couple of things. Firstly, why are you looking to buy overseas? I mean, is that really driven by the opportunity for diversification, for different return sources? Is it really a function of wishing to back specific companies or sectors? So I think there's a portfolio aspect that people should be thinking about. Where does that fit in, in terms of slowly diversifying your asset base away from just domestic Australia? Secondly, I think you should be thinking, how do you want to access that? Is that through a passive vehicle? Is that through a managed fund? So I think that's a consideration. And then the third thing, I guess is you really got to think what kind of asset class do you actually want to access? Because clearly there's a much broader and deeper opportunity set across asset classes globally. So think about corporate debt, for example, quite apart from a more diverse source of equities.

Okay. So Talaria Capital, how does Talaria Capital and you as the Co- Chief Investment Officer, think about investing overseas? Do you go through those three processes for your funds? Is that how it works?

No. We have a pretty rigorous bottom- up process where, in effect, since the inception of the fund in 2005, it's always looked globally. So our universe is everything ex Australia, though it does need to be developed market listed.

Right.

So really we're assessing the opportunity from a bottom- up basis to invest in mispriced companies that have a fantastic kind of asymmetry between the risk to lose money on the stock versus obviously the long-term return profile of the business.

Okay. And where are you mostly invested? So presumably Wall Street's a big chunk of it.

We're very diversified. I mean, as you can imagine, our opportunity set is around about 3000 companies. We have significant exposure to Europe, including the UK. Japan's around about 14% of the portfolio. The US is around about 30, that includes several Canadian companies, but we access via the New York Stock Exchange. We also have exposure to countries as diverse as Mexico, Brazil as well is a reasonable holding currently in the portfolio.

Okay. So there are a few emerging markets in there. Those latter two being examples.

There are. There are. As I said, Sean, you do need the company to have a developed market listing. So they need to be listed on the New York Stock Exchange for example, or in London.

Okay. Yes. Right. So let's get into it. I want to talk about US tech stocks. Wall Street is pretty much outperformed for a decade or so because of those FAANG stocks and other tech stocks. Where are they up to? Are they too expensive now?

Well, certainly through our process, they are. I think it's kind of interesting. For example, just over the last four or five decades, if you look at the largest 10 capitalisation stocks in the start of each decade, about eight out of the 10 typically have fallen down the ranks over the course of the subsequent decade. And so that's really that they get mispriced to be able to generate reasonable returns. So from our bottom- up process, I think the embedded expectations around profitability, but also long-term growth are unrealistic if people are expecting the returns of the last decade to be a reflection of what's likely to come, Sean.

Okay. So that is a way of saying that potentially you won't get over the next 10 years, the returns out of the tech stocks that you got over the last, is that right?

Yes, absolutely right.

Okay. So what are the areas that you would look at over the next 10 years or so that you think might replace the tech stocks given they're kind of coming to the end of their decade and mispriced?

Well, I'm certainly not in a position of forecasting what's going to become the kind of darling sector going forward. That's really not what we do, Sean. It's sort of individual securities from a bottom- up perspective. But what I would say that investors need to think about is what are the embedded risks in their portfolio, because rather than trying to forecast the future, which is a fool's errand, what we can do, of course, is we can really create a portfolio through diversification primarily that actually stands here in good stead in a range of outcomes. So I think what people should be doing, given my comment around US technology, but also the crowding of the positions in US technology is a secondary aspect, is that they should be looking for geographical diversification. They should be looking for diversification by return type, because clearly over the last decade, the majority of returns have been capital growth rather than this balance between and income and growth. And I think the third thing is that they need to be able to diversify by sector because if I have a look at the companies in, say the Russell 1500 or the S&P 1500, the top 20% of those, so there's sort of 300 companies that are most dependent, or most correlated, with falling interest rates, make up around about 51% of the market capitalisation. Now the 300 companies that are most correlated with, for example, a rise in the consumer price index, they make up less than 10% of the index.

Right.

And that gives you two things in that example. One, it shows you the concentration about really what's been the 40- year trajectory of interest rates to, well, 4, 000 to 5, 000 year old lows. But it also shows you the opportunity. You've got 300 companies here that can give you a diversification within your portfolio, which allows you to prosper, irrespective of actually the outcome of, in this instance, consumer price inflation.

Okay. Just talking about inflation, in a sense what you're talking about, diversification and setting yourself up for whatever happens, the debate at the moment is whether inflation is persistent or transitory. Does that matter as much? I mean, I think what you're saying is actually just be prepared for whatever it is.

Absolutely. Our approach really over the 16 years of the fund, I mean, I can only really speak for myself, is when the market's complacent or extremely positive, investors and us should be prepared to give a little bit of that upside up to make sure that they quickly recover that when so- called unexpected events take markets lower. So I think there's too much energy going into working out what might happen rather than managing risk about the range of scenarios that possibly could impact people's financial wellbeing.

Okay. Stay with me, Hugh, we'll be back in a minute.

I'm speaking to Hugh Selby- Smith, Co- Chief Investment Officer at Talaria Capital. Hugh, you're listing two global equity funds as active ETFs in the next few weeks, hopefully. Now for listeners not familiar with ETFs and active ETFs, what's the benefit of active ETFs vis- a- vis passive ETFs?

Sure. So I guess a passive ETF in effect is where every dollar that flows into a passive ETF is a price insensitive buyer. Okay. So in effect, there is no security selection. It's just really mirroring the sector and index weights that are currently on offer within the market.

Yep.

What we've seen is, since the GFC, an enormous amount of money has flowed into passive ETFs. And of course, given that flow and it makes up well over 50% of the current equity market asset base, they've been forced to buy very large capitalisation and mega -cap stocks. So I was getting back to the point about diversification, the top 20% of companies, for example, in the S&P 1500 account for 83% of the market cap. So in effect, when you put a dollar into a passive ETF, really 83 cents of that is going into 20% of the companies. So you're far less diversified than perhaps you imagine.

I would have thought. Yeah.

I think the difference in terms of an active ETF and what are the benefits, it's really a mirroring of a manager's individual security selection and discretion in building a portfolio, which is not reflected in a passive ETF. I think the benefits for savers is that it's accessible. So there's no minimum investment amount, which is quite different to a whole range of other kinds of funds. It's liquid, so investors can buy and sell intraday on the ASX in this instance. It's very transparent. You have live trading prices, you have quarterly full portfolio disclosures. So there's nothing behind the scenes. It's all extremely transparent. Plus, all the benefits of an actively managed portfolio. So in our instance, obviously our acumen and so on in terms of building robust portfolios to be able to deliver a greater certainty of outcomes for our clients.

Okay. And then just finally, you've got a diversified portfolio of 25 to 40 large caps. Can you run me through some of the stocks that are in that portfolio?

Sure. We've talked a lot about the US market being potentially in aggregate relatively overvalued, but that's not to say that we don't find a whole range of well- priced securities in the US that are great companies. So I sort to highlight something like McKesson, many people don't know McKesson. It has around 200 billion of revenues. It is America's largest pharmaceutical distributor. It's a very consolidated market. The top three account for 93, 94% of all pharmaceuticals distributed in the US. It's very cash generative. So there's not a lot of capital required in the business. They don't have to build out infrastructure. They don't have to build out servers and manufacturing plants. And that means that every dollar of earnings really converts fully into cash. Now the current P/ E on the company is around about 10. So it's a shorthand for a free cash flow yield of about 10%. So you're getting 10% per annum of cash back to you as an equity holder. And the management is doing a relatively good job in terms of capital allocation. The majority of that is coming back to you as a shareholder.

Okay.

Another example in the US specifically would be America's largest fertiliser producer, which is called CF Industries. Clearly, food and food security is a huge structural area of concern, I think for the globe over the next 20 to 30 years, as we continue to see populations grow. It's got a very competitive advantage in the sense that the largest cost input into the production of fertiliser really is energy and they mostly use natural gas. And the natural gas price in the US is significantly lower than the global peers, particularly in Europe, but also the reference price in Asia. And what that means is that the company has a cost advantage. Now by our bottom- up work, the implied difference between the cost of gas in the US and the cost of gas in Europe and Asia is around $ 2. 80. And that compares to the 10- year average of about $ 4. 80. So even taking in that kind of current $ 2. 80 price, you're getting around about 10% of your cash back per annum over the next couple of years in CF Industry. So, that'd be two examples in the US. Strategically important companies, leaders cheap, but happen to be listed in the US. So, there's no dearth of opportunities. Out of interest, those companies wouldn't really turn up in a passive ETF at all. They're just totally irrelevant. From a global perspective, we sort of touched on Latin America. We have a position in Ambev that is a fantastic market leader, particularly in the Brazilian beverages market, beer in particular. They have over a 60% market share. They have margins that have historically averaged well over 30% EBIT margins. There's very supportive demographics in Brazil, in terms of consumption trends. The company is net cash. And we continue to see them able to redeploy capital at extremely attractive incremental rates of return. So that would be another in terms of holding of the fund, Ambev.

Ambev.

And as I said, 14% of the fund is in Japan. I would say highlight Secom, it's Japan's largest security firm. You haven't seen any negative year of growth in the last decade. Around about a third of the market cap of the company is actually in cash on the balance sheet. You're not really being asked to pay anything for that. Management has made selective acquisitions of further security companies, and it can currently has a free cash flow yield direct to equity of around about 6%. So we find that an attractive structural growth area as well.

Absolutely. Hugh, thank you for talking to Fear and Greed.

Really appreciate your time.

That was Hugh Selby- Smith, Co- Chief Investment Officer at Talaria Capital. This is the Fear and Greed Daily Interview. Join me every morning for the full Fear and Greed Podcast with all the business news you need to know. I'm Sean Aylmer. Enjoy your day.