Simon
Welcome to Fidelity Sound Bites. A straight to the point, no nonsense, monthly podcast where you'll learn from some of Australia's leading portfolio managers on what's happening in markets, how they're positioned, and the outlook going forward.
I'm Simon Glazier and I'm hosting the podcast this month as Andrew Dowling takes a well deserved break.
This month marks the 20th anniversary of the Fidelity Australian Equities Fund. The fund launched in June of 2003. And since then has delivered a return of over 11% per annum after fees*. That is over 2% per annum more than the benchmark and anyone that understands the power of compounding would say that's a pretty good effort. And for those that find it difficult to think back that far back in 2003, the cash rate here in Australia was around 5%, the median house price of Sydney was $460k, $290k in Melbourne and $240k in Brisbane. We had a Liberal government under John Howard. Finding Nemo was the top film here in Australia at the end of June 2003 Delta Goodrem had the top song on the Aussie charts with innocent eyes. I'm sure we all remember that.
So today, we'll be looking back on our key learnings, observations and what's driven that success over that time, which will likely to deliver positive outcomes for many years to come. So again, we're joined by Paul Taylor and Paul, good morning, and congratulations on a really successful 20 years.
Paul Taylor
Simon, thank you so much. It's actually so much nicer to have you here interviewing me today than Andrew. So we're off to a good start. But yeah, incredibly happy and proud of what we've achieved over the last 20 years as well.
Simon
And I think it's definitely an achievement to be proud of.
So let's just kick off with performance. Performance doesn't happen in a straight line. Like we know, there's ups and downs. What are some of your observations over the last 20 years on both the positive performance periods, and the more challenging periods of performance?
Paul Taylor
I guess, what I'm really happy about and the as you talked about, we've been able to generate after fees, a level just over 11% per annum* for our clients, that's helped them, you know, achieve better retirements or, you know, save more for for university or whatever, whatever the they were saving for in that in that process, or just part of their superannuation fund. But what I love to sort of look at it in terms of, you know, if you had invested $10,000, in the fund at inception, that $10,000 would now be worth a little bit over $80,000. So more than eight times your money in that 20 year period. And I you know, comparing against that against the market, if you just invested in the main index of the market, the ASX 200 accumulation, and that doesn't include fees, that would be about $55,000. And even cash, which I think is a really interesting one, you know, that's probably worth more like $20,000 in terms of cash over that period, as well. So you can also see, while it's 2% per year, over 20 years, that really adds up. And that's sort of the compounding of equity markets to start off with, but also just getting a little bit more than the what the markets able to achieve actually makes a big difference over a long period of time. So and, you know, I'm incredibly proud and happy that that's, you know, at the end of the day, we've helped clients retire better, you know, have better savings for whatever they wanted to spend the money on.
Now, as you rightly point out, it doesn't go on a straight line, you know, that doesn't work exactly. We're just outperforming by that 2%, every year, some years, it's 4%, some years zero, in some years, we go backwards a little bit as well. But the important thing is the long term process, which is which is the key thing, and which is what we're focused on when we invest in companies as well. But if you look at the sort of negative side of things, I think there's probably been three periods where we had a tougher period. Now that I would categorize those periods as if you go back to 2005-2006 was a tough period for us. 2016 was a tough year, as was 2022. So that sort of three periods where we've had sort of two or three quarters of underperformance and each of those periods, it's the underperformance of for slightly different reasons, although there's some commonality.
So if you go back to 2005-2006, what was happening at the time was a lot of private equity firms were buying into what we consider to be very low quality businesses and really undertaking financial engineering so gearing them up buying them out gearing them up. And we just didn't think that was ever a sustainable process. It's not a sustainable it's a genuine value creation. And so we didn't get involved in that we didn't participate in that. And that and unwound violently through the global financial crisis. And obviously, we performed very strongly through that period, which obviously just highlighted that what was happening in 2005-2006 wasn't sustainable.
2016 another tough period was really I was talking about it as the Trump bump, because when Donald Trump came, became president in the US.
Simon
He did mix a few things up.
Paul
He did, he did, and it negatively impacted us for that year as well. But basically a year over year member of but that was, there was a view that all we were gonna go on a global growth run. And basically, a rising tide lifts all ships, including very low quality, structurally challenged businesses. And, you know, we tend to favour better quality good management teams, great businesses, and that they did that wasn't a good year for them. But what was a once again, an unsustainable bounce in poor quality businesses.
And similarly, in 2022, the increase in inflation and interest rates, was advantageous for structurally challenged businesses where their earnings are today, but their future earnings in doubt, they were much better positioned than companies that had a really good long term earnings outlook as well.
So some similarities, some commonality across those three periods, but three tougher periods for us. And I think we'll always have those so you can't, your your style, the way you go about investing is not always going to be in favour. In the short term, you get fads fashions, you get lucky you get unlucky. And you'll always have that. So when I go into the future, I'm sure there'll be years or periods that we do it a little bit tougher. But what we're fundamentally trying to achieve is great long term investment returns for our shareholders, for our unit holders. And that's going to deliver great results over the long term. And hopefully, now our 20 year numbers sort of indicate, you know, the strength of that.
Simon
yeah, absolutely. And in terms of just, you know, listening to those challenging periods, and performance up versus down, there's been times and looks like that's the consistent where, you know, we've avoided those fads and fashions, and just came back and stick to the knitting. So in terms of just diving into a little bit of that, how do you make it work? 20 years, a long time, you know, people are always saying active managers can't outperform or struggle to outperform. Hear, we've got evidence of the fact that we can, but how do you make it work? What are you always looking for?
Paul Taylor
So I think it is it is a focus on duration, it's focus on length of time. So we, when we invest in a company, we are looking at the next five to seven years. So as I said, fundamentals look out three months, six months, or even 12 months. But we do think fundamentals will always outperform over that five to seven year investment horizon. And we think that's quite, that's a critical timeframe as well. So and now, that's also focused on the long term prospects for those companies and the opportunities for those companies. That also does tend to, you know, if you if you think about what has really worked for the fund over the long term, it tends to be what we call compounders. So they are businesses that have a high return on invested capital, and can reinvest at a high rate. Now, we'll also talk about it beating the fade. So if you know if...
Simon
It's not a gold term is it? Beating the Fade?
Paul Taylor
Beating, the Fade, exactly beating the Fade, so hanging in there, keeping those long term those returns higher for longer. So for the average return on invested capital across the market is 7%. Businesses that are currently generating 20. Over the long term, everybody should come back, because because the market is competitive, there's there's new entrants, new technology. Long term and that everybody will come back towards that 7% return on invested capital. But if you're able to do a slightly higher return and keep it for slightly longer, that's what I mean by beat the fade. So fading to seven, if you can beat that fade, you're going to create a lot of value and the longer you can beat that fade, the more value you're going to create. And if I look at the businesses that have really done well in the portfolio, or that's generated those extra returns, they are those compounders that have higher return on invested capital, are able to reinvest at a high rate, and beat that fade to the long run average.
Simon
My sense, makes sense. And in terms of the portfolio, right, you've got how many stocks 50 Odd there are there abouts?
Paul Taylor
So we that's another key point we have between 30 and 50 stocks. So we also think as you get below 30, you can have a very concentrated portfolio, and that's fine. But for us as a core portfolio, below 30 is not as diversified aren't really diversified portfolio, but above 50, you're getting too close to the market to close. So we think 30 to 50, or within that core group, really is the sweet spot.
Simon
So how many good ideas? Do you think you need a year to deliver that consistent outperformance mean, is it in the realms of you know, 10 really good ideas or you happy for the majority of the portfolio to do the lifting? And then a couple of ideas really generate that alpha? What are the thoughts?
Paul Taylor
So, you know, new ideas, I think you if you get one or two, you're doing well,
Simon
you're doing
Paul
But the portfolio itself, they'll have will have major positions in stocks. So the top 10 is an example would average only about 3% overweight position. And that's still a sizable position in those companies. And I guess in the top 10, what I tend to focus on is companies, I love that sort of call option payoff where the company doesn't have a lot of there's not a lot of downside in the share price. But there's a lot of upside if things go right, yeah. And that's what I love to set it up like that. We will invest in companies that have a lot of upside or downside. But they're never going to be major positions, they're gonna be much smaller positions. So they're getting a lot more upside, but there's potentially a little bit more risk. So there's always going to be smaller positions in the portfolio that top 10 are going to be much more around companies that don't have much downside and a lot of upside.
Simon
So we've talked about the winners, and the outperformance over those 20 years, no doubt you've seen some some. No doubt, you've seen some companies that haven't performed so well. So let's dive into that a little bit. What are some of the key lessons learned? And some of the challenges and some of those positions that haven't necessarily worked out so well?
Paul Taylor
Yes, Simon definitely. And I guess that's as part of investing, you know, investment is a risk return. So you are always taking risk. And in fact, I want to take risk in the portfolio, just that I want to get it correctly priced. That's really what I'm looking for. Now, unfortunately, sometimes those risks don't pay off for or you do get, you might get unlucky, or you just get your investment thesis incorrect. And that's right. As you look over the 20 years, we've definitely had stocks that haven't performed well, that have gone poorly. And we've just, you know, we just got it wrong, basically. But I guess the, you know, in a positive sense, why the portfolio's done well over time, is that the stocks that have done really well, we've had big positions in, and the stocks that have had tougher times, we've had small positions. And so I think that's made a big difference in that sort of, I always talk about portfolio construction being an evolution, not a revolution. So as we gain conviction in the company, we increase the position or as we lose conviction, we decrease the position, it's never, you know, a huge position from the start or get out of it straightaway. It's really an evolving position, we want to gain conviction. So we're meeting with the market every quarter, we're maintaining our own proprietary earnings, cash flow, valuation, balance sheet models on all those companies gaining conviction. What's the management saying? What's their strategy? Is that changing through time? Are they are they doing what they say they're going to do? So we are building conviction those companies. But having said that, even as you build, you know, even as you take a position in the company, things can still go wrong. And I guess I'd come back to probably a couple of, I probably put some of the poorer performing business or investments really, in a couple of buckets, and they've come in two, probably two things. One is balance sheet. And the second one is cyclical versus structural, and maybe we've got that wrong. So, you know, balance sheet's, just critical. Even in a business that's in a cyclical decline, that's often easy to value when it's in a cyclical decline. You can say, okay, they're down, but, you know, we think that they'll recover over the next five years and if the valuation there looks really attractive, that's great. But if they don't have the balance sheet to get you to the other side or the some issue with their inventories, that's going to deteriorate the balance sheet, you might not get to the other side to actually get the benefits of that cyclical recovery. So that's the first that's the first area. And then the second area probably is we spend a lot of time working out whether a business is cyclical, or structural. And really, the ultimate is a business that's in cyclical decline, but has structural growth, that's what you want to buy, you want to buy into that long term structural growth. If it's a cyclical decline, often you can pick it up and much better valuations. So that's really what you want. But, you know, sometimes you don't get it right. So I know, you know, a couple of examples of we have, you know, we thought it was structural growth, but it was really cyclical. And I think, you know, the experience and, you know, following these things in markets, if it was, if it's a cyclical business, it very seldom changes at spots and becomes a structural business. So once cyclical, normally always cyclical. And you just learn those lessons through time. So we do spend a lot of time working out what's cyclical, what's structural, but you don't always get that right as well.
Simon
Yeah, yeah. And sometimes, the timing just doesn't work.
Paul Taylor
Definitely, you can do everything right. And they're just the timing is, you know, you got the timing a little bit wrong. Yeah. And, you know, timing is everything as they say.
Simon
Yeah. And you talked about the balance sheet is the one that comes to mind specifically,
Paul Taylor
although we've had a few different ones, but probably the one that jumped out to me when I think about it is we were an early investor in Billabong. And Billabong, had done well, but then was rolling over, there was some concerns about whether the fashion was still attractive to younger people. We did a lot of work in social on the social networks. And the positive comments that were coming out, were very good for Billabong, I think there was still very much there on the fashion side. But what they had done is that expanded into the retail. Billabong, were always a wholesaler selling to retail. But then increasingly, a lot of the people that they sold to the retailers were becoming competitors and Billabong, Billabong didn't like it. So started buying their own retail stores, and started building up inventory in a whole range of areas, which was straining their balance sheet. So they were in a cyclical decline. We thought the balance sheet was okay, but it was actually deteriorating more than we thought. And so they weren't in a good position to recover. We ended up getting out of Billabong, and it wasn't, you know, it wasn't too much of a disaster, but it is one where you do need that sort of thing is exactly what you need to focus on the balance sheet.
Simon
Now, Paul, you've talked about compounders, particularly those over the longer term. Can you give us some examples of some of the really successful combination of you've seen or and purchased?
Paul T
Yeah, so they go great. compounders for us would be companies like SEEK, so we bought SEEK at IPO back in 2004. Around that $2 level. We bought Domino's, also just a little bit over $2. It's now $50. Wisetech is another great example of a compounder. So high return on invested capital business that can reinvest at a high rate. And the really interesting thing with Wisetech is we actually bought Wisetech pre IPO. So we can invest in companies up to 12 months before the IPO. And with Wisetech was a great opportunity in a private setting to get to know the management team, get to understand the company, get very comfortable with the business model and where they were heading. And actually, we bought more at IPO as well. So at IPO, we bought it at $4. It's now today, almost $80. So it's obviously been a fantastic company for us, and for our investors. It is has it's a very high returning business, it's got an incredible runway and still sell a lot of opportunities. So that higher return, able to reinvest at a higher rate is going to create a lot of value through time.
Simon
And how long does it take to get comfortable with a firm like Wisetech? Before you invest in in that private company before it IPOs?
Paul Taylor
It's an interesting one. So like I said, we it was a year, it was 12 months pre IPO. You obviously got comfortable, from an initial research, we got more comfortable through their private and I guess it's a little bit different, because it's you're meeting them in a private setting rather than a public setting. But still even then, you know, I want to be meeting them every quarter, I want to you know, you, you need to be speaking with the management team. What are they saying? Are they doing what they say they're doing? If this is their strategy? Are they executing on that strategy? What are they want to execute? If they're jumping all over the place? It's, you know, it, it's doesn't give you the conviction that you want to invest in this company long term. And that's the idea. You know, what I want to be with companies for 20 years. Yeah. So you gain that conviction.
Simon
Geez you'd have to like them then wouldn't you?
Paul
Well, there's been some great companies, you know, think about the global companies, you think look at, you know, Apple, now that's a $3 trillion business. Just getting the conviction, what Apple have done over, you know, 20 plus years, 30 years, has been phenomenal. So gaining conviction really pays dividends in the long run.
Simon
Right Paul. So looking forward, what gives you the confidence you can keep this up?
Paul Taylor
You look, I think it's what I have a lot of faith in is the repeatability of our process. So we have really institutionalize that process. So we meet with the market meet with companies in Australia, every quarter. We meet with the management team, we update our earnings, cash flow, valuation, balance sheet model. We update the strategy, we update our investment rating. And that's every quarter, but it looks out five to seven years. Now we've got one of the biggest equity teams in the market, in our team here in Australia. But also the really interesting thing or what were our competitive advantage is not just the quality and size of that local team. But what we do here in Australia, we do everywhere else in the world. So that allows us to do a 360 degree view on the company. So often the company's competitors, suppliers, distributors are not other Australian companies but global companies. So as an example, we are meeting with, you know, our we've got a Chinese steel analyst that's meeting with Bow Steel, we're looking at Bow Steel as a standalone investment, but we're obviously asking them about the steel production profile, the price of iron ore, the price at coking coal. They're fantastic inputs when we're looking at a Rio Tinto or a BHP Billiton, but we've got a Chinese steel analysts there's looking at Bow Steel, so we've got a Korean steel analyst ooking at POSCO, we've got a Japanese steel analysts looking at Nippon steel. That's a 360 degree view on that company and on that industry, that really gives us incredible insight and a real competitive advantage, which should drive the repeatability of that outperformance over the long term.
Simon
Very good. Let's go get him the next 20 years. Thanks, Paul. Thanks for joining us. That was a really good chat. Appreciate it. If you've enjoyed this episode, please share it with a friend and subscribe to the podcast via your favourite streaming platform. And we'll see you next month.
Paul
Thank you Simon
*The Fund's latest performance information can be obtained via [Fidelity Australian Equities Fund | Fidelity Australia]. Please refer to the relevant footnotes and disclaimers regarding performance and related matters in the Fidelity Product performance summary - Monthly report 30 June 2023. Past performance is not a reliable indicator of future performance.
