Profit is an opinion, cash is a fact
Not many people get to meet an investing legend in their lifetime, let alone someone who pioneered markets like Peter Lynch, but as a graduate on Fidelity's analyst program Amit Lodha had the opportunity to do just that. On a recent trip to Australia, we sat down with the portfolio manager of Fidelity's Global Equity Fund to discuss some of the most valuable lessons that the legendary Peter Lynch taught him, where he is finding the most compelling opportunities in 2020, and why the biggest bubble in the market has nothing to do with equities. Enjoy.
Can you remember the first share you bought? How did it turn out?
The first stock that I bought was HDFC bank and it was a long time ago. I started my career as an accountant with KPMG and I was specialising in financial services. They had strict rules, and we couldn’t buy stocks or companies that they audited. Once I finished my chartered accountancy, I joined Solomon’s, which is now Citigroup. I was a research analyst then and I thought to myself, which company did I enjoy auditing the most, which management team impressed me the most, and it was HDFC Bank. At the time they were a fledgling start up, now it's a $60 billion company. So that was the first stock I bought, and I still have some.
Do you think those early days and the lessons you learned from working at KPMG made you a better Fund Manager?
I think so. One of the things that I consistently talk to in terms of my process is my focus on cash. And that comes from my audit days where I learnt that profit is an opinion, cash is a fact. I've always focused on cashflow based metrics because that's the real number which matters to us as shareholders.
It has been nearly 30 years since Peter Lynch stopped managing the Magellan Fund. Do you think his investment principles can still be successfully applied today or do they need to be adapted?
Peter is a true inspiration. One of the most important points of my career was back in 2004 when I joined Fidelity and they sent us all for training in Boston. You got a chance to sit with Peter and ask him how he managed money. In September of this year, he completed 50 years at Fidelity, and he wrote a piece around his learnings over that time. It's amazing because all the things that he talks about are exactly the same things that he said 20 years ago when we had the chance to sit together.
- Stocks follow earnings and cash flows. Get that right and you get the stock right.
- Turn over as many rocks as you can, and the more rocks you turnover the more chances you have of finding diamonds.
- And finally, you will get maybe six out of 10 things right. Learn to deal with it. Managing money is more about the stomach than the brain. And once people understand that, they become good managers of their money. It's about staying in the game, having the stomach to manage the volatility.
I think a lot of the basics of what Peter said in terms of how you should look at buying stock all hold true even today. From a professional asset management perspective though, there are some changes that I think we need to think about. The world has become a lot more globalised over the 20 years that Peter's not managed money. And I think that globalisation, how you look at a company, not only in its local context, but its global context has become very important.
Lynch talked about investing in what you know. What is a sector that you are most passionate about?
I think technology is the sector that most people would choose at this point in time. It is a sector seeing a tremendous amount of change, a tremendous amount of disruption. I'm really interested in how technology is impacting various sectors around the world. If I take the mining sector, just the autonomous trucks, which are now running around in the Fortescue and Rio Tinto mines are really increasing the efficiency quite dramatically as you look at what the impact of robotics and autonomous driving has been in that sector. In terms of the healthcare space, just the mapping of the human genome has been one of the most important changes in medicine that we've seen over the last 10 or 15 years. In 2001, it costs you about $10 million to map the human genome. Today it's down to $1,000, which is a faster than Moore's law.
This year has seen flows into equities and bonds move in opposite directions, with recession fears causing many investors to head for the perceived safe havens. Do you think investors are justified to do this or have they left the party too early?
One of the classic questions that people ask me is where are the risks, or where are the bubbles if you like? It is tough for me to find bubbles in equity markets. Yes there are pockets, maybe areas in software are overvalued, or trends like the cannabis sector or beyond meat and things like that, but those are at the margin. If you look at broad valuations across the world, we are on the expensive side but we are not egregiously expensive. These are companies making good cash flows, good cash returns, really strong free cash flow margins.
"The bubble is not in the equity world, the bubble is in the bond market."
25% of sovereign bonds around the world are currently yielding negative rates, which is making investors in fixed income really search for yield. This dash for yield is a big phenomenon that I see with my fixed income colleagues. To me that's a huge risk because what's happened is because of this central bank policy of negative interest rates in parts of Europe, people have been chasing yield because retirees obviously find it very difficult to make ends meet with 1% rates and so they need more and more yield than that is a demand and they don't want to go up to the risk curve in equities, but they are, because what I see is very interesting is if you look at equity markets and how equity markets have behaved in 2019, the sectors which have done the best are the defensive sectors.
So that's REITS, consumer staples, healthcare. What is the worst performing sector? The cyclicals, energy. So if you ask your equity market participants, they've been very defensively positioned and that's kind of worked out well for them. If you ask how my fixed income colleagues are positioned, they’ve been buying companies which are levered three, four, five times because in the investment grade and sovereign space, they've just not been getting the yield pickup. So while equity investors have been defensively positioned, fixed income investors are the most aggressively positioned, which is kind of completely counter intuitive to the way finance 101 works.
If you were to hit even a garden variety recession, okay, your five times debt to EDITDA will easily go to six or seven times because in a garden recession you get a 20% to 30% EBITDA cut. If that were to happen, that would be more leveraged than what we saw in the 2009 financial crisis, 2001 or 1991. So, the high yield market will fall out of bed if we get into recession. That is the signpost that I'm monitoring the most closely when I look at what's going on in equity markets.
Sentiment towards recent tech listings has turned. Is this an inflection point or simply a bump in the road for tech stocks?
I think it shows the discipline and health of the public markets that while the private markets have gotten over excited about some of these valuations like WeWork or even Uber for that matter, if you look at range of IPOs which have happened this year, the market has been pretty selective in terms of which ones have been rewarded versus ones which it has not. There are a few factors that you need to look at.
- The IPOs are coming and much later than the life of the companies. Typically, you would get IPOs much sooner, but if you remember Facebook or Uber, they're all listing when they're a 30, 40, $50 billion company. A lot of the upside in the valuations have already been captured by the private equity markets, and so the public markets are of the view that what's in it for me now? And show me the cash. That's a good question to ask because you've got some of these IPOs coming in which are still burning cash.
- If you look at some of these IPOs, everyone wants to be a tech stock. It's Peloton, it's WeWork, they all pride themselves as if they are tech stocks, but when you want to be a tech stock you have to have two or three things in your field. You have to have very high operating leverage, which is the beauty of a software model. Microsoft office is programmed once and sold millions of times. But if you don't have that same kind of operating leverage in a WeWork where you need to keep opening offices, or an Uber where it needs to keep incentivising drivers, that operating leverage is not present and the market is calling them out. It's saying “you're not tech companies, you don't deserve those kinds of valuations”, and I think that is perfectly fair.
Almost twelve months ago, you wrote a piece for Livewire stating that in the decade to come Apple in its current form may not exist. Apple is currently your top holding. Can you explain your thesis?
Yeah, it's one of those classic ones when facts change, you change your mind. What do you do? So Apple's really interesting. When you're looking at his stock, you can have a three year thesis, a five year thesis and a 10 year thesis and your edge can be one which is different, based on the time period of your investment. And this is, I think a really important point. I think if I look at a 10-year thesis for Apple, innovation is critical and I'm not seeing that change or that innovation coming out of that company since Steve jobs passed away. What's changed for me on Apple and why it is my largest position at this point of time is that, I think the next three years I think are going to be a really important technology cycle on the iPhone side.
If I look at our phones for example, these are all iPhone sixes and sevens. We've not had any reason to change our phones because there's been no innovation, right? We will get a cycle over the next two, three years where we will need to replace our phones because the networks will change and 5G will come into play.
I want to be well invested to play that cycle because I think that will drive earnings.
Also, you know that I follow management teams, and what I've seen more recently is that two people from Google, very senior people involved in their search, have moved to Apple. One moved in April of 2018 and one moved fairly recently.
Both are focused on artificial intelligence, both are focused on search. They did all the search algorithms at Google at this point of time. And that's caught my thinking a bit out because if you are at Google and if you want to be in search, there is no other company in the world that you'd work for. But these people have given up their jobs at Google and moved on to Apple in a company which has the data sets to use search and actually be a real competitor to Google at some point of time in the future.
One final thing is that, Apple has also managed to really drive its services growth. They've been able to diversify from the iPhone to selling us more services. All these factors along with the valuations made me change my mind on Apple from a three year perspective, but I don't change my view from a 10 year perspective that the company needs to innovate, they need to be invested in some ‘moonshots’ or make some aggressive acquisitions if they're going to survive for the next 10 years.
Another sector you like is Healthcare. What do you find so appealing about that space?
It’s at the centre of a lot of things changing very rapidly, and whenever things change rapidly, there are always opportunities to find an edge. This is an area that we can add some amount of value. The usage of technology has increased quite dramatically. A company that we own is Illumina, and Illumina is the company that you go to for any tools required to map your DNA or your genes. As personalised medicine grows over a period of time, tools which Illumina supplies will only increase.
Healthcare for all these years has been about finding one drug which cures everybody and I think the paradigm is going to change to find that one drug which is best suited for your body, for your particular DNA and to manufacture that drug to cure you. I think that precision medicine as it grows will create some really interesting companies.
When you look at my holdings, I'm more of the camp that I like some innovation, some growth, some new product cycles in my portfolio. Boston Scientific for example, has very strong product cycles in various areas of growth, companies growing 7%, 8% over the next few years with margin expansion. AstraZeneca and Roche are two other companies that we own. Again, AstraZeneca has found some really good new drugs for particular cancer mutations.
Roche has done similar. It's the number one for breast cancer. So we like to focus on companies which are doing things on an innovative basis, have new drugs coming out, strong growth in pipeline.
At the start of the year, you put together a piece about what to call it and what's to fold in 2019 platform. What about 2020, what do you see as being the things to hold these folders?
It's very difficult to get a sense of market direction or economic factors from a short-term perspective, but I’d make two or three points on this.
- If you think about the decade of the 2000’s, it was all about China. So the largest companies would be BHP, Rio Tinto, ExxonMobil, anyone selling anything to the Chinese. As we end this decade of the 2010s, it's really been all about technology. Maybe things remain exactly the same, maybe they change. The US has been the go-to market for us in this decade because of the technology companies that reside over there and maybe that stays for the next six - 12 months.
If you're looking over the next 10 years, investors need to have a really flexible mindset.
- Things of the past like deflation could give way to inflation, growth could give way to value, lower taxes could give way to higher taxes, QE could give a way to more fiscal spending and helicopter money. Things could change quite dramatically based on what happens in the US elections, if not in the 2020s, definitely in the 2024. So I think one needs to be really nimble in terms of what they're doing with their portfolios.
- More nearer term, I'd say that there is really good value that I see in Europe, especially the UK. If it has a half decent resolution to the elections and Brexit, a lot of UK stocks look extremely undervalued to me. If I look at growth, I find emerging markets cheaper than what you see in the US. So if you're a growth investor, I think there's some really good opportunities with fairly decent corporate governance in emerging markets.
Outside of investing, what is a passion or unique skill you have that might surprise people?
I love reading books, as well as travelling. If I had to surprise you, I'd say that one of the things I've been doing just over the last year is trying to learn the piano and I find that reading music, which is in some ways reading, is something which is quite therapeutic and takes your mind away from all the crazy things that go on in our world. My wife tells me that I don't read enough fiction and I tell her I get enough fiction on a daily basis with what's going on in the world.
If I had to recommend a book to Livewire readers over the Christmas period? I have young kids and this year I've really enjoyed Range by David Epstein. It's a mind opening book that looks at the Malcolm Gladwell rule, where if you spend 10,000 hours doing something you’ll become an expert at it. Range tries to look at this from a slightly different perspective suggesting with empirical and scientific evidence that if you look at Nobel prize winners, if you look at people who've done well, who are happy in their professions over long periods of time, they've had a range of interests, they're not only focused on one area, one geography, one vocation, they've kind of tended to move along in doing different things.
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