We often say that we play the hand we are dealt by the market. We can control our research efforts and our decisions, but we certainly can’t control the market’s behaviour. Stock prices move for lots of reasons – some common to many companies, others much more idiosyncratic – but they all create headwinds and tailwinds for performance. John Christy, from our offshore partner Orbis, explains using the Orbis Global Equity Fund to illustrate his points.
A few broad trends have dominated global markets in recent years. US stocks have beaten their ex-US counterparts, highly valued stocks have beaten cheaper ones, shares of big companies have beaten those of small companies, and businesses insulated from the economic cycle have crowded out their cyclical peers to represent an ever-growing portion of world stock markets. Most of these trends were headwinds for the out-of-favour shares that we found most attractive, and the arrival of the pandemic only made it more intense. Pfizer’s vaccine announcement in November was just the sort of catalyst needed to turn some of those headwinds into tailwinds, but this has lost some steam in recent months along with concerns about the delta variant.
While we are always mindful of these broader movements, our long-term results will ultimately be determined by the performance of individual businesses. Our exposure to a few technology companies in China has been painful for performance recently – in this case for very specific reasons. The severity of new regulations in the education sector and the abrupt way they were announced have led us to conclude that regulatory risks are now higher in China. While we have long been mindful of “China risk” in its various forms, the ever-present possibility of regulatory change has now become a certainty.
With perfect hindsight, selling our Chinese holdings earlier in the year and buying them back at these levels would now look much cleverer than holding them throughout. But that’s not how we invest. Our job is to rationally assess – and seek out – attractive idiosyncratic risk based on our research and to remain disciplined during uncomfortable periods of underperformance. This sounds easy on paper, but never feels that way at the time.
Indeed, some of the biggest winners in the history of the Orbis Funds – XPO Logistics, NetEase, and Samsung Electronics to name a few – made us look foolish on more than a few occasions before ultimately living up to their fundamentals. We can’t help feeling the same way about a lot of our holdings today.
In the case of our China holdings, our view remains that these companies represent some of the very best opportunities we have found anywhere in the world and continue to warrant large positions in the Orbis Funds. Our assessments of intrinsic value are now somewhat lower – and we are being increasingly judicious about overall China exposure – but it is fair to say that we believe the sell-offs in the likes of NetEase and Naspers/Tencent have been excessive. Both NetEase and Naspers offer exposure to exceptional businesses, yet they are currently selling for below-average price multiples. And though these shares have weighed on returns in recent months, it is worth remembering that these same holdings helped offset the damage elsewhere in the portfolio during last year’s “COVID crash”.
International banks are another such pocket of value
Currently, banks make up about 10% of the Orbis Global Equity portfolio – compared to about 6% of the World Index – with holdings including ING Groep in the Netherlands and Sberbank of Russia. Banks are an even greater overweight in our International and Balanced Strategies.
Delta variant uncertainty notwithstanding, the demand for loans has picked up as businesses reopen, travel resumes, and people start going back to the office. Having gone into the current pandemic with ample capital buffers as a remnant of the tighter regulation following the global financial crisis, and having created generous default provisions at the start of the pandemic, banks are now in an unusually strong position. As an added benefit, these overstated provisions are starting to unwind just as dividends (which had been suspended in response to the crisis) are reinstated.
Other positions are more idiosyncratic, as even a glance at Orbis Global Equity’s top 10 holdings makes clear. The fundamentals that will drive the returns of America’s largest broadband provider, Comcast, are not the same as those that will drive the returns of German luxury automaker BMW. Nor does demand for Taiwan Semiconductor Manufacturing’s chips have much to do with Anthem’s health insurance coverage plans in the US. All of these companies will thrive or struggle for their own reasons. Many of them are executing in line with our expectations, and in some cases, exceeding them altogether. Yet a higher than usual number seem to be completely ignored by the market. That only makes us more excited about the long-term opportunity.
This article was published on the Allan Gray Website on 3 September 2021.