Tim Samway

Despite decades of evidence to the contrary, investment managers and commentators persist in holding a short term view of the market that’s unlikely to be in the best interests of ordinary investors, says boutique Aussie equities specialist, Hyperion Asset Management.

“The recent falls in the ASX are a case in point, with the extent of the interest and concern around short term movements indicating that some investors and commentators are missing the point,” said Tim Samway, Hyperion’s Managing Director.

“And the point is, with very few exceptions – such as professional traders or speculative investors – equities investing is a long term game. Treating it as anything else is one sure way to erode gains, which is the last thing that most Australians, who just want to build a long term, secure retirement, need.”

Mr Samway said that intensified focus on day-to-day stock movements can prevent investors from achieving their long term investment goals. He cautioned both investors and their advisers to make decisions about their holdings on the basis of quality, long term performance data rather than fluctuations which may seem significant on any given day but, over time, may be meaningless.

“The simple fact is that stocks cannot be expected just to rise and rise. The nature of the market is that they will rise and fall. The purpose of sound investing is to ensure that, over the long term, the rises outweigh the gains. Preferably significantly,” he added.

Mr Samway went on to say that the reasons for the current mood of short termism and market navel-gazing were probably many and varied – but that none of them was sufficient on the evidence to divert investors from a long term path.

“Whether it is the shorter news cycle, the increased sensitivity to market news since the GFC, a heightened sense of awareness about superannuation outcomes – or a combination of these factors, the noise that surrounds this kind of unhelpful and often ill-informed market “analysis” remains just that – noise,” said Mr Samway.

“Instead, investors who want a long term, secure retirement should be focusing on strategies that incorporate a robust investment process that will secure long term sustainable returns and preservation of capital. Ultimately this means investing in growing businesses with superior economics, at an attractive price.”

Mr Samway said that the key factors Hyperion looks for are a high return on equity, a proven track record of success, low gearing and organic, sustainable growth.

“What is frustrating about the current climate is that Hyperion’s focus on the long term is one with which most superior investors and commentators agree. So we thought it time to go on the record and call for some calmer, more informed discussion that may even add genuine value to the debate – and to client portfolios – which is surely what we are all here for.”

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Boutique Australian equities manager ECP Asset Management (ECPAM), headed by Dr Manny Pohl, has released the prospectus for Barrack Street Limited, a new listed investment company (LIC) targeting small and mid cap listed Australian equities.

The offering is targeting a maximum of $50million, with the LIC aiming to achieve medium to long-term capital growth and income through fully franked dividends.

Barrack Street will aim to exceed a benchmark return of 8%pa.

Dr Pohl has achieved outstanding results in the small and mid-cap segment during his 30 years of investment experience. He was recognised with multiple awards during his tenure as Managing Director and Chairman of the Investment Committee at Hyperion Asset Management, including Equities (Small Cap) Fund Manager of the Year (2011), Australian Equities (Small Cap) Fund Manager of the Year (2010) and Best Performing Australian Boutique Fund Manager (2009).

Applying the same investment strategy that has formed the basis of Dr Pohl’s investment career, in the period from inception in July 2013 to March 2014, ECPAM has returned 24.8% against a benchmark return of 5.3%, and the ASX Small Ordinaries Accumulation Index which has seen a modest return of 5.4%.

Dr Pohl said a particular target investor of the Barrack Street Investments LIC capital raising would be small super funds, that is, those with fewer than five members.

“Its widely acknowledged that SMSFs bias are heavily weighted to ASX top 50 companies and cash.

“Barrack Street will provide investors with a convenient and familiar pathway to high quality stocks outside the ASX top 50, an area where ECPAM and its team has an enviable and long-term track record.

“ECPAM’s philosophy is based on two hypotheses about market inefficiencies. One is that, on average, the market undervalues extremely high quality, capital efficient growth businesses.

“The second is the market tends to over emphasise temporary themes and short term factors.

“At ECPAM we buy businesses with superior economics. We buy to hold, not trade. And the basis of our purchasing decisions is seeking well priced, underlying value opportunities. We aim to structure portfolios with higher weightings in stocks with long-term returns above the risk free rate.

”Some of the Hallmarks of the ECPAM approach include not trying to predict short term price movements and not investing in high risk businesses. We don’t invest businesses that do not meet quality thresholds. Our definition risk is where a business does not meet a benchmark IRR, not deviation from an index.
“Our approach and track record demonstrate to us there is a strong demand for a specialist small and mid cap investor with this type of bottom-up, value based investing philosophy. We believe it will find favour with the increasing number of SMSF trustees looking for strong income yields, capital growth and low risk.

The offer is priced at $1.00 a share and investors in the IPO will receive a free 24 month option for every share they subscribe for, exercisable at $1.00.  Morgans Corporate is Lead Manager to the Offer which is scheduled to close on 31 July.

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Joel Gray

“Rising equity markets have seen the tide of initial public offerings (IPOs) rise as success breeds success and more businesses consider listing, but the lure of short-term profit taking can lead to disciplined investment processes flying out the window.”

This is the warning from Joel Gray, Portfolio Manager for award-winning investment manager, Hyperion Asset Management, who today acknowledged that rising markets and the liquidity they provide do encourage IPOs, as companies seek to capitalise on positive market sentiment.

“Hyperion has a fund which invests exclusively in Australian small caps, so we keep a very close eye on upcoming IPOs, because small cap stocks make up the majority of the listings,” Mr Gray said.

“It is well-known that companies often list at an initial premium, so the temptation is certainly there to buy in at the beginning and take the short-term gains,” he explained.

Mr Gray said that rather than looking to profit from short-term price hikes at listing, long-term investors, like Hyperion, would do better to analyse upcoming floats in the same way they would any potential stock, with a focus on the fundamentals and a long-term horizon.

“The excitement which accompanies an IPO can mean investors become carried away with positive market sentiment and lose sight of the value of fundamental analysis.

“In fact, we see the recent spate of IPOs as a good test of whether a fund manager will stick to a disciplined investment process, or succumb to the desire for short-term gains,” Mr Gray said.

Hyperion’s investment process focusses on the long term and takes the view that high quality companies will outperform over the longer term, and that sustainable earnings growth is key to success. Ultimately this means investing in growing businesses with superior economics, at an attractive price.

Mr Gray said that the key factors Hyperion looks for are a high return on equity, a proven track record of success, low gearing and organic, sustainable growth.

“This naturally cuts out a number of companies looking to list. For some it is because the listing is based on a promise of future success, and without a track record to judge by, we take the view that no matter how compelling the promise, we prefer to wait and see,” he said.

Mr Gray then explained that of the more than 50 listings which Hyperion had analysed over the past 12 months, only two had been chosen – OzForex, which offers an on-line, cost effective way of transferring international funds, and VEDA, the largest credit rating agency in Australia and New Zealand .

“In the case of OzForex, not only is the return on capital high, but return on equity is in the order of 60%, the company is debt-free and sales are growing at 30% p.a,” Mr Gray explained.

“And perhaps more importantly, we predict high growth for OzForex, which provides a quicker, cheaper option for transferring money overseas than the major banks.”

Mr Gray concluded by saying that a buoyant IPO market can certainly offer a rich source of potential investment opportunities, but investors looking for long term performance should exercise caution.

“Long term success can only be built on rigorous analysis of a company’s fundamental drivers of success, regardless of whether it is about to list or is an established market participant,” Mr Gray said.

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Justin Woerner

With miners leading the gains in this year’s interim earnings reports, many investors might be tempted to flock to mining stocks. However, award winning fund manager Hyperion Asset Management, warns investors that outperformance is driven by quality stocks not sectors.

“Market growth figures were strong, with sales, earnings per share (EPS) and dividends per share (DPS) growth for the market at a healthy 10%, 13.8% and 8.2% respectively. These figures were spurred by the big miners in particular (BHP and RIO), and it is clear that cost cutting continued to play a large part in earnings growth for this sector,” said Hyperion Portfolio Manager, Justin Woerner.

“Outside the mining sector, growth was more subdued, with Industrials ex Banks recording EPS growth of 2.3%. Ex-resources, overall the market recorded a more moderate sales growth of 6.4%, with an EPS and DPS growth of 5.2% and 5.6% respectively.”

While this might seem a strong incentive for investors to be overweight in mining stocks, Justin Woerner says there are plenty of opportunities for investors outside the mining sector.

“The long term experience of Hyperion’s portfolios and investors is that outperformance is driven by quality stocks, not sectors,” said Mr Woerner.

Mr Woerner went on to say that this is especially the case now that the much-predicted slowing of the mining boom is now a reality, leading investors to ask where the next growth stories are likely to come from.

“At Hyperion we think online stocks, such as REA and SEEK, will continue to grow, and we believe there is a strong outlook for non-bank financials.”

In the case of REA Group, the business continued to perform strongly, reporting a 37% increase in earnings. Australian revenue increased by 30% and ‘premium listing’ volume continued to grow despite a weak housing market, affirming REA’s strong value proposition.

Mr Woerner added, “REA’s market-leading Italian operation offers further growth opportunities once headwinds in Europe subside, and we expect that the business will be able to expand margins on top of growing revenue.”

As far as online job ad site SEEK is concerned, average yield per domestic job ad increased by 8% – offsetting an 11% decrease in the ad volume.

“This is pricing power in action,” explained Mr Woerner. “The business is also making inroads into the job placement market, traditionally the domain of competitor LinkedIn, and is realising growing revenue streams from its increasing global footprint. We believe SEEK is a low cost business leveraged to global growth and continues to offer a compelling value proposition. We are forecasting EPS growth in the mid- to high- teens over the next five years.”

While banks are historically popular within the financials sector, Hyperion believes that non-bank financials have a brighter outlook, especially those leveraged to the increasing equity market activity.

“Our portfolios are significantly underweight banks. We are forecasting long-term returns in low double digit territory due to tighter interest margins and the subdued credit growth environment,” said Mr Woerner.

“In non-bank financials, we like Henderson Group. The business’s long-term track record and management’s focus on customer service and performance is paying dividends by way of an increasingly strong brand presence and growing assets under management. We are forecasting strong EPS growth on the back of growing performance fee revenue and increasing inflows from the European and North American operations.”

Mr Woerner concluded, “This interim reporting season has been positive for the market and sets an expectation that the local market is in a good position to continue this growth throughout the remainder of the year. We urge investors to be sector agnostic and instead look for quality businesses leveraged to growth, with predictable and growing earnings streams. It’s these companies which will provide the next great opportunities to capture growth.”

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Mark Arnold

Market sentiment has improved over the past year, and with it investors’ appetite for risk, according to equities specialist Hyperion Asset Management.

Hyperion’s Chief Investment Officer, Mark Arnold, and Portfolio Manager Jason Orthman, said that equity markets in general had performed well over the past year, with many stocks re-rated upward as the lower earnings of the past few years started to pick up.

“Investors are feeling more comfortable taking on more risk, moving back into growth assets such as equities. And when it comes to which stocks are favoured, the companies that can demonstrate the potential to deliver positive future earnings growth have been trading at premium price to earnings (P/E) ratios,” said Mr Arnold.

In addition to P/E ratios, in the current low interest rate environment, dividend stocks were another major focus for investors in 2013. Accordingly, the major banks and Telstra, both of which offer appealing dividends, both rose sharply over the year.
However, Hyperion cautions that this trend may not continue.

“The long-term outlook for credit growth is subdued, and with regulatory requirements for higher capital levels, earnings per share (EPS) growth from the big banks is unlikely to move above the mid-single digit level for the next five years,” said Mr Arnold.

On the other hand, the performance of a number of Hyperion’s holdings over the year looks likely to continue to be strong in 2014. Three investments, REA Group, CarSales.com and Domino’s Pizza Enterprises are cases in point. All delivered strong earnings per share (EPS) growth over the year, up by 26%, 16% and 12% respectively, and were significantly re-rated as a result.

Mr Arnold went on to explain that, over the longer term, earnings and dividend per share growth is the best indicator of long term performance.
“Price to earnings ratios are an important metric, but they are not the best predictor of future value,” he explained. “Long term stock prices should, on average, grow in line with earnings and dividends per share growth, so these are the factors that investors should focus on.”

Mr Orthman predicted that performance in 2014 will be all about delivering in line with expectations, with predictability and sustainability of earnings growth crucial.

In addition to REA, Carsales and Domino’s Pizza, which Hyperion believes will again deliver strong EPS growth in 2014; Mr Orthman also cited examples such as Ramsay Health Care and Twenty-First Century Fox as stocks to watch for 2014.

“We expect that Ramsay Health Care (RHC) and Twenty-First Century Fox (FOX) will deliver solid growth next year. RHC had offered guidance of 12% to 14% growth in FY14 which should be comfortably achieved as it continues to expand its capacity in its existing portfolio of private hospitals. High utilisation rates, rising medical costs and the aging population mean RHC is well positioned to deliver consistent double digit annual EPS growth. FOX should also produce double digit EPS growth over the medium term due to its growing high margin subscription revenue and regular share buybacks. With quality content and high investment in new channels, we expect strong price rises over the medium term,” said Mr Orthman.

While online and health care stocks rate highly in Hyperion’s view for 2014, it is resources and mining related stocks that should be viewed with caution, according to Mr Orthman, who says their predictability will be low next year.

“We are not confident about the consistency and sustainability of their earnings,” he explained. “That’s one of the reasons Hyperion is underweight the mining sector.”

Mr Arnold concluded by saying that the recent spate of successful initial public offerings, such as OzForex Group, and strong share price movement of market sensitive stocks, such as Macquarie Group and Henderson Group, along with a willingness to support early technology plays like Freelancer was a sure sign that investors’ risk appetite is on the rise.

“It’s great to see renewed confidence flowing into the market,” he said. “But for investors looking for long term performance, a focus on strong, predictable earnings growth is still the best guarantee of success.”

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Managers need to avoid ‘Groupthink’: Hyperion.

Fear of expressing views at odds with the group could be causing some fund managers to ignore information which could lead to better investment decisions.

This is the view of Joel Gray, Portfolio Manager at Hyperion Asset Management, who says that fund managers need to be vigilant about avoiding the phenomenon known as groupthink.

We all know the story. When a stock is surging, investors flock to it, expecting essentially ever more unrealistic gains, seeking out information which backs up what they already believe, and ignoring information which is contrary to their view.

Mr Gray says that this is groupthink in action. “Groupthink tends to happen in closely integrated teams and is marked by a consensus of opinion without critical reasoning or evaluation of alternatives,” he explained.

While no one would deny that a collaborative team-based approach to investment decisions has much to recommend it, and is generally thought to be the backbone of a robust investment process, by the same token, a lack of conflict is rarely the sign of a well-functioning decision process.

“Too much consensus, or groupthink, can really compromise the quality of investment decisions,” Mr Gray said. “If analysis of company information is not complete, fund managers don’t question decisions, or are unwittingly biased in the way they process information, then opportunities can be missed,” he explained.

To contend with the biases prevalent in group decision making, Mr Gray, recommends having processes in place to encourage investment team members to play a devil’s advocate role.

“At Hyperion we have certain processes in place that promote preparation and careful thought on investment issues. For instance, investment team members are expected to express an opinion during formal team meetings, and actively encouraged to put forward a view contrary to the team consensus.”

According to Mr Gray, there are many benefits to contrary opinions within a team. “Not only are potentially entrenched views questioned, but questioning also improves the team’s understanding of a company’s overall competitive advantage and/or its growth prospects,” he said.

Mr Gray went on to explain that for any stock to be purchased and to remain in Hyperion’s award-winning funds, each of the four most senior investment team members has to sign-off on each individual portfolio holding.

“As a safeguard against groupthink, we require only one investment team member to challenge and veto a stock for it to be excluded. This is just another way of ensuring that each individual member has researched every company and comes up with their own independent view on the company’s investment worthiness.

Hyperion is a high conviction manager, which means we believe in a process that adheres to rigorous due diligence and provides the checks and balances required to come to well researched, considered decisions. And even more importantly, the process needs to be repeatable.”

Mr Gray concluded by saying that effective decision making requires a balance between diversity and convergence – generating ideas, but reaching agreement on particular decisions that need to be made.

“A clear set of responsibilities for investment team members and a defined and documented decision making process goes a long way in extracting the best investment decisions within a close-knit, high pressure team environment,” he said.

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This view was expressed by Mark Arnold, Hyperion’s Chief Investment Officer, who said that the evidence provided by the success of Hyperion’s investment process, with its overarching aim of identifying Australian companies with fundamentally positive long term economics, has led to this view. Hyperion was recently named Australia’s 2013 Fund Manager of the Year by Money Management.

“We are focused on long term growth potential which means we look at sectors and companies alike over a five- to ten-year time horizon, and hold stocks for an average of ten years. And when it comes to the ability to realise growth potential, small-cap and medium-cap companies are often better placed than the big players,” said Mr Arnold.

“We start by assessing a company’s addressable market over a ten-year period, which means looking at the sector as a whole. If the sector is growing and the company is small relative to the market, it has higher organic growth potential, and that means better returns over time.”

Mr Arnold further explained that Hyperion looks for two factors when identifying companies likely to outperform: a high quality franchise which must include a sustainable competitive advantage and the potential for long term revenue and profit growth.  Companies should also be capital light and should not carry excessive debt.

By way of example, Mr Arnold pointed to online businesses such as realestate.com.au, seek.com.au and carsales.com.au, all of which operate in a growing sector and all have been an important part of the Hyperion portfolio for some time.

“Each of these companies has a sustainable competitive advantage and a strong value proposition which in turn produces pricing power,” he said.

Another example of Hyperion’s investment process in action is JB Hi-Fi. When Hyperion bought the stock a decade ago, all it had to offer was an attractive retail story and a small number of stores, primarily in Victoria. Hyperion saw the potential for the company to be rolled out into other States, and it performed very well for investors. Hyperion has since sold out of JB Hi Fi, because it is now a mature stock with a less compelling growth story.

Size isn’t the whole story, however. Hyperion expects to achieve similar strong results with Brambles, a large company, but one that is targeting growth by driving successful products into new markets.

According to Mr Arnold, another favoured story at Hyperion is global rollouts.

“Products which are successful in one geographic location can often perform successfully in others,” he explained.

“That’s why we have invested in the University pathway provider, Navitas, and financial software provider IRESS Financial Solutions. Both have products that have proven themselves here, and are now being rolled out in other countries including the UK, the US and Canada.”

Mr Arnold then said that, while Hyperion is strictly a bottom-up, fundamentals-based investor, it also bears mentioning that companies in certain sectors often share some common features that do marry with this investment approach. In general, these are sectors that benefit from ‘secular tailwinds’; meaning that businesses in the sector operate in growing markets.

“Healthcare is a great example. An ageing population means that demand for healthcare services is increasing all the time. That’s why we like Ramsay Health Care. What it all comes down to is an ability to assess every company on its long-term economic merits,” concluded Mr Arnold.

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This is the message Hyperion Asset Management’s Managing Director, Tim Samway, delivered during his keynote speech at a series of luncheon presentations for financial advisers that are taking place in all major cities around Australia throughout December.

According to Mr Samway, this new investor outlook is seeing a shift away from cash and other non-growth assets as investors seek both good returns and preservation of capital.

“When investors are in ‘fear’ territory, they tend to stay overweight in cash.  However, as investors seek more volatile asset classes like equities they must look for the quality stocks,” said Mr Samway.

But according to Mr Samway some investors are likely to still be distracted by short-termism, a tendency for investors to shorten the evaluation periods.  Something that Mr Samway says is a killer of investment returns.

Mr Samway went on to explain that the key to providing both growth and capital preservation is due diligence. “The focus on due diligence for capital preservation rather than trusting diversification puts quality investing in a different league.  At Hyperion our unique investment philosophy and process takes a bottom up approach to investing and allows us to identity high quality companies that will always outperform over the long-term.  There is no substitute for quality.”

Mr Samway continued, saying that in order to pursue quality this means ignoring the benchmarks which are made up of poor quality businesses.  The key, he says, is to focus on the less mature companies which offer better growth in earnings.

By way of example, Mr Samway cites quality companies such as, SEEK, REA, Carsales.com, Trade Me and Domino’s Pizza.

“Around 25 per cent of Hyperion’s portfolio is invested in companies that are exploiting the secular transfer of sales from traditional forms to online.  Their valuations are above market but we think that the drivers of their long term growth have not been fully appreciated by the market.  There is also opportunity for market re-rating in the future but more importantly there is the opportunity for these companies to continue to deliver 20%+ earnings per share growth,” said Mr Samway.

Mr Samway suggested that the wealthy would be the early movers when the markets recover.  Referring to the phenomenon where gamblers take greater risks with their winnings (referred to as the house money) compared to the risks they will take with their original stake.

He noted that, “The house money effect kicks in after a period of market recovery.  Investors are happier to take more risk when they are making gains from their initial financial starting point.  Investors with more money and a smaller gap between their goals and their present financial situation will be the first to play with the house money when the markets recover.”

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The fund recorded positive outperformance during nine of the last 10 months in a period when the small ordinaries recorded positive performance only five times.

Since inception in September 2002 the Fund has returned 15.99% compared to the S&P / ASX Small Ordinaries Accumulation Index of 7.58%.

The Fund, aimed at achieving medium to long term growth through investing in high quality Australian companies listed outside the S&P/ASX 100, produced outperformance of 5.95% during the month of November compared to its benchmark, the S&P/ASX Small Ordinaries Accumulation Index.  In absolute terms the fund gained 3.52% compared to the S&P / ASX Small Ordinaries Accumulation Index return of -2.43%. 

According to Hyperion’s Managing Director, Tim Samway, the fund owes its long-term performance to Hyperion’s research driven, bottom up investment philosophy.  Tim commented: “The strong performance of the Hyperion Small Growth Companies Fund is due to our focus on only the highest quality small cap stocks.”

During November Domino’s (+12.4%), IRESS (+7.4%) and Corporate Travel Management (+12.3%) made the greatest positive contribution according to Hyperion.

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This event brought members of the investing and funds management community together to hear some of their peers put the case for a range of different asset classes in volatile times.

• Hyperion managing director Tim Samway, exhorting investors not to confuse due diligence with diversification – and highlighting that the Australian equity opportunities are out there for investors which examine the fundamentals and invest in quality rather than ‘rubbish’.
• RaboDirect Executive Manager of RaboDirect Australia and New Zealand Greg McAweeney, underscoring the value of certainty from cash – and urging investors to check that they are not paying unnecessary fees and choose genuine high interest savings accounts, not ordinary transaction accounts.
• Susan Buckley, Managing Director of QIC Global Fixed Interest, letting the performance of fixed income speak for itself, pointing to ongoing returns of 8% or more in recent times as some other asset classes have struggled to deliver any positive returns at all.
• Jason Huljich, CEO of Centuria Property Funds zeroing in on the lower volatility and higher returns of unlisted commercial property compared to its listed counterpart, along with its non-correlation with equities providing genuine diversification and a counter-cyclical buffer in the portfolio. 

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