Mark Arnold

According to recent Morningstar reports, Hyperion Asset Management’s (Hyperion) funds have returned market topping performances both over the last two decades and in recent months, despite market volatility and a poor end to FY2020 for the ASX. 

Hyperion’s Australian Growth Companies Fund has been named the top performing non-geared fund over the 20-year period to 30 June 2020, outperforming 521 other large cap Australian equity funds^[1]. The report, based on the Morningstar Direct Global Fund Manager database, shows that the Fund’s unit trust delivered an average annualised return of 9.80 per cent after fees over the two-decade period.

The Hyperion Broad-Cap Equities Composite delivered an average annual return of 10.6 per cent after fees during the 20-year period to 30 June 2020. The fund has been managed by Hyperion since September 2002.

The Fund was the nation’s best performing large cap Australian equity fund* for the 20 years to May 31 2020, according to the Morningstar Global Fund Manager database.

But despite adverse market conditions, Hyperion has managed to keep its significant lead more recently as well. Its Global Growth Companies Fund delivered a return of 14 per cent after fees from 1 Jan to 30 June 2020, outperforming Morningstar’s World Large Growth category by 10.21 per cent, while the Australian Growth Companies Fund and Small Growth Companies Fund not only still topped the Equity Australia Large growth and Equity Australia Mid/small Growth categories respectively over the same period, but were the only funds not to deliver a negative return.

The Small Growth Companies Fund was also the top performing small-cap fund of the decade to Dec 31 2019 according to Mercer’s 10-yr fund manager performance survey.

Outside of Australia, Hyperion’s Global Growth Companies Fund is also the best performing fund out of 70 Morningstar Equity World Large Growth category over a five-year period, as at 30 June 2020.

An approach that continues to deliver

Managing Director and Chief Investment Officer, Mark Arnold said, “Our performance demonstrates that it is possible to take a long-term view and deliver short-term results with the same fund, growing our investors money through lean times and bountiful. We design our portfolios in a way that allows us to consistently profit from market highs as well as to protect capital during periods of market volatility. Our results prove that you do not need to use complex hedging strategies and derivative products to protect your capital during downside movements.” 

The data compiled by SPIVA in the Australia scorecard reveals that over the 10 and 15-year periods, 83.9% and 85.30% of Australian equity general funds underperformed the S&P/ASX 200 on an absolute basis respectively.^[2] The findings demonstrate that Hyperion is one of a very small group of managers able to consistently outperform over the short and long term.

Mr Arnold credits Hyperion’s consistent results to its strict proprietary investment process which allows the team to separate the winners from the losers.

“Going forward we believe it will be more crucial than ever to identify the winners as they become fewer and further between. COVID-19 has further pushed the global economy into a period of low growth and we think that only a select group of companies will be able to continue to grow in this challenging environment. We see this growth stemming from their ability to innovate and take market share from their competitors.

“We invest with the mindset of long-term business owners and evaluate not only the quantitative side but also the less tangible qualities including company culture, leadership team and investment in research and development.”

Disruption and innovation for returns

Jason Orthman, Deputy Chief Investment Officer, added that Hyperion’s focus on disruptive and innovative companies has had a large impact on the manager’s success over the past two decades. 

“We back these new-world companies that are challenging the status-quo and shaking up entire industries. These are businesses which consistently demonstrate that they can thrive in the disrupted world we live in. We think that many old-world companies’ business models are fundamentally challenged and with the overall economic pie no longer growing, earnings growth will come under increasing pressure and especially as they lose market share to disruptive newcomers. 

“We have been watching the electric and autonomous vehicle space for many years now and see that as one area which will have a big impact on transport in the future,” Mr Orthman added.

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[1] Luk, P. & Gupta, A. (2019) SPIVA Australia Scorecard. Available at https://www.spglobal.com/spdji/en/documents/spiva/spiva-australia-mid-year-2019.pdf.
[2] The large cap Australian equity funds report sourced from Morningstar Direct includes the following Morningstar categories: Equity Australia Large Value, Equity Australia Large Growth, Equity Australia Large Blend and Equity Australia Large Geared

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Commenting on the award win, Managing Director and Chief Investment Officer Mark Arnold said: “We developed Hyperion Asset Management’s bottom up, structural growth focused investment process over two decades ago. While some may not find it exciting, we have consistently applied our rigorous standards to our investment decisions across our domestic and global equities products and as a result we have delivered substantial excess returns for our clients since the business was established in 1996.

“We are a research driven business that has always taken a long-term view and invested as business owners, rather than as short-term share traders. We continue to focus on delivering long-term outperformance for our clients, and delivering for our clients over the long-term is what we find exciting,” said Mr. Arnold.

He went on to say, “Hyperion’s proprietary investment process is what allows us to identify high-quality businesses with clear and sustainable competitive advantages that are well-positioned to outperform in the long term.”

Hyperion Asset Management beat out Greencape Capital and Platypus Asset Management to claim the title.

Hyperion Asset Management has won the Domestic Equities Small Caps category four times prior and the Domestic Equities Large Caps category twice in previous years.

Jason Orthman, Deputy Chief Investment Officer added that Hyperion’s long-term focus is a vital ingredient of their success.

“We always take the long-term view rather than be distracted by short-term noise. It allows us to uncover the innovative and high-quality structural earners who are able to take market share in all sorts of environments, including economic downturns. As we head into an extended period of economic deterioration in the next five to ten years, this is ultimately what will allow Hyperion Asset Management to continue to deliver attractive returns for our investors.”

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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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However, according to Australian equities fund manager Hyperion Asset Management, the low number of initial public offerings (IPOs) need not translate to serious slumps in portfolio performance. 

In Hyperion’s view, the key is to view IPOs and capital markets activity as the exception, rather than the rule. But the IPO habit is one that many, whose fortunes grew with the ‘big deals bubble’ of pre-2008, are finding difficult to break.

“In the last five calendar years IPOs have been running at less than 25 per cent of the average in the five years prior to the GFC,” said Jason Orthman, one of Hyperion’s Portfolio Managers. “And in terms of industrial IPOs, where Hyperion’s interest really lies, the figures are closer to 15 per cent over the same time period.”

Mr Orthman went on to explain that this habit or expectation around IPO-related returns is due to many investors’ experience of boom markets. A boom market can foster ‘hot’ IPOs that deliver short term high returns, often in the first day after listing. He cited examples including the tech boom of the 1990s and the resources boom immediately prior to the GFC.

“However, in the current environment of low credit growth, moderating commodity prices and weak investor sentiment, both economic and capital activity will be subdued. What investors should be looking for is a quality portfolio of stocks that can grind out earnings and dividend growth well above GDP.”

While Hyperion has never relied on capital market activity to generate returns and rarely participates in IPOs, it does monitor the market closely and will occasionally take a stake in growing companies that are evolving into a model that will deliver sustainable long term success.

“Two IPOs we have participated in since 2008 are carsales.com in 2009 and Trade Me Group in 2011. Both are online companies that we understand well through our existing holdings in this space,” Mr Orthman explained.

“We regard IPO investment as the exception, rather than the rule. We think better gains are to be made from early identification of listed stocks whose track record suggests they can grow into ASX300 or even ASX100 companies.”

By way of example, he cites Domino’s Pizza Enterprises, an existing small cap holding with a market capitalization of around $740M that first entered the our portfolios in September 2011 as an ex-ASX300 holding at around $7.00. The stock has since appreciated 52 per cent to $10.65, with the company growing earnings-per-share (EPS) 25 per cent in FY12 and recently announcing a $30M capital return.

Another is Navitas, a mid-cap holding with a market capitalisation around $1.5 billion that is also forecast by Hyperion to produce high double digit EPS growth over the next five years. Its EPS growth in FY12 was -10 percent due to the high Australian dollar, weak overseas enrolments and the acquisition of SAE delivering below expectations. However, with a proven model, global leadership and an improving domestic regulatory environment, earnings are expected to rebound strongly over the medium term.

“Inclusion of stocks that meet our rigorous selection criteria which aims for long term sustainable growth and performance has led to continued strong performance forecasts from our Hyperion Small Growth Companies and Australian Growth Companies Funds. We are unaffected by the IPO drought because our focus is very much on the broader game.”

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The paper, entitled ‘The Economic Costs of Excessive Short-termism’ was co-authored by Hyperion’s CIO, Mark Arnold and Portfolio Manager, Jason Orthman. It examines the economic costs of short-termism by key industry agents, including corporate management, active fund managers, asset consultants, super fund trustees and ‘mum and dad’ investors. 

Presented by Hyperion CEO and MD, Dr Manny Pohl, the paper was named the best Due Diligence Forum (DDF) Research Paper from a total of 32 initial submissions, of which 20 were accepted and 5 were shortlisted by an expert panel for the ‘Editor’s Pick Award’.

The paper provides sweeping evidence of the way an increasing focus on short-term gratification is distorting the behaviour of companies, markets and investors – leading to impaired financial performance and ultimately, significant losses to equity holders.

“Rappaport describes short-termism as a disease and short-term earnings and tracking errors as the carriers, and we can see that this is increasingly cascading through multiple sections of the economy and society becoming entrenched and systemic,” said Mr Arnold and Mr Orthman.

While identifying the impact of short-termism is straight-forward, developing a cure for the pandemic is harder. 

“Fixing this issue requires a major shift in mindset and, especially, the fortitude to foster and measure long-termism,” they said.

“All the behavioural finance evidence shows us that people tend to over-emphasise the importance of recent events and let emotion rather than rationality dictate their behaviour. 

“This is particularly true for corporate management, which in recent years has increasingly focused on achieving short-term EPS and DPS growth targets at the expense of long-term growth and sustainability. It’s an approach that only reduces long-term shareholder value – often quite quickly.

“Hallmarks of this kind of short-termism include the over-use of financial leverage during strong economic conditions, underspending on essential R&D, marketing and key staff and a deferral of attractive long-term capital investments because of a likely short-term negative impact on earnings,” they claimed.

According to both authors, duration of tenure is another example of short-termism’s negative effect and is evident among both corporate management and active fund managers.  They said that domestic executives cannot focus on delivering long-term – five to ten years’ – ­value, when they are likely to be in charge for much shorter periods.  Duration of departing CEOs from the world’s largest 2,500 companies has declined from 10 years in 1995 to 8 years in 2000 and 6 years in 2009. And turnover in Australia is even higher, with average tenure of 4.4 years. That means that, in the absence of clear results a CEO’s position is arguably under threat after just two years.

Similarly, both Mr Arnold and Mr Orthman cite examples that show many active fund managers have been pushed towards short-term thinking in an attempt to avoid underperformance.  This is despite evidence that suggests periods of underperformance relative to peers or the benchmark is to be expected.

“Short-term relative underperformance risk, combined with the client’s ability to withdraw funds at any time, causes many fund managers to undertake activities to reduce this risk,” said Arnold and Orthman. 

“The widespread use of index hugging is a prime example.  Couple that with the fact that the average period of tenure for the head of an Australian equity team is under three years, compared to the 5 to 10 years needed to deliver significant alpha and there is clearly an issue.”

However, the ultimate cost of excessive short-termism is too often borne by mum and dad investors.

“As most investors and super fund members’ main objective for investing their savings is to have sufficient savings for retirement, trustees’ and investment managers’ decisions should be framed based on the key factors that drive long-term investment returns,” they said.

The paper outlines several suggestions to address this issue, including:

For corporate management:  setting long-term strategic goals, ceasing short-term earnings guidance and changing remuneration structures from short-term earnings to long-term sustainable value accretion for equity holders.

For active fund managers: extending performance measurement to five years or more, payment of annual bonuses on the basis of rolling medium to longer term performance and the requirement for portfolio managers to make meaningful investments in the fund.

For mum and dad investors: superfund investors need to lengthen time periods in which they provide reports and focus their commentary on the long-term returns achieved by the fund and relevant benchmarks, as well as providing realistic and fundamental based long-term return estimates.

To read the paper, click here.

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