Joel Gray

“Jittery investors are struggling to respond to market volatility and must accept that capital preservation is now a real risk.”

This is the view of Joel Gray, Portfolio Manager at award-winning Australian equities manager Hyperion Asset Management, who yesterday said that continued subdued global economic data has vindicated the US Federal Reserve’s decision to keep rates on hold, and that markets remain jittery as a result.

“Staying focused on fundamental drivers of return can be difficult in periods of uncertainty and market volatility, yet it is actually more important than ever when the market becomes unpredictable.

“A rising tide may lift all boats, but as the tide recedes, only those companies with a robust and sustainable business model will preserve investors’ capital, and continue to perform into the future,” he said.

Hyperion’s view is that all businesses should be assessed from the point of view of protecting long term returns, and that there are four key, unchanging attributes which define a successful company and translate into outperformance for investors.

These are:

• A high return on capital, in other words, efficient and profitable use of capital.
• The ability to grow organically, without the use of excessive debt, and without falling prey to investors’ desire for high dividend payouts but rather re-investing into the business.
• A sustainable competitive advantage, and hence control over pricing.
• A predictable earnings stream.

Mr Gray said that only businesses which exhibit these attributes will continue to do well, and that attempting to circumvent rigorous due diligence and stock-specific research in favour of simple market metrics can be dangerous.
“A good example of what I’m talking about is the price-earnings (PE) ratio, which measures a company’s share price relative to its per-share earnings.

“For many investors, this ratio provides buying guidance, and in theory, a low PE ratio can indicate that a company is undervalued, and prompt them to buy. Unfortunately, the experience of the global financial crisis proved that buying solely on the basis of a low PE can have disastrous results.

“Except in extreme pricing environments, business risk trumps pricing risk,” Mr Gray said.

In conclusion, Mr Gray said that it was understandable that investors are concerned about market volatility, particularly given the subdued outlook for global growth, the slowdown in China and the uncertainty surrounding the timing of the US Federal Reserve’s decision on interest rates.

“There’s no question that volatile markets throw up both opportunities and risks. At the same time, capital preservation and performance over the long term will always stem from the strength of the underlying business and not on short term-market movements.

“The good news is that investors who are able to keep their head and maintain a steely focus on the fundamental quality of the businesses they invest in need not fear capital loss in the short term.

“And better still, they will be rewarded with outperformance in the long term,” Mr Gray said.

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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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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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In his new role Mr Gray will assume added responsibilities in the functioning of the Australian equities team.

Mr Gray has been a Senior Portfolio Manager at Hyperion Asset Management since 2001, assisting Hyperion to achieve outstanding results for its clients over the medium to long-term.

According to Dr Manny Pohl, Managing Director of Hyperion, the expertise and commitment to Hyperion’s unique investment philosophy displayed by Mr Gray as Senior Portfolio Manager were key factors when assigning his new position.

“Joel has made positive contributions during his time with Hyperion and he has a thorough understanding of Hyperion through his 11 years as Senior Portfolio Manager.  I’m sure he will transition seamlessly into his new role,” said Dr Pohl.

Dr Pohl confirmed that the new role is a direct result of substantial business growth Hyperion has experienced over the past few years. 

“In order for Hyperion to continue to deliver the investment outcomes required by our clients, meaningful personal development and career opportunities for our staff, and value to our shareholders, the business will need to continually evolve.  The creation of this new role is in keeping with this strategy, and recognises the contributions that Joel has made to the Hyperion business in recent years.”

Mr Gray brings 16 years’ experience to the role.  Prior to joining Hyperion Asset Management in 2001, Joel worked as an Investment Analyst/Assistant Fund Manager for three years before becoming an Industrial Research Analyst focusing on the consumer discretionary sector for Wilson HTM. 

Joel holds an undergraduate qualification in Economics, is a CFA charterholder and is a shareholder of Hyperion Asset Management.

Mr Mark Arnold continues as Hyperion’s Chief Investment Officer, the guardian of the investment and portfolio construction process and ensuring consistency in application across the listed equity products.

This appointment is with immediate effect and Mr Gray commences his new role from the Brisbane office reporting to Dr Manny Pohl, the CEO and Managing Director of Hyperion Asset Management.

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