A symbiotic relationship – Value Investing and the SMA


By Hugh MacNally | Chairman and Founder of Private Portfolio Managers (PPM)

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Hugh MacNally – Chairman PPM

Combining the benefits of Separately Managed Accounts (SMA) with a disciplined Value Investing philosophy creates a symbiotic relationship with clear advantages over managed funds and self-managed direct investments for the advised client and provides a compelling investment solution for advisers looking for a high conviction, long term strategy for their clients with direct equity holdings.

Value investing is founded on the belief that the best long-term investment returns will be achieved by investing in companies where the pricing has a favourable relationship to the underlying returns being generated. This is the approach that is almost universal among the great long-term investors, whether it be John Templeton, Benjamin Graham, Warren Buffet – the list is long. It sounds logical and simple and it is in essence; the trick is sticking to the principles when there are all sorts of temptations: exciting stock stories, impressive results from trading, long/short strategies, momentum investing etc., etc. Over nearly 25 years at PPM I have learned the importance of the approach – drummed into me during my years of training. The market rarely gives you accolades as most of the time you appear to be the tortoise rather than the hare. Results however need to be judged over the length of race not the first lap.

Runner, Race, Competition, Female, Athlete, Marathon

PPM approaches value investing by looking for the following characteristics in stock we acquire:

  1. The price has a favourable relationship to the underlying return generated by the company,
  2. The company has a strong financial structure,
  3. The company has a strong position in its industry and the industry has an attractive structure.

Exploring these a little further; the relationship between price and underlying return a company generates is critical to the return the investor will receive. Most of the time this approach is counter intuitive as you almost never buy popular stocks. Buying such stocks with dedicated followers is one of the surest ways of generating low long-term returns. These companies are almost certainly overpriced as cheer squads push them along. A company may be very well run and be doing extremely well, but if the price already reflects the best outcome there is nothing in it for the new investor.

I’ll give you an example, Microsoft, a great company, monopoly of office software, a growing market at the time, revenue and profits growing strongly, a balance sheet awash with cash, but priced to perfection at Christmas 1999. It took investors over 15 years to see the $59 share price again (however during this time they did receive $9.03 in dividends, a return of a little under 1% p.a.!).

At PPM, we look for situations where we buy into an underlying return of 10% or better – sometimes that looks a bit slim when there are trading returns being made of more than 20%; we’d rather have a more certain 10% over the long term rather than flashes in the pan of twice that.

The second key factor we consider important is a strong financial structure. Economies regularly go through difficult times when finance is just not available, or only at exorbitant rates, as we saw during the 2008 financial crisis. Companies that require finance at such times are in big trouble as we saw with so many highly geared property and infrastructure stocks and banks, some of which will not recover former levels in our lifetime.

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Being able to survive difficult times is critical and having a survivor bias in your investment strategy is a huge advantage. It is not something that is hard to analyse but applying it rigorously during booms requires discipline as at these times when financial strength looks unimportant. Indeed, highly leveraged companies may have extraordinary returns when everything is going well (remember the fight for stock on the listing of Babcock and Brown).

One of the most astute questions asked of me by a prospective investor was what stocks we held at the height of the last boom – it’s a very revealing question to ask.

Finally, PPM looks for industries where the structure is such that one or more players can sustainably generate high returns. There is little point in being in an industry where your margins are competed away all the time or prices are dictated by stronger customers. Michael Porter wrote the seminal work on competition theory and we apply this rigorously to identify companies which we think will do well over extended periods. This is the most difficult part of the process.

In implementing our value investing philosophy we invest in 20-25 companies, with no more than 10% exposure to any one, nor more than 25% to an industry. We hope to hold investments for extended periods of time (we’d prefer to keep the returns for our investors rather than share them prematurely with the fiscal fiend).

We characterise our approach as Strength and Value.

  • PPM has a proven 20 year track record of value investing and delivering consistent long term returns for our portfolios.
  • The PPM Australian Equities Growth SMA and a Global Equities Growth SMA are both available through Powerwrap. (include link to their PDS)
  • PPM’s Global Equities Growth SMA in particular, provides easy access to direct international model portfolio with the difficulties for clients of establishing and managing global custody, trading and currency accounts.

For further information on PPM SMA’s please contact Simon Michell sm@ppmfunds.com on (02)8256 3777 or go to ppmfunds.com

Private Portfolio Managers (PPM) is a privately owned boutique investment manager founded in 1995 with an established track record of constructing concentrated Australian and Global equity portfolios.