Hamish Douglass: 'We're lucky this pandemic hit when it did'
Lex Hall: We're on the sidelines of the Morningstar Individual Investor Conference. And you mentioned in your presentation that kind of this year reminds you somewhat of 2000. Can you expand on that a little bit?
Hamish Douglass: Yeah, the comment I was making early on about 2000. Obviously, we've got a market that's been dominated by technology companies, 20 per cent of the S&P 500, which is the main US index, is comprised of five or six companies, that's higher concentration than we had back in 1999-2000. The difference, of course, these companies are earning a lot of money, and they're very proven business models. Way back in 1999-2000 many of the companies weren't earning anything. And many of them had very questionable business models that were unproven. But we do have companies that have been very highly valued in the technology space. So, I wouldn't say those proven business models, but in unproven business models, where the markets putting extraordinary valuations on companies that really may never work out. And that's how caution is, it is one thing about, Alphabet or Alibaba or Microsoft is doing really well, and therefore there's this younger company, let's get on board and its share price’s going up. You know, there is some warning signs out there for us that people are not discriminating very well, between the true winners and the wannabes.
Hall: It seems to me that, you know, the pace of change in technology has just been so rapid, I mean I remember when I got my first iPhone, and now it's ubiquitous, and the change that has occurred in that period, is staggering. The Magellan…
Douglass: Lex, I'd just say we're absolutely right. You know, we're on a webinar, we're on a Zoom link at the moment. [If] we went back five years ago, how would have this world coped from a business perspective? Even five years ago in terms of bandwidth and everything else to carry on our lives. So, you're right, the rate of change … we're very lucky, this pandemic hit when it did. Five years earlier, the damage to the world because of the loss of total productivity of service industries would have been extraordinarily large.
Hall: Hamish, you've just I mean, all that you're saying just sort of brings up so many questions. And what you've just said then makes me think of “COVID-20”. Will we approach it differently? Will we say, ‘hey, we're not going through that again? We'll do it differently this time’?
Douglass: Yeah, it's a very good question. Yeah, as bad as COVID is, we're very lucky that the mortality rate is actually pretty low. If we had an airborne virus that had a mortality rate like MERS had, it would have been truly frightening. And frankly, you couldn't have let anybody out of house, you know, we would have had a total lockdown until we had some way out of it, because the mortality rates of that are up at 50 per cent or 60 per cent instead of point something of 1 per cent. And you asked whether or not we will change, and we'll learn things. I hope so because at some point in human history, we will get a coronavirus that comes from an animal that is both very contagious, most likely by airborne transmission, and deadly. And you know, this is a dry run for something that could be much, much worse. I know it sounds very bad at the moment, but there could be something that literally could be a threat to humanity. And I hope we're going to learn the lessons out of this, and we will find ways of dealing with it much more quickly.
The one thing I'd say both central banks and governments responded actually fairly quickly, well the response hasn't been perfect around the world. I think Australia and New Zealand and Taiwan got a close to perfect responses in terms of managing the health care side of it. Many countries haven't and they've let politics get in the middle of it. If this was more deadly, and we had that going on, it worries me. I hope we will have better sort of PPE reserves and things in the world. I hope we will have very good game plans worked out. Certainly, the fiscal and monetary response came hard and came early and that was very, very worthwhile.
Hamish Douglass and big tech
Lex Hall: Let's talk about while we're on—while we were on tech. You don't own, if I'm not wrong, in the Magellan Global Fund, you don't own all the FANGs, do you? And which ones don't you own and why?
Hamish Douglass: No, we don't at the moment; we don't own Apple at the moment, but we only sold that recently. And that was purely on valuation grounds. We actually, you know, we like to be very disciplined at Magellan; we think it had gone ahead of our view of value, it's a wonderful company. You know, we bought it at less than $100 a share, when it was out of favour; we made a lot of money, and it just got beyond our valuation. Rightly or wrongly, we haven't owned Amazon ever. It is one of the best businesses in the world: the AWS business, their cloud business is extraordinary. Their ecommerce business is deepening their economic moat and competitive advantages, but really it was the valuation; we struggled to actually understand the valuation of the business. It wasn't about the business or the business quality, but unless we have a very firm view around there's a margin of safety in the values there, we won't buy notwithstanding we actually would probably put it in the top five businesses in the world.
And I would say it's not just FANG; you have to add the Chinese. We own the two big Chinese companies; we own Facebook and Alphabet, which owns Google. Not normally put in the FANG is Microsoft and it should be in the FANG, you know, it's depending on Apple’s share price on the day, it's the second largest company in the world now. You know, it's $130 odd a share and we bought it at $22 a share when it was deeply out of favour, maybe it was $24, between $22 and $24, back in 2014. And there's one other where we may have bought that we will disclose, but we're very disciplined in price.
These companies are extraordinary, they have very powerful what's known as network effect, you know, they tend in almost winner takes all, not Amazon, but most of the others are almost winner takes all markets because of the power of network effect operating here. Of course, that's going to attract regulators, they are attacking very, very large global markets, and because they are digital goods effectively, you can attack markets globally with this. They are massively disruptive, like the entire advertising markets moving from sort of all television stations, and all newspapers and all sorts of other forms of radio advertising, which we just to a few players in the world, which is extraordinary, and very, very large shares. You know, these big cloud platforms, there may be four hyperscale players in the world. We're going to move all the computing power of the world, and there's going to be so much more data in the world and so much more software. You know, software's going to eat the world as we start digitalising everything and all this is going to be hosted on maybe four companies' platforms in the future, on a global basis.
Hall: Perhaps that's a good time to mention regulation, does that spook you at all?
Douglass: No, we expect regulation. Wherever you get a company, which has very high market share in an important industry, you have to expect regulators will come in and look “are consumers being protected?”, and what's the—are they shutting out competition from competitors in that?” So, it is logical for the regulators to come in. First of all, I would say is, you know, the seven or eight sort of technology companies we own, most of them are facing either limited or very different technology risks. You know, we own Visa and Mastercard, they've been regulated in the past, they're facing some disruption risk from things like open banking and real-time payments in their debit franchises, in the long term. It's kind of not regulated; the regulators are changing the rules to open up the system. Microsoft really isn't facing much regulatory risk; the Chinese companies are deemed as national champions in the payment space yes there's some regulatory risk, but in the ecommerce space there is very limited regulatory risk there, they don't have the same privacy risks.
And then you really come down to sort of Alphabet and Facebook. If we owned Apple and Amazon, they're the four that are really getting caught up with the regulators. We own two of the four, you know, combine they may be 12 per cent of our portfolio or so and they have different risks. We understand the risks. We spend a lot of time speaking to people in Europe and in Washington, including, you know, former chairs of the Federal Trade Commission were the ones who have been investigating Facebook. We spend a lot of time with the Department of Justice in trying to understand the break-up risk in there and the other issues going on with Alphabet. We speak to politicians in the United States and elsewhere and it's a very, very public debate that's happening. So, we're unlikely—we will get regulation, but we're unlikely to get surprises of what the boundaries of that regulation could be. And then we look at the price compared to what we think the realistic regulatory intervention is going to be and the cost of that on the business.
Hamish Douglass: Winners and losers in the covid era
Lex Hall: What sort of opportunities—we were talking about big companies—what are you seeing in smaller companies?
Hamish Douglass: Well, we tend to invest in big companies. So, we're managing nearly $100 billion. We don't tend to get in to small investments. We like investments with competitive advantages, as well, maybe different opportunities. Obviously, tech's been an area that's been very constructive. We've got quite a lot of consumer staples, more people are eating at home, Nestle’s results and PepsiCo's results have been fabulous. People have been washing their hands more; we own Reckitt Benckiser and their sales have been sort of 13% per annum through this period. So, there are certainly winners that are occurring here, both in technology and in sort of consumption businesses. We've got benefits from lower interest rates happening here.
But there are losers, in the real estate world we don't own, but you know, do you want to own shopping centers in this world? There's been an acceleration to ecommerce. And we don't think that acceleration is going to go away. So, it's going to challenge what you can charge in rents in physical retail, because physical retailing is less valuable in the future. What is all this work from home and these flexibilities going to mean to office buildings? That we do not know the answer of.
Travel, travel is something we're spending a lot of work on, we haven't invested there. But there are a lot of travel-related stocks, that of people moving around the world, it could be payments, it could be airlines, it could be aircraft manufacturers, it could be online travel companies, software companies in this space. There is a broad spectrum of companies that are very, very leveraged to travel. American Express would be a good business. You look their volumes are down 20 per cent, largely because people are not travelling. And when people start travelling again, their earnings should come back very, very rapidly. But there is a question in large business: how much of large business are going to stop their employees travelling in the future because of Zooming, doing it on video conference? That we don't know the answer to. But that is a very interesting area, particularly as we're going through a second wave of pandemic, these stocks are under pressure. And if you take a longer-term view, that could be an interesting area that isn't being valued by the market at the moment, I'm not giving any specific stock advice. And we haven't made any investments because we don't know all the answers yet.
So, you know, there's a lot of different things going on market. Some things are cheap, and they deserve to be (treated), just because some share price has gone down. Some of it may be telling you something; and there are other things that have gone down just because of uncertainty and they may be good places to invest and others that have gone up. People may go ‘they're expensive, I'm not going to buy them’, it could be that their businesses are accelerating because of what's going on, and they're not overvalued. So just looking at the share price doesn't tell you whether it's a good buy or not.
Hall: How long Hamish would you suggest people stay in the Magellan Global Fund to get the value add at a minimum?
Douglass: Well, we really talk about an economic cycle being seven years, you know, we really think that people should have a longer-term perspective, sort of that five- to seven-year period would be our view of the economic cycle. And I wouldn't say just in relation to Magellan, I would say almost any equity investment people should be taking a five to seven-year view. And if you're taking a five to seven view, largely what's occurring now in this pandemic and what's happening in the US election are largely irrelevant issues.
Lex Hall is Content Editor for Morningstar Australia. This article is general information and does not consider the circumstances of any investor.
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