In the last of an AFR summer series, investment experts give us their thoughts on what's ahead for investors and tell us how they unwind when they're not caught up in market events. Madeleine Beaumont, senior portfolio manager, Australian fundamental equities at Blackrock, outlines the themes investors should look out for in 2017 and warns against our inherent domestic bias.
What is the "gold" you look for in Australian companies?
The Australian stock market is unusual in that the majority of the largest companies are still domestic-facing oligopolies. Historically, investors have done well by buying and holding these "blue chips" as these companies have maintained a high return on capital, compared with global averages. However, the economic landscape is changing due to increased competition from global companies, technological disruption and increased regulation.
Australian investors should look beyond historic blue chips to uncover the leaders of the future. Australia has a competitive advantage in many areas including healthcare, technology, agriculture and food safety. Unsurprisingly, some of Australia's best-performing companies are those that have moved global early on in their corporate life.
Australia also has the advantage of a growing population, which is unusual in the developed world. So great investments in Australia don't necessarily need to be global leaders. I also look for stocks that are mispriced due to local market misconceptions.
Why have high dividends become a problem?
Dividend payout ratios in Australia are well above the global average for three reasons: franking credits encourage high payouts as it is tax-effective; the strong cash flow generation of the oligopoly businesses have enabled companies to pay high dividends; and a decade of very low interest rates has meant that retirees are relying on equities for income.
But there is a tradeoff between paying high dividends and retaining capital to reinvest for future growth.
The average dividend payout ratio in Australia is close to 80 per cent compared with the developed market average of around 50 per cent (excluding buybacks). This means that companies and investors are prioritising current income over future income and capital gains.
If Australia is to "bring capital investment out of its cave" we can't rely on government policy alone. It requires strong leadership from government, business and the broader investment community.
How do you apply a global perspective to picking Australian stocks?
In three ways. First I compare returns on capital for similar industries but different geographies, to understand how sustainable returns in Australia are. While each market is slightly different, the trends can often repeat in different geographies.
Second, I look to inherent local market biases with a fresh perspective. When Charlie Lanchester [head of Australian fundamental equities at Blackrock] hired me, he was adamant that this would be an advantage and he was right. Human beings are extraordinarily influenced by the opinions of the people around them. If you come in with a fresh set of eyes, it is easier to challenge the consensus view.
Finally, I genuinely think about each investment opportunity with a broader mindset. I ask myself would I buy this stock if I had everything in the world to choose from. If the answer is no, then I don't buy it.
I have been extremely lucky that I have worked with very talented fund managers investing in European and global equities and I can bring some of what I have learnt back to the Australian market.
What themes should investors be aware of in 2017 which will impact their investments?
I try not to get caught up in the short-term macro-economic changes as I find them too hard to predict. I look more to longer-term structural changes. Some examples include:
- The trend to the mobile and well-informed consumer. Companies that are winners in mobile will be the winning companies of the future. This theme can be played through owning either the technology companies developing mobile apps or by owning the companies which are thriving because they are the early adopters of this trend.
- The value created for enterprises taking advantage of cloud-based IT systems. I was an early user of Dropbox, as I was the treasurer of the P&C; for the local public school. It transformed the way we operated and saved so much time and money. The advantages of the cloud for businesses both small and large are underestimated by the Australian investment community. We have several listed businesses which are solution providers in this space and world leaders with enormous potential.
- The emerging Asian middle class, particularly in China. If you take the wine or luxury goods markets, Chinese consumption is moving from a gifting market – which was quite seasonal and cyclical – to a pattern of consumption as an everyday occurrence, much more like western market consumption. This is a massive opportunity for Australia.
- The ageing population and the retirement of the Baby Boomer generation, which is not just an Australian trend but a global phenomenon. Healthcare is the obvious sector to benefit from this trend, but there are also companies selling retirement living and financial solutions.
- Companies with genuine pricing power in an over-supplied world. I look to high and/or improving gross margins as a measure of this. I think the simple gross margin is overlooked as a value creation indicator in equity investing, as operating margins tend to grab all the attention.
How do you pick a management's ability to create value?
I look at cash flow return on invested capital as the key indication of value creation. I think Australian investors are too focused on P/E ratios. While I am mindful of the P/E ratio, this is just a static measure and ignores the balance sheet and cash flow conversion of a business.
I also look to management teams that are doing well when times are tough, as to me this is a true measure of ability.
What has been your best personal investment?
Our apartment in Warwick Square, Pimlico, London. My husband (Michael Parker) and I lived in London for 11 years and bought the apartment because we thought Pimlico was undervalued as an area and we loved living on a garden square. We planned to hold on to it as an investment. However in 2013 we became nervous about the underlying political tensions caused by increasing wealth inequality. We sold the apartment and reinvested the money into a portfolio of UK shares. Around 12 months later, George Osborne [then Chancellor of the Exchequer] introduced substantial changes to stamp duty for UK property and the EU capped bonuses in the City of London.
The UK property market was hit by these changes, while our share portfolio has done well and has a deliberate bias towards global companies based in the UK.
What has been your worst personal investment?
I bought myself a saxaphone in my late 20s and I decided that I was going to learn to play a new instrument. Needless to say, after about six months of lessons, with very little progress, the saxophone sat idle for the next 12 years. At least my nephew plays it now, so it wasn't a complete waste of money.
How do you relax?
I love playing sport, particularly tennis – it's good for your brain. It's quite a complicated intellectual process to anticipate where the ball and the other players are going. It's good mentally as well as physically as I get older. I play at least once a week, usually with some girlfriends. I also do yoga once a week – I couldn't do everything else if I didn't. I didn't really think about the mental side of it when I first started but that's just as important as the stretching. With three daughters, we don't have a lot of leisure time. When we do, it's all quite physical. It's great that the kids are old enough to go on holidays skiing. We go skiing every year to the US for two weeks, which is what my husband and I love doing having lived in the US. [In terms of work-life balance] Charlie, who runs the team at Blackrock, understands it's not about "face time" but output. That said, you never really switch off because you don't know when the next insight will come up. But it's not about staring at a computer. Equity markets are ultimately driven by people's day to day life in the real world. The more time you spend in the real world, the better you are as an investor.
