Interactive Investor

Here’s how we protect capital and outperform during turbulent times

15th November 2022 11:01

by Sam Benstead from interactive investor

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Sam Benstead, deputy collectives editor at interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Doug Ledingham, manager of the ACE 40 sustainable recommended fund, Pacific Assets (LSE:PAC) Investment Trust. Doug, thank you very much for coming into the studio.

Doug Ledingham, manager of Pacific Assets Investment Trust: Thank you for having me.

Discover more: ACE 40 Sustainable Investments List 

Sam Benstead: So, can you tell me a bit about the trust? Where do you invest, what types of companies do you buy, and what makes it sustainable?

Doug Ledingham: The Pacific Assets Investment Trust seeks to deliver long-term capital growth by investing in 40 to 70 of what we deem to be the highest-quality companies well positioned for sustainable development. At Stewart Investors, we are long-term active investors who seek to preserve and grow our clients' capital by owning high-quality companies run by high-quality people who are well-positioned for sustainable development.

We do so because we believe that these companies have the best-quality, lowest-risk stream of future cash flows, and are thus best positioned to be able to deliver attractive long-term returns to minority shareholders. Our truly bottom-up approach means that the Pacific Assets Investment Trust looks and behaves very differently to the benchmark and other funds that invest in the region.

An outcome of our focus on quality and capital preservation means that the trust will underperform markets where there's lots of speculation and euphoria, and maybe high-flying technology companies driving the market higher, whereas it will outperform the vast majority of down markets, and we've seen that this combination of capital preservation in times of stress, while also being able to offer and deliver capital growth, has allowed the fund to generate attractive, long-term absolute returns for shareholders.

Sam Benstead: You're investing in the Asia-Pacific region. What does that mean with regards to the stocks you own and where are you invested? And does that include all countries in Asia Pacific or are there some exclusions?

Doug Ledingham: If you were to look at the trust today, you'll see that the trust has a significant overweight in India, and that's really the result of our bottom-up approach. And India being home to some of the greatest opportunities for long-term capital growth. It's home in our eyes to some of the world's greatest owners of companies, some of the highest-quality, most interesting franchises and home to markets that have the ability to offer decades’ worth of growth thanks to a growing middle class, increasing technological adoption, increasing financial penetration, and India's emergence as a manufacturing hub.

We also have exposure to China, but our exposure to China and the companies we are owning in China look very different to that of the benchmark. And that's really the result of our inability to build an extensive list of companies within the country that meets our quality threshold.

The vast majority of companies in China are either state owned or indirectly state controlled, which means that they very quickly fall down, and I want to allocate the trust’s capital to high-quality people and high-quality franchises. You'll also see that the trust has roughly 7% invested in Japan, and that's the result of this trust's flexible mandate, that allows us to own companies listed outside the Asian region if they have a large and growing presence in the region. One example would be a company we own called Unicharm, which, despite being listed in Japan, is Asia's leading personal hygiene company. And we believe it to be very well positioned to benefit from increasing penetration of feminine hygiene products and adult incontinence care in China, Indonesia and India.

Sam Benstead: You're trying to find quality companies, but what does that mean and what types of stocks does that lead you to?

Doug Ledingham: So, we are long-term quality investors and we're looking to allocate the trust capital to quality companies. They have the ability to generate long-term attractive growth. We do this because we believe that we have no ability to forecast the macroeconomic environment. I think if you were to look back over the last six or seven years, we failed to predict Trump's election, Brexit, India choosing to remove 99% of its currency in circulation overnight, a military coup in Thailand, or Covid.

We are looking to own companies that have the ability to survive and prosper through any macroeconomic environment. An example would be taking the top 10 companies, so the average age of the company in the top 10 of the investment trust is over 50 years. So, these companies have been able to survive war, pandemic, multiple political environments, multiple inflationary and interest rate environments, and most importantly, increasing technological disruption.

But they have been able, in our view, because of the quality of people at the top of these businesses, to survive, prosper and continue to deliver long-term growth to minority shareholders. We care so much about the quality of people because of our long-term time horizon. The time horizon that we wish to allocate capital to these companies is the quality of people that will drive long-term results. So, you'll actually see that more than 80% of the companies we allocate the trust capital to have a family, an entrepreneur or a foundation at the top.

And these individuals and these groups of people have a long-term time horizon and thus manage their business for the long term. Which, in today's environment, with such increased financial speculation and short-termism, it's a true competitive advantage, and as a result of this long-termism and conservatism. Again, the vast majority of the companies that we own have no debt or net-cash balance sheets, and this is a result of both the long-term institutional memories that these companies have, as well as franchises that generate lots of cash flows. And again, strong net-cash balance sheets allows these companies to survive the unexpected and also act opportunistically in times of stress.

So really, we're long-term focused, high-quality investors because we want to own great companies for the long term and not have to trade in and out, and allow these companies to compound the trust capital over the long term. So, one example of that would be a company called Tube Investments, and that's one of the largest positions in the trust at the moment. It's been held in the trust for nine years now, and we have got really excited about the evolution that's going on underneath a new CEO, as well as a family that's now in its fifth generation.

The CEO is looking to transition the company from a manufacturer of simple industrial products to emulate the world-class industrial groups similar to what we see in the US with Danaher (NYSE:DHR), or UK and Halma (LSE:HLMA).

Sam Benstead: You are a bottom-up stock picker, but you're investing in a potentially quite volatile region. You have this huge democracy in India and China, tensions with Taiwan. So why do you focus on companies and not take a view on the big top-down picture?

Doug Ledingham: Well, it takes us back to that point that I made earlier that we just believed that we had no value in trying to forecast the macroeconomic environment. We instead focus very much bottom-up on understanding the people that are running these businesses and their ambitions for the long term.

Again, over the long term, it's the quality of the people at the top who drive companies outperformance. And that's why we spend most of our time meeting companies, meeting board members, talking to competitors, talking to customers and suppliers to build up a picture on a mosaic of quality. We spend little time trying to forecast what the inflationary environment or the interest rate environment for next year will look like, primarily because we know that we won't get the answer right. And second, we know due to history and the quality of companies that we're allocating the trust capital to, that these companies should have the ability to survive and prosper no matter what happens tomorrow.

Sam Benstead: The guiding philosophy of the trust is not to succumb to irrational exuberance nor unjustified pessimism. Can you explain what that means for you as a portfolio manager and perhaps give an example of an area that you've avoided or invested into against the herd?

Doug Ledingham: So that line is from our Hippocratic oath, which all team members are asked to say when they join the team. It's a pledge to uphold the principle of stewardship and serves as a constant reminder to us of the obligation that we have to protect our clients’ capital. It serves to keep us focused on the long term and ensure that we are owning high-quality companies, run by high-quality people.

Rather than getting dragged into the short-term noise or share price volatility that tends to induce all kinds of behaviours that get in the way of the long-term protection of our clients’ capital. So more recently, one example of where it has served its purpose, I think, is that in those markets, post-Covid, where most countries in the UK, India, China, and in the financial headlines were full of fast-growing technology companies with unproven business models. And you'll see that the trust didn't allocate any of its of its capital to those kind of businesses. Again, because of our belief that there was a lot of euphoria in the markets. And again, we prefer to own companies that have been around for 50 years, that have proven business models, that have people at the helm that we can trust our clients’ capital with, rather than having to be induced into participating in what felt like slightly speculative markets.

Sam Benstead: Your benchmark is UK CPI inflation plus 6%. Why have you got a benchmark which is based on UK inflation when you're investing in another corner of the world and with inflation near 10%, have you been struggling to outperform it?

Doug Ledingham: So, the trust is measured against both the regional benchmark as well as the CPI plus six metric. The CPI metric was introduced by the trust's board in 2019 to better reflect our focus on the want to preserve our clients’ capital in real terms rather than simply measuring us against an arbitrary benchmark. Since the introduction of the metric, we haven't changed what we do. We're always looking to have a margin of safety and the ability to own companies that have the ability to deliver above-average returns for clients.

More recently, as you say, with inflation rising and growing concerns from a macro perspective, markets across the globe and in Asia have been relatively weak. We have been pleased to see that the companies we own in the trust have been able to preserve capital better than the market.

And again, we believe this is a function of our ability and want to own companies that look very different to the benchmark and companies run by great people with the ability to survive macroeconomic stress. And certainly the trust's exposure to India has helped of late, especially some of the larger holdings in the trust that have exposure to a return in the domestic infrastructure cycle.

Three of the largest companies in the trust, Mahindra & Mahindra (LSE:MHID), Tube Investments and Elgi Equipments have all performed very well to date and helped drive the trust trustperformance. But what I would say is that these companies have been held on average for eight years in an investment trust. So, it's not been a short-term trade on our part, driven by a top-down view of the Indian macroeconomic environment.

Sam Benstead: Doug, thanks for coming into the studio.

Doug Ledingham: Thank you very much for having me.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can, like, comment and subscribe. See you next time.

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