Momentum building in UK but these stocks still cheap

Orbis Global Balanced manager Alec Cutler sits down with ii’s Sam Benstead to discuss how he manages his “value” focused multi-asset portfolio. 

He explains why the UK is such an attractive market right now, even after a good run, and gives examples of shares he continues to like, such as engineering stocks.  

The fund manager also speaks about the appeal of some emerging market shares, and also explains Orbis’ unique fee structure, where they only charge if they beat their benchmark.  

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Alec Cutler, manager of Orbis OEIC Global Balanced fund. Alec, thank you very much for coming into our studio.

Alec Cutler, manager of Orbis Global Balanced fund: Thanks for having me.

Sam Benstead: The fund has performed very well this year. It's thriving in a world where US shares are falling and the dollar is falling, but undervalued shares are doing better. So, why is this and what types of companies are performing well for you?

Alec Cutler: I think you just described it. The important thing to keep in mind is what's working today are investments that we made two, three, four, five, six years ago, some of which were quite painful for the first few years. So, we've had some comments about performance looks too strong now. But it's coming from investments that we've made, not just in terms of buying the stocks or bonds, but periods of tough performance as we built those positions when people didn't want them. Shares can stay out of favour for quite a while.

But some of the things that have worked well thus far this year, defence continues to work well, critical energy infrastructure as the world recognises that the bottom of the pyramid of needs is quite important, so the bottom pyramid being things like national security, energy security, food security. Right above that industrial security. So, do you have a decent industrial base? Because all the things that are above that, things like social programmes, don't exist unless you have a firm base to your nation and your economy. So all that, the refocus on the base of the pyramid has been where we've been investing and preparing for years.

Sam Benstead: You're a bottom-up as well as a top-down stock picker. On the top-down, on the macro, what type of world are we living in today and how do you invest in this world?

Alec Cutler: There are new areas that are emerging that were quite popular four or five years ago, and things like biotech that we're starting to look at. But more so, those themes of energy security and national security, the fringes of those themes are beginning to emerge.

So, nuclear, is that a national security issue, or is it an energy security issue? They're kind of somewhere in between. Nuclear is becoming quite interesting, and that's not just buying uranium, but that's really understanding the building blocks of nuclear, the importance of nuclear, the resilience of nuclear; is this just a fad or is this, as we think it is, going to be the primary energy input five, 10, 15, 20, 25 years from now.

It takes 10 years to build a nuclear power plant, so it's not five years, but 10 years from now, we'll start to see significant nuclear power plants, many small modular reactors [will] come online, and that will regrow as the base of the electricity infrastructure of the world.

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Sam Benstead: People often talk about growth versus value. You're very much a value investor and value has been the best place to be this year. So, are we at a juncture where in the future value shares do better and growth shares struggle?

Alec Cutler: So, first of all, just thinking about it from real big-picture, and putting today in a historical context, the world had become fairly complacent after Vietnam, after the fall of the Berlin Wall, that this thing that was called a peace dividend was forever, that the world was going to be a peaceful place, we'd all get along. Globalism was a very popular thing.

Recently we've started thinking about maybe we'll re-enter a Cold War. I think - and we've been believers in that, that's part of where the defence weighting came from - that we've been wrong in that regard and instead of re-entering a Cold War period, we may be reverting back to the way the world was from caveman times to the First World War, which was every country for themselves. No grand alliances, but temporary regional alliances or temporary alliances that were more indicative of, you know, a quote from Henry Kissinger who said, “America doesn't have any permanent allies or enemies, only self-interest”.

I think we're reverting to a period like that. That quote never made sense to me until very recently, if you look at the way that not just Donald Trump is behaving, but the way the rest of the world is behaving. Countries are acting in their own interests. They're focused on that bottom of the pyramid of needs. How do we create national security? How do we create energy security? How do you create food security? How do we make our industry competitive? Less about alliances, and if you look at the grand alliances that were created after the Second World War, many of them are breaking down. The World Health Organisation, the WTO, the UN...these grand alliances are falling apart.

Sam Benstead: In this world, what do you buy and what do you avoid? What's the key investment decision you need to make in this new world?

Alec Cutler: The key investment decision for us, we believe, is don't buy expensive things and look for things that are selling well below their value.

So, just block and tackle, do the hard work to find things that are undervalued where we believe there's a catalyst that can return them to normal value, and while we're doing that, avoid things that have very high expectations in them, where you don't know, as you just described, how the world's going to play out.

Good things could happen, bad things can happen. But invest in things that don't have the expectations for things to continue to be good.

Sam Benstead: What could cause the fund to keep performing well, and importantly, what could it cause it to underperform?

Alec Cutler: The biggest risk in the world that we see is inflation that's driven by governments overspending. So, that's the risk that we're kind of prepared for in the portfolio. So, the risk to the portfolio from a relative performance standpoint, not really an absolute performance standpoint, but a relative performance, would be a reversion to the environment that we had for much of the last 15 years since the global financial crisis of governments smashing liquidity into the system, of low interest rates that are kind of manufactured by central banks and that drive the discount rate down or the valuation rate of future cash flows and make the mega-cap growth stocks look very attractive again.

Sam Benstead: Your UK allocation is quite high versus peers and versus your benchmark. Why do you like the UK market and where are you finding the best opportunities?

Alec Cutler: We like a lot of companies in the UK. We find the UK market to be very attractive. You think about it from us as contrarians, what do we want? We want excellent companies that are valued like crappy companies, and we find a lot of those. The problem, as you point out, is that's been the case for a long time. Having said that, I think the UK has outperformed the US over the last 12 to 18 months.

So, you're starting to see some momentum build behind the UK and we've had very high success in our UK holdings - they're up a lot. But we bought them so cheap, so inexpensively, they're still very inexpensive.

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Names would be like a Balfour Beatty (LSE:BBY). It's one of the best engineering construction companies in the world. We were able to buy over a seven, eight-year period where the cash on the balance sheet net of debt plus their portfolio of infrastructure holdings where they own toll roads and student housing and government military housing, where they're kind of getting rent every month. Very secure, low-risk assets. The value of those assets plus cash is more than the market value of the company. So, we're getting one of the world's leading engineering construction firms for free. Recently the shares have performed nicely. We're starting to see a pay-off for that investment. But it's still very, very inexpensive.

Keller Group (LSE:KLR) is the world's leader in geo-engineering. So they're the ones, if you want to build a harbour or a road or an airport or a building, a school, a fire station, you have to put a foundation in first. These are the guys who you hire first, before you do anything else, to go in and test the ground, and decide what kind of foundation you need and then put the foundation in, whether it be pilings or just straight cement. They're the ones that do that. They're world leaders in it.

The cool thing is that oftentimes in developments, the developments go out of business and a contractor doesn't get paid, but they're first. You don't do anything until you put a foundation in. So, Keller gets paid first. They're leaders in what they do, and we were able to buy Keller over a three-year period at four, five times earnings. The stock has doubled and they've grown earnings, so now we own it at eight times earnings. It's a fantastic company. If it was listed in the US, it would be 20 times.

Sam Benstead: Do you think more international investors are waking up to the UK market being attractive and are finally slowly taking the decision to allocate less money to the US and more to the UK and Europe? And does that excite you or worry you a little bit?

Alec Cutler: I think we're starting to see that, because you just look at the performance. So, momentum is starting to build in Europe and the UK, and the momentum is staring to wane in the US.

Historically, over the last five, six years, tonnes and tonnes of money flew out of the UK and Europe and the rest of the world into the US, so there's this massive wall of water, money, that's been ploughed into the US and pulled out of everywhere else. That's starting to come back. As that gains momentum, we will benefit tremendously from our holdings in the UK and Europe and elsewhere.

Sam Benstead: Emerging markets is another overweight sector. Where are you finding the best opportunities there?

Alec Cutler: They are tremendous companies in the emerging markets. The perception that people have is that they're lesser companies or input companies. Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM), I think the most important company in the world is in the emerging markets. It's very attractively valued in part because it's in the emerging markets and has some emerging markets-type risk like China invading Taiwan.

But to be able to buy the most important company in the world at 17 times earnings? We'll do that all day and the Balanced and Cautious [Orbis funds] have the ability to hedge out some of the fat tail risk if you will.

So, we can short the Taiwan dollar, we can short the Chinese renminbi to hedge out some of that Taiwan Semiconductor invasion risk and get that 17 multiple very attractive emerging market company for a very attractive price.

Sam Benstead: Orbis funds have a quite unique fee structure. The actual management fee is zero, but there is a performance fee. Can you explain how that works?

Alec Cutler: We charge zero base, and 40% of the outperformance of the benchmark. So, if we don't outperform the benchmark, if we perform in line with the benchmark you're getting basically an index fund for free. No charge.

If we outperform, we take 40% of that outperformance, it goes into reserve, and starts filling up a reserve. That reserve, if it continues to have funds in it, we pull our fee from that reserve at 30% of that reserve tank a year. If the fund subsequently underperforms, the money flows back out of that reserve into the fund.

So, a very, very unique fee structure that we think is very fair, has us incredibly aligned with our clients, which is why we like it. And it's the only fee in the world that can produce a negative fee.

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Sam Benstead: And over the past few years, do you have a figure of what percentage of the assets as a fee you've taken out of the fund, and how has that affected net returns for investors if they've still been very strong?

Alec Cutler: So, the net returns are purely a function of the gross outperformance, the gross fund, and then 40% of that outperformance going into that tank.

I think the last five years we may have underperformed in one or two of those years, and some of that money in that reserve tank would have gone back into the fund via a negative fee.

Our fee, our net fee from that, from the inception from 2014 has, I think, been around less than 40 basis points (0.4%). So, I think we're one of the top-performing funds in the UK doing what we do, and we've charged 38 basis points (0.38%).

Sam Benstead: And finally the question we ask all our guests, do you personally invest in your funds?

Alec Cutler: As an American, I have difficulty doing that. I can't invest in the OEICs. I can't even invest in our Bermuda funds, but I'm as invested as I can be.

Sam Benstead: Alec, thanks very much for coming into our studio.

Alec Cutler: Thank you.

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.