Why gold and defence shares will keep rising

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 speaks about his preference for inflation-linked bonds over regular bonds, why American shares are too expensive, and why the artificial intelligence (AI) boom could turn to bust. 

Cutler also explains why he continues to back gold and defence-linked shares, even after a strong run.  

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Alec Cutler, manager of the 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: Many people at home may not be familiar with Orbis, so can you give a quick overview of the funds that the group manages and what the investment style is?

Alec Cutler: Sure. In the UK, we offer three funds: a Orbis OEIC Global Equity fund, which would be kind of a higher-risk fund, a Global Balanced fund, which will be moderate risk, and Orbis OEIC Global Cautious, which is lower risk.

Sam Benstead: And what is the investment style, then?

Alec Cutler: We're contrarian investors, value investors, so we tend to try and buy stocks or bonds that people don't want. We would look at a universe of things that have fallen out of favour, and then we would filter through and find the nuggets of companies and other securities that are worth a lot more than we can buy them for.

Sam Benstead: So, you're running a contrarian investment approach. What does that mean to you and where are you finding opportunities today?

Alec Cutler: Currently, we're underweight equities. Typically, for a balanced fund, per se, you'd have about 60% in equities, we have a bit less than that. So, fixed income is becoming more interesting to us as interest rates go up and yields go up, and we still have a significant position in gold.

Sam Benstead: So, underweight equities, can you explain why you see them as a risky bet at the moment?

Alec Cutler: They're not risky, they're always risky, but right now they're just a bit more expensive than they used to be and bonds and commodities are relatively attractive. So, we just...take what the market gives us and the portfolio concentrations wind up from that.

Sam Benstead: What is the investment case for gold? It's gone up a lot in value, but why do you still back it?

Alec Cutler: We didn't own gold until 2019. We started worrying about debt levels and deficit levels in the United States and developed world, where governments are just spending way too much money. And that puts the currencies of those countries at risk.

So, gold, if you will, is a 9,000-year old currency that's never been devalued, it's never gone broke. So, it is the most attractive currency over the very, very long term, and the dollars just got quite expensive, a quick answer.

Sam Benstead: And how do you access gold in the fund? Are you doing it via an exchange-traded fund (ETF) or gold miners?

Alec Cutler: Yes, we use ETFs and gold miners and royalty streamers, which we don't own currently. We've been shifting from the gold to the gold miners. As the gold miners have fallen behind, as gold has risen, the gold miners haven't kept up, so we've been shifting from gold to gold miners.

• Fund Spotlight: consistent performer yielding over 6%
• How to invest like the best: Benjamin Graham

Sam Benstead: And just how high could gold go? It's been on a very strong run. People might be thinking about maybe taking some profits. What's your position there?

Alec Cutler: Gold can just go higher. If the dollar devalues, then gold goes higher. So, if gold currencies or paper currencies go down, then gold goes up. We think that paper currencies will go down relative to gold because, again, governments are spending too much money. Deficits are too high. The debt levels are going up and up and up. That makes those paper currencies worth less. Against what? Against all material items. Gold being the best representation of a material item. So, gold can and will go up over time, and we think it still has a decent place in the portfolio. We've been trimming it in favour of inflation-protected bonds, but [it's] still a significant position in the portfolio.

Sam Benstead: Fixed income in a world of rising government debts is generally negative, as well as higher inflation. So, what types of bonds are you finding value in today?

Alec Cutler: So regularly, so buying a US Treasury, for instance, you're buying to try and park money somewhere and get a return on it. But that return has to be higher than inflation, otherwise, you're falling behind. So, we look at a 10-year US Treasury yielding 4.5%. We think inflation is going to be 4.5%. So, you're actually earning nothing and you're just treading water. Whereas a 10-year inflation-protected bond yields 2% real. So, you get 2%-plus inflation twice a year, you get inflation plus your real interest rate. So, if inflation winds up being 4.5% and we have 2% real on top, we're getting a 6.5% return risk-free.

Sam Benstead: Do you take any measures to hedge the duration risk of owning inflation-protected security?

Alec Cutler: We just modulate the duration that we own, so we own a ladder of treasury inflation-protected bonds out to, say, 20, 25 years, and the average duration of that is about six and a half years.

Sam Benstead: On the equity side, you're underweight, but where are you finding the best opportunities?

Alec Cutler: 55% of the fund is invested in equities, that's net. We do use some hedging. There are certain equities that seem higher risk, or are higher risk, higher beta, if you will. So, we'll use market hedging to reduce the risk of those securities.

A high-risk security example would be Micron Technology Inc (NASDAQ:MU), a semiconductor company in the US. It goes up and down a lot [when the] market goes up and down a lot. So, we'll hedge off the market risk and lower the volatility of that. We're underweight because equities are expensive. Equities are becoming less attractive relative to fixed income or commodities. So, that's where we go.

Sam Benstead: What are the best undervalued markets today?

Alec Cutler: We're finding value all around the world, except the US in general. There are some securities in the US that are interesting, some stocks that are interesting, things that aren't household names. It's not the Nvidias of the world that we're invested in the US, it's more like the Kinder Morgans.

So, rather than owning a very expensive AI stock, we'll own the company that owns 40% of the natural gas infrastructure in the US. Just moving natural gas around and taking a toll. A very simple, mundane business that's really attractive from a cash-flow standpoint and we don't have to pay a lot for.

And then the rest of the world, we've been heavily invested in defence contractors for the last five, six years. Energy infrastructure, in particular critical energy infrastructure, so the companies that make the natural gas turbines that are needed to produce the electricity to feed the AI factories, to make AI. Rather than own AI, we own the companies that make the electricity for them.

• The great investment strategies: value investing
• Fund managers’ favourite UK smaller companies

Sam Benstead: On that defence theme, these shares have done amazingly well over the past two, three years. You don't like expensive shares, so are some of these companies now expensive or is there still value in there, and which companies do you like?

Alec Cutler: Some of the defence contracts that we continue to own today, we bought four or five years ago, and they are up 10 to 12-fold. That said, if Europe is going to spend 3.25% of gross domestic product on defence, they're still cheap. Even though they're up 10, 12-fold, we bought them when they were extremely inexpensive, as contrarians will do. They've been successful investments, but that doesn't mean they need to be sold.

Rheinmetall AG (XETRA:RHM), which we own, if Europe spends 3.5%, 4% of gross domestic product on defence, Rheinmetall is still a cheap stock. It's still a low valuation stock. If instead Europe reverts to spend less than 2% on GDP, say peace breaks out around the world and you don't need to spend, then it's a quite expensive stock.

So, at this point, a Rheinmetall is more a bet on continued growth and defence spending, than it is about Rheinmetall itself and what they make and whether the products are successful in the market or not. All that's proven at this point, which was not proven when we bought it to begin with.

So, we own Rheinmetall, we own Saab AB Class B (OMX:SAAB B), we own Leonardo SpA Az nom Post raggruppamento (MTA:LDO) in Europe. We own Hindustan (Aeronautics) in India, the biggest defence contractor in India; Hanwha, the biggest defence contractor in South Korea; and Mitsubishi Heavy, the biggest defence contractor in Japan.

As the global Cold War continues to spread out from Europe and Ukraine to Asia, where it's actually more likely to be active in the next five or 10 years.

Sam Benstead: Artificial intelligence is a big theme at the moment, but you avoid that generally. So, what is your take on AI? Are we in a new stock market bubble?

Alec Cutler: Possibly. These companies were expensive, and rightly so to some degree, and they've been very successful companies.

If you think about the core of AI, you're thinking about Meta Platforms Inc Class A (NASDAQ:META), Google (or Alphabet Inc Class A (NASDAQ:GOOGL)), Apple Inc (NASDAQ:AAPL), and, arguably, Microsoft Corp (NASDAQ:MSFT). Right outside the ring of those core hyperscalers, if you will, is NVIDIA Corp (NASDAQ:NVDA) providing the infrastructure to make AI happen.

We're not invested in any of those, they're quite expensive, and they are also challenged. So, that core AI group is investing like crazy, in part because it's an existential risk to them. All those companies have a golden goose, if you will, like search for Google. That's been a monopoly for them for years, and it makes all their cash flow, which they use to invest in all their other businesses like YouTube and Waymo. The search engine's at risk because of AI.

Similar for the other companies, whether it's social media or online retail, AI puts those businesses at risk. So, they have to spend a lot. There's as much upside as there is risk, and the multiples are quite high. We don't like the risk.reward there.

Nvidia is just quite expensive. It's a very successful company. It will continue to be a successful company. It's interesting though, and many people don't know this, but Nvidia doesn't make anything. They're kind of a virtual company. Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM) makes their chips, and surrounding those chips are memory chips that enable the Nvidia chip to work properly. The memory chips are the input-output, flowing stuff in and out, the data in and out. We own those companies. We own Taiwan Semiconductor, we own Samsung Electronics Co Ltd DR (LSE:SMSN), and we own Micron.

• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis
• Ian Cowie: 11 income investment trusts ticking all the boxes

Sam Benstead: Are there any other markets that are very overvalued today?

Alec Cutler: There are plenty that look expensive. We don't spend much time on them. As contrarian investors, we wait until things fall into our lap and then we'll look at them. So, when we talk about areas that are super expensive, unless it's AI and very topical, we don't tend to know a lot about them.

European luxury stocks have been expensive for a long time. We'll get to know them when they fall off the bridge and we can take them and look at them. But there's really no need to study them until they become cheap.

Sam Benstead: Alex, 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.