Glenn Freeman: I'm Glenn Freeman for Morningstar and I'm joined here today by Kerr Neilson co-founder and managing director of Platinum Asset Management.
Kerr, thanks for joining us.
Kerr Neilson: Thank you very much, Glenn.
Freeman: Kerr, what's your view on the rise of global indebtedness both from a corporate and from an economy-wide perspective?
Neilson: It's made the world just that much more sensitive to interest rates. You saw evidence of this when we got the first rate rise late last year and, you know, the markets lost their hearts and heads. I think that's the real problem.
And secondly it's not evenly distributed. So if you look at Wall Street, for example, there is a whole host of fine companies with no debt, in fact huge amounts of cash, some of it offshore. But then this is a very large group that have taken on more debt. So it's concentrated, which makes them more dangerous.
And overall now the corporate sector in the States is 30 per cent more geared than it was in '07-'08. Governments, of course, have taken up the slack and become much more indebted and so their opportunity to take action is diminishing, but it is far from over.
And then you’ve got the sort of really difficult countries like Japan, where you know it's 350 per cent, 400 per cent debt-to-GDP. And of course China is bringing up a fast second here where they are taking on a lot of debt, both at the corporate sector.
Now, central government is inheriting debt from others. So it's small now, 50 – 60 per cent of GDP, but it's picking up speed.
Freeman: The Australian currency has been trending downwards in line with our official interest rates policy. How does this play into your investment approach?
Neilson: Right. Of course when looking at currencies we tend to look at the bilateral rates, so the Aussie versus the U.S. And we run many currencies that we tend to take a little more sort of peripheral view of.
But against the U.S. dollar, we have been observing that when rates start going up, perversely, the currency starts losing some of its momentum. It’s terms of trade, because basically it's growing faster than the others.
So there is deterioration to see the currency coming under pressure. The oil price is more of a negative, so a higher oil price is more negative for the U.S. than a positive.
Having said that, the real problem we face here is that we have a current accounts deficit. We see our resources as not having the same pricing powers as before, because everyone putting in more capacity ourselves and everyone else. And indeed we can see how our economy could well slow down because of the resource investment now coming to an end and then this building boom coming towards a much slower period.
So our rates are going to come down as well. So that's one attraction that the Aussies had. This nice idea – nice eulogy picked up on being an Aussie, and we see as that comes away which we think is eminent and has already started obviously, the Aussie might bounce a bit but then ultimately it gets quite a lot lower.
But in the meantime, there have been all sorts of play to be had on owning the NOK, that's Norwegian Krone, owning the yuan, which we have done and now we've been reducing our yuan position. We happen to increase our position in the Euro. So there is a few more moving parts than just the typical dollar U.S. mix.
Freeman: Do you have any sense of how many SMSF investors make up your retail client base and has this been increasing over the last three to five years?
Neilson: It has but I couldn’t give you the numbers off hand, but it's certainly a big share. We put them in a category of controllers; they are interested in the market and they want to run their own affairs and that seemingly has been growing.
That's against the folk who just want to leave it to someone else, they just hate the idea of actually getting involved in financial markets.
So it's the sort of clients you attract, because what we've done is spend a lot of effort on communicating as open as we can with clients.
I seldom use the word education, because frankly you can't re-educate fear and greed, you can try and modify it but that’s as far as you'll get. You can't go to re-education camp, I don't think. But what we are trying to do is give people an understanding of the excesses when they start building and then give them some forewarning.
So, for example, on the Chinese banks we are making it very clear they are going to have huge write-offs, magnificent proportions, 10-15 per cent of their loan books completely written off.
So we try to get that out into our literature so when it happens and they see it on the front page of the paper, they don’t overreact. But of course, they still get that daily buffeting of information, which frightens them.
Freeman: Morningstar research has consistently shown Platinum as underweight offshore markets, particularly the U.S. Can you talk a little about why you have maintained this approach?
Neilson: Yes, it has and to some extent I think we should have had more, I think if you want to be very critical of oneself. But what we were always doing is finding better value elsewhere and it shows because in the last five years, we slightly underperformed. But we have been 75 per cent invested and if you look where we have been invested is sort of ghastly markets like the emerging markets and so on, which have gone down in that period. While Wall Street's gone up by 65-70 per cent. So it's a tribute to our stock selection, but maybe not enough macro input.
Whether we want to change that is dubious, I don’t think we'll be making any change. Particularly now, where we think the valuation gap is so large with the U.S. cyclically adjusted earnings of 26 times and the rest of the world much more like 15 to 17 times cyclically adjusted.
Whereas on just standard P/E, standard accounting, GAAP accounting, the States is on 19 times and Europe is under 15 and emerging markets more like variously between 10 and 12. So there is a huge arbitrage there.
And we are guided by that because when you are starting on low valuations, it’s more prospective then when you are starting on high one, unless you've got some extraordinary companies. And the whole market is unlikely to have extraordinary companies.
Freeman: Just lastly: which countries is Platinum most bullish on. And what's your outlook for market performance for the rest of 2016 and into next year?
Neilson: Well, I'm a bit of spoil-sport here because I don’t think it's the best way to look at things. I think it's better to look at industries, because there is so much competition now that is transborder. So even the S&P Index derives 50 per cent of its earnings offshore.
So it's better to say what are the interesting industries and I think pharmaceuticals are very interesting. Because right now, there is a bit of a cloud over them should Clinton come in – President Clinton, if she becomes one.
And there is concern of health care costs. But you know, medicines, actual drugs, are about 16 per cent of the U.S. systems costs, the rest are legal fees and specialist fees and the whole operation of infrastructure of hospitals and nursing homes.
So it's a bit difficult one to nail down, particularly as you get the sort of lobbying from that thing. So that's one industry we like.
And then we love some of these IT companies in China, which are actually on par or slightly ahead of some of the Americans.
Like Tencent with it's WeChat platform, which is designed on mobile from the very start. So it is really very advanced it has apps within apps and all those sorts of things. And these stocks are growing at 30 per cent, they are not cheap, 25 times next year's earnings, which is not cheap. But we think they can just hold those valuations for quite a while and continue to grow at very high rates.
Freeman: Kerr, thanks for joining us tonight.
Neilson: My pleasure.
Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.