‘A modest sell-off, not a panic’: Douglass on coronavirus fallout

-- | 14/03/2020 Text size Decrease

Glenn Freeman: And from a portfolio perspective, so I think you're quite fully invested at the moment you haven't moved into cash. How should end investors respond in their own sort of portfolios? Hamish Douglass: Yeah, well, I'd say moving in and out of cash is very difficult for most people and most people are doing it, reacting after data has come out and they're reacting to the emotion of the time. And most of the time, that is the wrong thing to be doing. As Buffett says, you want to be fearful, when other is greedy and greedy, when others are fearful and selling out because of all of this news and things will probably turn out unless you lock it, that you get back in, when they fall. If you just want to sit this out, it will probably -- you've sold out when the markets have really come off somewhat. And you're probably into it when the markets are above what you sold them out. So, we would advise people not to do that as a general rule. We typically, when we've gone to cash is where we've said we want to reduce our overall market risk because we're predicting something's going to happen and we've got data on it. So, in 2018, we held 20% cash because we knew the Federal Reserve, and they told it we're almost going to increase interest rates. So, we were just predicting that was going to impact asset valuations, as rates go up, valuations come down, and that exactly happened through 2018. And we wouldn’t just sit with even less with the markets for something we knew was predictable. But 2019, the game changed again, and they said they're going to cut interest rates. So, we actually came out of cash. We don't sit in cash because there's a black swan event that could happen at some time. We do that by having a super high-quality portfolio and running risk, less risk than the markets run in our portfolio and actually our portfolio through coronavirus has held up pretty well. If we were sitting in 20% cash going into coronavirus, it would have done even better to portfolio. But in the last 12 months, our portfolios outperformed the market by 10 percentage points that would not have happened. If we'd been sitting in cash for the last 12 months. So, all I'm saying for a lot of people the cash is -- we do it because we're issued about a foreseeable macroeconomic event. Not because we panic and go cash during the middle of uncertainty. Freeman: And I just want to pick up the point that you raised about Warren Buffett, I know you watch, you're something of a disciple of Buffett. Douglass: I'm not the only one by the way. Freeman: There are a few of them around. But what would Buffett be doing now. Douglass: He's got a lot of cash, he got a lot of cash and his inclination would be to buy, to swing the bat when markets are selling off, I suspect an 8% to 10% sell off, he wouldn't find mouthwatering. And don't forget even that it's in the context in the last 12 months the markets were up over 30 percentage points. So, coming off 10% when the markets were up 30, I suspect he would say this isn't what I call a panic and it's not a panic. This is a relatively modest sell off with extreme information being passed around and uncertainty at the moment, but I suspected markets came off 20% or 30%. Buffett has 120 billion cash I suspect he would start spending that money. I would think at his age. I think he's probably hoping for an event. Warren quite likes when markets panic at the end, but I would say if you ask him, he would say I don't regard this as a panic in terms of the market movements at the moment, it's relatively modest, but it could get -- anything can happen in the next three months. There's a lot of uncertainty. It's fluid at the moment. Freeman: And underpinning a lot of this is obviously China. So, will the disruption in China have a long-term effect on say supply chains in disrupting the way that businesses around the world actually interact with China? Douglass: Well, it's very interesting, the beginning of coronavirus where it looked like it was an epidemic. I'm not using pandemic, epidemic within China. People were saying well China's really risky. We're going to have to move our supply chains out of China. And what I would say to you is first of all, moving on scale supply chain somewhere else without the infrastructure is really hard to do. Maybe one company can do it, the scale of manufacturing that they have for all people to move their supply chains one just isn't viable. And secondly, doubts on epidemic but people were thinking of a pandemic is at low risk having your supply chain in China or in Indonesia, or Vietnam, if this starts spreading into Indonesia or Vietnam as a pandemic, and that's what a pandemic is, it spreads across national borders, is your supply chain safer. I would say that Chinese ability to curtail it, because of the way they can operate and effectively control things. Freeman: They can flick a switch and things happen. Douglass: They can flick a switch. Good luck in Vietnam or Indonesia or India. If you put your supply chains into those countries and most people try and go to low cost jurisdictions, you may be actually increasing your risk to a pandemic by moving your supply chain to a third world country that actually doesn't have the ability to control things as much. What I would say is probably the more realistic scenario is people have moved their supply chains to make them as efficient as possible to take out all the infantry in the system to get it to just in time manufacturing, shipped it straight away, straight to your warehouses. And people weren't predicting that that production could get shut down for an extended period of time. And then they ran out of goods, when it ran out goods. Freeman: Because they don't have big inventory. Douglass: They don't hold infantry and that was the trend in manufacturing that sort of infantry less manufacturing supply chain, I suspect, people will initially think let's just move somewhere else and realize well that's probably not the viable and actually doesn't really change our risk dramatically. But what they may want to do is put more latency into their supply chain and put more warehouses and more infantry into the supply chain line. So, they've got more resilience to something like this in the future that costs money, you have to put cash in to do that and who's going to pay it, is it going to be the manufacturer of the good, the retailer, the brand owner, how's it but I'll suspect where we're really talking to companies and we're thinking about from a financial modelling, is there a working capital requirement here from a cash flow perspective? Or putting more resilience in the supply chains at the moment. Freeman: Okay, so that's the main. Douglass: For us it’s a flow on, which does have some impact on valuation at the end of the day, depending on whether they get it back in price or in any way. But all this manufacturing, people just say, oh, everyone is going to move their manufacturing out of China. I go good luck. Freeman: You don’t see it happening. Douglass: I see it at the margin. But I just don't think that when people think about it, that actually is going to solve, one it's very hard to do at scale. And then secondly, does it really reduce your risk to a pandemic? And a pandemic, by definition is a global spread of a disease. Freeman: Just lastly, in the higher volatility environment and the low inflation should investors be expecting active managers to outperform and obviously Magellan, you've outperformed in an up market, investors right to expect managers to continue beating the benchmark in this current environment or are passive funds becoming still a popular option in this sort of environment. Douglass: You're asking the general passive versus active debate. The first thing I would say is the trend towards passive purely I mean the true passive investing in the index it's super low cost, invented by Vanguard Jack Bogle. The office next to my where I sit is called the Bogle room. That's because I've got a huge amount of respect for what Vanguard and Bogle did for investors around the world. They commoditized the index. So, I'm a huge fan of index investing, it's very, very low cost, and makes a lot of sense for a lot of people. I do believe that true active investing that people are very concentrated and taking very high active shares, maybe if they've got some skills in reading the environment and changing the allocations through that. I absolutely believe that you can add additional value over and above the index. I don't think all active managers can do that, because a lot of active managers are running very large hundred stock portfolios. The probabilities of those things materially outperforming net of fees are actually very low. Most people never move their positioning and then risk positioning a lot of it looks backwards about just repeating what worked for them in the past. But you know, good active managers can absolutely add value particularly in these environments, but the index has its place as well. So, you're never going to hear from me people putting their money in index funds is a stupid thing to do. At the end of the day, and I think they've done a service because it made it a lot tougher for the active managers who weren't truly being active. They were marketing machines more than they were evaluating machines for, for investors and that part of our industry is in trouble. And frankly, it deserves to be in trouble. Freeman: So, you are saying this environment is heading into a downturn, this could sort the wheat from the chaff, so to speak, in terms of active managers that can continue to outperform? Douglass: Well I think the last decade – the last decade has been a very interesting decade and it's sorted lot of people out. You know, at the end of the day, I think this is more of the same when you get volatility, and particularly this type of volatility. People dramatically underperform the index. People don't like that. And then in the last 10 years, it's been a difficult environment that you've had to navigate around. A lot of active managers have underperformed there but there have been a number of active managers who have dramatically outperformed as well because they're doing something very different to them, so I'm not afraid at all of passive investing. I don't think it in any way harms our business in what we're doing. And I think it's done a great service to, to society and to many investors around the world. Freeman: Thank you very much for your time today, Hamish, I really appreciate your time. Douglass: My pleasure, Glenn.