Orbis Global Equity Fund Retail Class (ETL0463AU) Report & Performance

As discussed in last quarter’s commentary, our Global Equity Strategy has meaningful exposure to selected banks that we believe offer compelling value. For reasons discussed in Our Thinking, we continue to believe that the Strategy’s bank holdings are attractively valued and more resilient than many of their global peers. Although not a bank, Interactive Brokers is another business in the financial sector that we find attractive. We initially established the position in November 2021 and have added in recent weeks. Interactive Brokers is now the Strategy’s 6th-largest holding at 3% of the portfolio.

At first glance, Interactive Brokers might seem similar to many of its competitors. It offers online trading in stocks, bonds, futures, options and other securities. It makes money through a mix of commissions and interest income, and its client base includes both individuals as well as institutions such as financial advisors and hedge funds.

Taking a closer look, a picture of a far more differentiated business begins to emerge. Interactive Brokers occupies a unique niche as the go-to platform of choice for active and sophisticated traders. Its core customer trades 300 times a year, while the majority of retail investors trade less than 50 times a year. This makes Interactive Brokers very different from the likes of Robinhood, which is geared to novice investors, or other online brokerages like Schwab that cater to clients who need “high touch” services. Interactive Brokers delivers on what its core customer desires: low costs, best execution, a high degree of automation, and global market access. Its intense focus on customer value is reminiscent of what investors Nick Sleep and Qais Zakaria once called “scale economics shared”. Here is how they described it using Costco as an example in their Nomad Investment Partnership letters (1).

This could take a while. The everything bubble of 2021 has started to deflate, and valuations have started to turn towards sanity. But only started.

Typically, bubbles can take years to wash out, and whatever the recipe for the “perfect” bubble may be, conditions of 2021 can’t have been far off. Near zero interest rates and stimulus cheques made money seem free, and governments imposed lockdowns that made normal spending impossible—all but guaranteeing that all that “free money” would be used for speculation instead.

The frenzy thus created gave us meme stocks, dogecoins, and, most bizarrely of all, the Bored Ape Yacht Club, which describes itself as “a collection of 10,000 unique digital collectibles living on the Ethereum blockchain.” That’s right, 10,000 “unique” collectibles (no irony), which at their peak in May traded for $420,000 a piece, with one fetching a price of $3.4m. Dutch tulip bulbs, stand aside. The stockmarket was not spared its share of speculation. The same recipe led to booms in cash-gushing tech firms, cash-torching tech firms, metaverse stocks, electric vehicle outfits, and any company with the intoxicating whiff of disruptive innovation. Many of those stories started with a kernel of truth, but as Seth Klarman puts it, “at the root of all financial bubbles is a good idea carried to excess.”

Anyone with paper to sell took advantage of that excess. Tesla sold $12 billion, or about one Nissan Motor Company, worth of shares. Whatever the motivations of the offsetting buyers, long-term intrinsic value doesn’t seem to have been high on the list—the average Tesla share is bought and sold more than six times a year. 2021 set all-time fundraising records for stocks, corporate bonds, leveraged loans, blank cheque SPACs, private equity funds, venture funds, and crypto assets. Financial promoters became celebrities, and celebrities became financial promoters.

Over multiple decades, the traditional value approach of buying cheap stocks has worked remarkably well. Over the last decade, it hasn’t, leading an increasingly large chorus to proclaim that value investing is dead. While we aren’t textbook value investors, this debate is not academic for us, as the value philosophy and our fundamental, long-term, and contrarian philosophy are intellectual cousins. Value investing has taken knocks before and recovered— can it do so once again?

To cut to the chase, our answer is an emphatic yes. It will work in future for the same reason that it has worked so well over the long-term past— at its core, its efficacy is driven by thousands of years of basic human nature, specifically the survival instinct that causes humans to respond to greed and fear. These primal drives lead investors to run with winners and from losers. In markets, investors habitually expect the winners to forever thrive and the losers to forever struggle, and they price the companies accordingly. History has shown that investors tend to overshoot. Growth fades and struggles subside. Whether through the power of incentives, the levelling gravity of capitalism, or even luck, great and bad companies alike often prove their adjectives wrong.

As painful as the first six months of 2022 have been for global stock markets, it’s worth keeping the decline in perspective. Since 2009, global equities have returned 12.5% per annum at a time when the yield on safe cash has collapsed to near zero. The difference between the two—the compensation that investors receive for buying risky assets—has been unusually wide, thanks in no small part to unprecedented support from central bank actions. Those actions have led the financial world to a strange and precarious place.

Today, we see three giant sources of risk and opportunity in global stock markets. First, and most importantly for us, valuation dislocations are extremely stretched and should unwind. Second, economic conditions may look extremely different from those of the last decade. Third, many industries may face a future that is extremely different from their recent past. And crucially, these three forces feed on each other.

Russia’s invasion of Ukraine is a painful reminder that there is more to life than markets, and our concern goes out to the people suffering.

As investors, our job is to assess the impact on our clients’ portfolios. Coming into this year, Global Balanced held no Russian positions. We did hold BP, which has since walked away from its 20% stake in Rosneft, but we sold out between late January and mid-February, feeling that the Russia-related risk was underappreciated. We recycled much of the cash from BP into more attractive energy ideas.

In markets, the conflict has accelerated shifts that had already begun—towards higher inflation, shortages in energy and commodities, a retreat from globalisation, and rising geopolitical risk. We have worried about these risks for some time, and we have sought to mitigate them in the Global Balanced portfolio.

The portfolio has fared much better than its 60/40 benchmark amid the conflict-related volatility. As alreadyhigh inflation has eclipsed 7% in the US, 10-year Treasury yields have risen from 1.5% in December to 2.3% today. That has punished global government bonds, which have lost 6.2%. It has also punished the richly priced growth stocks that are valued on future hopes rather than present profits. While global value shares are roughly flat this year, the Nasdaq is down 9%.

In life and in markets, 2020 was a year painted with lines on charts. In daily life, the pandemic made some charts indispensable: charts of new cases and tests, of vaccine trials and mask habits, of mobility and stringency, of hospitalisations and—tragically—of deaths. In markets, charts of stock prices captured the full spectrum of investor emotions, from fear to despair and, later, to hope and greed.

February and March were portraits of panic. In the steepest crash ever, global stock markets fell 34%, and the financial press joined together in a coordinated symphony of anxiety. In seven weeks, the Wall Street Journal used the word “fear” in 800 articles. That is 16 “fear” reports per day—hardly an aid to level-headed thinking. We spent the crash period conducting sober stress-tests of our businesses and paying bargain prices for companies we’d be happy to own for years. On March 23rd, the US Federal Reserve announced that it would print as much money as necessary to support smooth market functioning. The market, having suffered the steepest crash ever, began to chart the steepest recovery ever. Sitting in March, it would be hard to imagine that both the stock market and the Global Equity Strategy* would produce a 16% return in 2020. Yet they have. More important now is the outlook from here.

In short, the relative value on offer in stock markets today looks exceptional, but we are cautious about the absolute valuations of stock markets in aggregate. With bond yields falling to record lows, there are few good alternatives to equities, which has supported ever-higher valuations for stocks. On almost any metric, headline indices like the S&P 500 trade at or near their most expensive valuations ever. But looking at headline averages masks enormous gaps within stock markets.One gap is between the largest companies and everything else. Headline indices have been pulled up by a handful of the very biggest firms, most of which are in the US. While the tech goliaths in the Nasdaq 100 have nearly doubled in price over the last two years, the typical global stock has only just regained its high of January 2018. This wasteland of neglected companies has proved a fertile hunting ground for us.

The other gap is between fundamentally cheap and expensive shares. The chart below plots the spread between the expected return of cheap vs expensive shares based on historical fundamentals and valuations for each company. When the dark line is low, cheap shares are only slightly cheaper than richer shares, making it an attractive time to pay up for better businesses. When the line is high, cheap shares are much more attractive. Since 2014, this gap has widened from a narrow crack, to a deep chasm, to a yawning gulf. We thought the gap was wide coming into this year, but over the course of 2020, valuations only got more extreme. In September, spreads reached an all-time record.

The relative return potential from here could be unusually rewarding. As the shaded area shows, our approach struggles when cheap stocks get cheaper and expensive stocks get more expensive. That struggle is not only normal, but necessary. If it was easy to stick with our contrarian approach, we would not be able to add value over the long term. The shaded area also shows the rewards for patience—our approach has thrived when share prices converge back towards fundamental value.

Indeed, as the dark line has ticked down ever so slightly following November’s vaccine news, our shares have outperformed. We welcome the glimmer of hope, and with valuation spreads still near record levels, the market has scarcely begun to unwind the excesses of this cycle.

The current valuation spread has two sides. On the expensive side is a mixture of excellent businesses at full prices and overhyped businesses at what look to us to be ridiculous prices. In the first group are Facebook, Amazon, Netflix, Google, Apple, and Microsoft—the so-called FANGAM stocks. We recognise the fundamental strengths of these businesses. The trouble is, so does everyone else! With those lofty expectations already reflected in prices, anything less than awe-inspiring results could disappoint shareholders. So even if the FANGAMs repeat their stellar fundamental performance of the last decade—a big “if” as battles with regulators and each other heat up—it may not be enough to deliver an encore of their lucrative share price performance.

We prefer to invest in opportunities where expectations are lower, and we have found several in tech-related shares. Today some 20% of the Global Equity portfolio is invested in tech-related companies like NetEase, Naspers, and Taiwan Semiconductor Manufacturing Company. As a group, our tech businesses have faster growth and higher margins than the US leviathans, while trading at lower prices.Still, the FANGAMs are not the ugliest stocks in the world. The stocks trading at truly scary levels are generally younger and less profitable—think of Tesla and its clones, lockdown beneficiaries like Zoom, and any company promising such-and-such “aaS” (as a service). Here we see signs of speculative froth that recall the 2000 tech bubble: stocks like Snowflake, Airbnb, or DoorDash rocketing in price on the day of their initial public offering; stocks worth more than the whole Japanese market trading at over twenty times enterprise value to sales; a record fundraising haul for blank cheque “special purpose acquisition companies”; and even retail investors gambling with call options.These parts of the market are portraits of greed, where the fear of losing money has taken a back seat to the fear of missing out. Worryingly for passive investors, the global stockmarket has become increasingly concentrated in precisely these areas.

We remain focused on the risk of losing money, and we believe the best way to mitigate that risk is to buy shares at a steep discount to what they are worth. As a result, we have been avoiding the frothiest areas of the market. That does not mean that we have blindly gone the other way, as many companies that have struggled recently face too much debt or disruption and are cheap for good reason. Rather, throughout 2020, we have found attractive ideas across a range of industries. Companies like XPO Logistics, NetEase, Anthem, Comcast, and Newcrest Mining each have completely different fundamental drivers, so unlike the market, the portfolio has not been lashed to one view of the future. The flexibility afforded by our intrinsic value approach has benefitted Orbis Global compared to textbook value strategies, which have suffered this year.Today, however, we are increasingly excited about the opportunities we are finding on the cheaper side of that valuation spread, particularly in markets outside the US. Two excellent examples are BMW in Europe and the trading companies such as Mitsubishi in Japan. Unlike the many companies that look deservedly cheap today, BMW and Mitsubishi appear to us to be babies thrown out with the bathwater.

BMW has a long history of compounding at attractive returns, driven by the strength of its premium brands. Investors now question whether that history is at an end. Will Tesla dominate cars as Apple has smartphones? Will electric vehicles ever be profitable? Will BMW’s premium brand carry over to electric vehicles?. It’s possible that one of these concerns may prove valid, but we think BMW has every chance of success. The company has been preparing for the transition to electric vehicles for over a decade. Next year, it will have 20 battery and plug-in hybrid models available and the ability to make at least one of them in every one of its plants. And those models sell well—BMW today has a higher market share in electrified vehicles than in the overall market, and in 2020 it has grown its electrified volumes faster than Tesla. While uncertainty remains, we believe we are more than compensated for leaning into it. Today BMW trades at less than 1.0 times book value, and roughly six times normalised earnings—levels only seen once before, during the global financial crisis.

In Japan, Mitsubishi and its fellow trading companies currently account for 4% of Orbis Global. The trading companies are best thought of as ever-evolving industrial conglomerates, with investments ranging from commodities in Australia to infrastructure assets in emerging markets to convenience stores in Japan. We have owned these businesses for years, and for years, most investors had ignored them—until the August announcement that Berkshire Hathaway had acquired 5% stakes in Mitsubishi and each of its four closest peers.We see the appeal. Mitsubishi generates ample cash flows backed by its low-cost resource and industrial assets, and in recent years, management has imposed greater discipline on new investments to free up more of that cash for shareholder returns. Over our holding period, Mitsubishi has grown dividends per share by 12% per annum. Today, at a still-affordable 40% pay-out ratio on normalised earnings, that translates into a 5% dividend yield, which we expect to be supplemented with periodic buybacks such as the record 6% repurchase announced last year. In today’s yield-starved world, the company’s encouraging commitment to its progressive dividend policy—growing the dividend even through Covid—looks very attractive.

That improvement is not reflected in the stock’s valuation. Mitsubishi generates double-digit returns on tangible equity, above-average for Japan, yet today it trades at a discount not just to the average Japanese stock, but also to its own book value. While the stock price can be choppy in the short term, we are willing to be patient as we wait for the market to see the value in Mitsubishi as we do. Pulling all of our ideas together produces a portfolio that is very different to the wider market—and in our view, much more attractive. The simplest way to see this is to compare the aggregate characteristics of Orbis Global and the FTSE World Index.

On an absolute basis, valuations are plainly not as attractive as they were at the market bottom in March. Our shares are now about as cheap as the market was then, and the market is now expensive. But if we focus on the current gap between Orbis Global and the market, we see that our shares trade at a 30% discount, despite growing more quickly. That is an unusually big discount.

We can never know what path our performance will take, but from these valuation levels, the relative opportunity we see in the portfolio looks exceptional. Accordingly, our relief at seeing 2020 behind us is matched only by our hopeful anticipation of the years ahead.