Bucking the Trend: Contrarian Investing in Australia with Dr. Suhas Nayak
Sep 26, 2023
Praemium
What does it take to invest in the stocks that no one else wants? For Suhas Nayak, separating fact from opinion is key to finding value where the market sees none. Suhas Nayak is a portfolio manager at Allan Gray, an entirely contrarian fund manager that seeks to find diamonds in the rough in places other buyers aren't willing to go. Join host Damian Cilmi as he and Suhas discuss how Allan Gray's team of STEM qualified stock pickers stay focussed on long term objectives, the diversification benefits of defying the herd, and where opportunities exist in the Australian market today.
Praemium Limited is the issuer of the Investment Leaders and Advice Leaders podcasts. These podcasts are for information purposes only and aren't tailored to individual financial situations and do not contain financial advice. Views expressed by presenters may not align with Praemium's and nothing in this podcast should be seen as an endorsement or recommendation of the product or strategy. For more information about Praemium, including our disclosure documents, please visit our website.
We recommend that individuals seek professional financial advice before taking action.
What does it take to invest in the stocks that no one else wants? For Suhas Nayak, separating fact from opinion is key to finding value where the market sees none. Suhas Nayak is a portfolio manager at Allan Gray, an entirely contrarian fund manager that seeks to find diamonds in the rough in places other buyers aren't willing to go. Join host Damian Cilmi as he and Suhas discuss how Allan Gray's team of STEM qualified stock pickers stay focussed on long term objectives, the diversification benefits of defying the herd, and where opportunities exist in the Australian market today.
Praemium Limited is the issuer of the Investment Leaders and Advice Leaders podcasts. These podcasts are for information purposes only and aren't tailored to individual financial situations and do not contain financial advice. Views expressed by presenters may not align with Praemium's and nothing in this podcast should be seen as an endorsement or recommendation of the product or strategy. For more information about Praemium, including our disclosure documents, please visit our website.
We recommend that individuals seek professional financial advice before taking action.
Damian Cilmi:
Welcome listeners to another episode of the Premium Investment Leaders podcast. I'm your host, damian Chilney, head of Investment Managers and Governments at Premium. Today we are joined by Suhath Nayeq, portfolio Manager from Alan Gray. Alan Gray was founded in 2005 and is a specialist Australian Equity Manager located in Sydney with a fund of $10 billion across institutional and retail clients. And about our speaker.
Damian Cilmi:
Suhath joined Alan Gray as an analyst in 2011, as been a Portfolio Manager since 2016. Bright to this, suhath spent five years at McKinsey Co, leaving as an Engagement Manager. He is a Bachelor of Science with Honours from Caltech and holds a Doctor of Philosophy in Mathematics from Stanford. Suhas, welcome to the program, thank you. So today we're going to talk about Australian equities, value in investing in contrarian behaviour, and it's been an interesting period for value as an investment style, with a growth factor dominating for an unprecedented five years or so, and then value make it a bit of a comeback in 2022. But the picture in 2023 has been a little bit more mixed as investors hurting once again into a few favourites. So we're going to talk about hurting contrarian behaviour and your approach to all of this, but to kind of set the scene, so just tell us about Alan Gray's, I suppose, unique investment approach to do investing and how you've organised your team to deliver on that.
Suhas Nayak:
Yeah, so Alan Gray is a long term, fundamental and contrarian manager. I think the long term and the contrarian bits are some of the key features of the strategy. Being long term can be difficult in this environment. In most earnings calls you get analysts who are always asking about the next six months, the next 12 months of earnings and what could sway earnings here or there over that period. But our task is really to focus on what the next three, four or five years could look like, and so that can be difficult in this world filled with noise and information.
Suhas Nayak:
The second part that is also difficult, or could be difficult, is being contrarian and doing it consistently. And why is it difficult? Well, generally means that you're going to be going after fairly unpopular stocks, things that most people will think are close to basket cases. You're going to look embarrassed at times, and so it goes against most of our instincts as social humans to be in unpopular areas of the market and then be willing to be embarrassed every now and then. And so how do we organise ourselves so that the strategy can keep delivering that long term focus and being contrarian consistently?
Suhas Nayak:
It comes down to people and process, and I think on the people side we try and hire people who have a bit of a science and engineering bent, who don't have the baggage from other investment firms, because growing that capability Within the firm tends to be quite important. And so we try and find these sorts of people who can separate fact from opinion, and that helps us stay different, stay contrarian and stay long-term focused. And then on the process side, I think we try and make sure people act independently and we ensure that all voting on stocks is done independently ahead of time and we try and avoid that group thing that can come to permeate firms and, yeah, it could detract from this strategy.
Damian Cilmi:
And that's an interesting point in itself, where you kind of want individual thought in a sense, but then you still want a collegiate kind of, I suppose, behaviour and also there has to be a common direction as well. So kind of getting that balance right and very, very different from what I imagined.
Suhas Nayak:
It is. I think we want our analysts to have the freedom to explore and we encourage them to do that, and when we debate ideas, it's not about the analysts who's brought the ideas, and hopefully they realise that it's not about them. It's about the idea.
Damian Cilmi:
And so for many, going against the herd and you kind of touched on that earlier it can be. It's extremely comfortable for humans generally on that. So why should advisors consider adopting this kind of mindset of seeking, I suppose, discomfort and going against the herd with their own investment decisions and how they position client portfolios? How does that serve their clients in the long term?
Suhas Nayak:
So I think going against the herd lets you buy good assets at lower prices and I think over the long run that can deliver outsized returns.
Suhas Nayak:
When you're looking to buy an asset even when you're looking to buy a house you're trying to get a good deal, and when you get a good deal, when there are more sellers typically in the market, then there are buyers, and that happens normally when people are a bit uncomfortable about the situation for whatever reason, and so we're trying to find those opportunities in the market where there's a discount to what is fair value and there's a reasonable discount. So you've got a little bit of a margin of safety when you're deploying that capital. And then I guess, on the flip side of that, we're trying to buy, to sell those good assets when prices match the quality of those assets, and so we're buying assets at a discount and then selling back at that intrinsic value that we see. I think that's the way to deliver returns over the long run. I think the other feature of this is that we can be quite uncorrelated, and so there is a bit of a diversification benefit for clients over the long run as well.
Damian Cilmi:
So on that point, for many, the idea of going against the herd and you kind of mentioned that a few times it can be uncomfortable. It's not something that's very natural to humans. So why should advisors also have a look at adopting this kind of mindset with their own portfolio construction?
Suhas Nayak:
I think going against the herd lets you buy assets at a discount and then hopefully sell them at prices that are closer to intrinsic value, and doing that consistently over a long period of time can deliver outsized returns, and I think that's what we try and do. Going against the herd means that often there are more sellers in the market than there are buyers in the market, and that often means that you can get a good deal when you're out buying a house. It's helpful when there aren't too many other people competing for that asset, and I think that's the kind of philosophy we bring to equities as well. And over the long run, I think that can deliver returns with some volatility in the process, but it also can deliver quite a bit of diversification, because we don't have a lot of overlap with other managers in terms of the names we hold, and that diversification can also help client portfolios.
Damian Cilmi:
Yeah, and that's true. You know, looking at your portfolio holdings compared to many of your peers, you know, and there is a very different set of top names, at a minimum, and I think it extends all the way through, and there's definitely some benefits from that blending perspective, not only in names, but also when those returns are going to occur. Would you say you're probably the deepest value manager out there in the market.
Suhas Nayak:
Well, I think there is very little overlap in the names that we have with other managers and I think it is actually a prompt that we have. When we see other managers hold some of the stocks that we have at large weights, we do wonder whether we're in the right places, because if we're trying to buy things that are cheap because you know they're unpopular and there's a bit of discomfort around, then we may not want to be in some of those names. So it can be a prompt for looking at new stocks.
Damian Cilmi:
Fair enough, fair enough. So, looking at those uncomfortable stocks, you know how do you differentiate between genuinely undervalued or those that are just simply underperforming and, you know, may not re-race in the future as well, because that's, I suppose, the balloting act out of this could be contrary in at the front, but actually you need the market to recognise you as well and actually the herd to catch up in a way. You know, is there telltale signs that you could see on those turnaround of the things that should get through?
Suhas Nayak:
let's say, I wish there were. Unfortunately, I think, with investing good managers, good managers get it right 60% of the time, but there's a flip side to that. Even those good managers get it wrong 40% of the time, and it's probably something that most people don't want to admit. But yeah, getting it wrong 40% of the time means that you are going to look embarrassed every now and then. And are there ways to figure out which ones are going to end up on that 40%? Probably not. If there were telltale signs, those telltale signs would probably be priced in by the market and some of the opportunity would be lost, and so there aren't metrics as such, and I think one of the learnings we've had over the last 10 or so years is that when you're buying things that are structurally challenged and we do do that from time to time you really want to buy them very, very cheaply, and I think that is the one thing that perhaps, over time, we could make sure that we're doing that more than we have in the past.
Damian Cilmi:
And so what does that that protects you lock in in terms of an asset break up at that point of time Is that where the protection kind of comes in, at those really depressed, structurally challenged levels.
Suhas Nayak:
Yeah, I think the asset backing helps, but I think the reason that you really want to buy them very, very cheaply is that structurally challenged companies because they have an imperative to survive they end up using the capital that they're generating. Even if it looks like a lot of capital relative to the share price, they'll use it to kind of dig themselves out of the hole and doesn't necessarily come back to shareholders at the rate or the quantum that you would expect, and I think that is something we've learned, probably the hard way of the years.
Damian Cilmi:
Yeah, and I've heard a lot of experience I imagine very much through the team, and so let's just talk about certain sectors. Is there any sectors in particular that have been more uncomfortable than others, and are those sectors they show in some later opportunities? Is that? Is there something structural around that there, or do these sectors kind of rotate, let's say, over time, and then new ones are unpopular and so forth?
Suhas Nayak:
Yeah, I think we're bottom-up builders at Portfolio, so we look for individual stocks to put into the portfolio that look deeply discounted. But every now and then there are particular sectors that have a collection of those stocks that look particularly interesting, and so every now and then the portfolio looks quite tilted in a particular direction. Back in, during the GFC, there was the REITs. They say they got really hammered. The portfolio went up to 30-35% exposure to REITs, which is huge in the context of the market, a huge overweight. But that's where the value was identified and so we went in hard there. More recently, the portfolios had up to 20, 25% in energy up until 2021, 2022.
Suhas Nayak:
Because again, that's where the value seemed to have been built up, or the latent value, and so the portfolio from time to time does tilt towards particular sectors. We're now at the stage where, maybe, that there isn't a clear sign as to which sector. The opportunities seem to be a little bit more idiosyncratic. But there are particular sectors that are generating some interest from a research perspective. So things like office REITs, you know, starting to look interesting, consumer discretionary, because everyone's afraid of the recession that's coming tomorrow, and so you know, some of that is generating interest, research interest, but it's not a big feature of the portfolio yet.
Damian Cilmi:
And I appreciate it's still a work in progress. But what is the negative sentiment, say, around office rates and discretionary that's kind of guiding this very poor outlook? Let's say for these stops from a sentiment point of view.
Suhas Nayak:
I think with office rates it's things like occupancy levels and declining occupancy levels. As you know, people work from home. A recession would compound that because there would be less demand for floors and I think over the years a lot of the assets have been written up to quite extraordinary levels Because of lower and lower interest rates, and so those three things kind of working the other way may change people's view of, you know, the future trajectory of earning.
Damian Cilmi:
That's because there's a tendency to extrapolate, so I think, like on a work from home and obviously office attendance, as everyone's kind of thinking well, it's only 20% occupancy there, ever after men.
Suhas Nayak:
That's right, yeah, and so that's the worry. You know, if occupancy suddenly drops by that 30%, 40%, because you know people don't need as much office spaces as they had wanted in the past, then there's going to be a lot of space and income streams for these office rates are really going to collapse, and that's where I think the fear is starting to build. That kind of scenario is not yet reflected in share prices, but you know, some of that trajectory towards that is starting to get priced in, and so you know it could get interesting. And there is, you know, hard asset backing around particular buildings. If they're good buildings and good locations, then maybe there's some value in some of them.
Damian Cilmi:
And isn't there? There's some discussion now about CBD buildings, about where they could get converted also into residential as well, and there's got to, you know, I suppose, overlapping around housing shortages as well too. So there could be a refurb or a re-engineering of some of those.
Suhas Nayak:
That's true, although the repurpose costs are quite, quite high. Offices only have one or two bathrooms for floors, a lot of extra plumbing and to get apartments out of them, but that's not the only cost, yeah sure, and on consumer discretionary as well too.
Damian Cilmi:
I suppose this looming recession that we've been waiting since probably back of 22 and now we're in our third quarter of 23, hasn't shown itself in its full form as yet, but has that put a lot of negative sentiment around?
Suhas Nayak:
discretionary yeah, I think the sentiment around the recession has rolled through different stocks at different times, and so we've been trying to find those stocks that are pricing in recession the most, because if a recession happens well, it's already priced into stock price. If it doesn't happen, they're going to do well. And if it does happen, well, fast forward a year or two and the recession's over. As long as the assets are still good and the earning streams are more or less intact, then those stocks should do quite well from where they are today as well. So there are some opportunities that we're finding in things like building products and some select consumer discretionary names, where I think people are starting to think well, earnings next year are going to be awful, and they may well be, but again, it's that long-term focus and trying to look through that. What's on the other side?
Damian Cilmi:
Yeah, and there's certain discretionary stocks, that kind of surprise a little bit on the upside in the last 12 months or so, because the sentiment has been that bad and when it's come through hasn't been as bad as what everyone expected. So you've kind of seen that in this last 12 months already that kind of behaviour.
Suhas Nayak:
Yeah, I think most recently Harvey Norman was one of those companies that delivered a sales number and a sales update. That didn't look so good, but I think there was a bit of a relief that it wasn't worse than the thought they delivered. And that's happened to a few different names in the market and it's not to say that the sentiment might not turn again when the recession that everyone expects happens.
Damian Cilmi:
But yeah, these relief rallies are not uncommon and the sentiment gets that poor, yeah, no, no, no, great, great and I suppose, managing this discomfort because you're showing names in the portfolio or imagine people are and okay, that's an interesting holding in there, so you're constantly probably having to defend very unpopular kind of decisions there. So how do you, I suppose, manage this kind of these concepts with investors, because it's not only uncomfortable starting, but then the positions that get entered into. So what kind of strategies and techniques have you developed over the years to dealing with investors about some of these very uncomfortable positions?
Suhas Nayak:
Yeah, I don't know if I'd go so far as to say strategies and techniques. I think we just are who we are and we try and make sure that investors understand who we are and I think that from the outset, right from the get-go, hopefully they understand that we're contrarian, that we're going to be holding very unpopular things, that we're going to underperform and test people's patience from time to time and over the long run hopefully they'll see the rewards of that. But I think being transparent around what we hold and being upfront about our mistakes through the cycle and through many cycles will hopefully stand us in constant with investors.
Damian Cilmi:
And I remember reading one of your last updates around Len Lings, for example, and I think it was very clear in the transfer of communication about your thesis on Len Lings to help investors understand exactly why you initiated that position where you see the latent value. Any summary thoughts about that Len Lings position?
Suhas Nayak:
I think where it trades today is below NTA, which is unusual for a company that is a developer and has a lot of its balance sheet written or booked at cost, and I think, if I were to summarize the thesis in that respect, that that's where the value is. It's to say that these things should trade at a premium to NTA, and we're getting it at a discount. So there seems to be value, but there's also risk, and I think we're staring into what could be a property downturn, making it difficult for Len Lings to realize assets at good prices, and that can detract from some of the capital that they've already invested, and I think that's where the fear is, but hopefully that's where also the opportunity is. Yeah, excellent.
Damian Cilmi:
All right, we might leave it there. That was an excellent discussion. Thank you, sir. It was a pleasure having you on the show and hopefully we'll see you again. Thanks, amin, thanks.
Praemium Disclaimer:
Premium Limited is the issuer of the Investment Leaders and Advice Leaders Podcasts. These podcasts are for promotional purposes only and aren't tailored to individual financial situations and do not contain financial advice. Views expressed by presenters may not align with premiums. For more information about premium, including our disclosure documents, please visit our website. We recommend that individuals seek professional financial advice before taking action.