Roundtable Delagates
- IAN BARNARD, Founding partner & CEO - Capital Generation partners
- NAJIB EL-RAYYES, Portfolio manager - River Capital
- JAMES PENNY, Senior investment manager - TAM Asset Management
- VALENTINA ROMEO, Managing editor - Citywire
VALENTINA ROMEO: Najib, I know you managed a tech portfolio back in 2000, what parallels can be drawn with the market today?
NAJIB EL-RAYYES: I was responsible for the tech portion of a portfolio at Sagitta Asset Management at the time. We learnt that human nature doesn’t change and when you look at bubbles in the past, such as the tulip fever or the gold rush, you learn that people see an opportunity and they rush towards it. We saw that very clearly in the early days of the internet. We’ve also seen it more recently with bitcoin.
What happened in the 2000 crash was that you got the really strong contenders which survived and all the froth fell by the wayside. I was looking at a portfolio I was managing back then and a lot of the companies we held simply don’t exist anymore. It was a total clear out and the ones that survived, Apple, Microsoft, Amazon, eBay, came out much stronger because they paid off their debt and rationalised all their expenditures. Everything was cleansed and they became the strongest companies, not just in their sector, but probably in the whole market, as a result of what happened in 2000.
What is different today?
NAJIB EL-RAYYES: I don’t think we’re anywhere near the valuation highs we were then. The forward PE back then was around mid-50s ― we’re at 22x right now for the sector. That is probably expensive. We’ve had a huge upward spike in a lot of the tech names, but I think that’s not necessarily because there’s a rush to buy tech names so much as an asset allocation decision, but because yields are very difficult to come by in fixed income.
There’s been a PE expansion, rather than actual earnings pushing these valuations up. It might just be a reallocation of capital, but it’s probably the best sector to allocate to at the moment. That doesn’t mean that it won’t suddenly fall flat, but I can’t see the same opportunities in other sectors.
NIC SPICER: I actually started my investment career after 2000. That was when we were in the full flash of the mining super-cycle. The market likes a good theme, they tend to gather pace and get pushed to extremes and then they come off and something else dominates. That’s how I think about tech at the moment, but what’s different from 2000 is that these companies actually make money now, whereas, in 2000 they were just hope.
And let’s not forget, at the end of the day they were right. The internet was transformational and tech was the promise of what it could actually do and how it could revolutionise business. They were right and yet, that didn’t really help you in 2000 because the wave had just crested.
What does your tech exposure look like now?
NIC SPICER: It would be very dangerous not to be exposed to the Faangs (Facebook, Apple, Amazon, Netflix and Google) in some way, therefore being selective is probably key. It is harder to be excited about the big names. What excites me is technology and what it can do for other businesses as well. You are moving into an era where that ability to do more, to productively reach more people with the use of new distribution capabilities, it can actually solve problems in other areas. What you’re seeing is that it’s no longer just the tech companies, but it’s companies that are actually using tech more efficiently.
Amazon is a great example of this. It is interesting because it’s a retailer, but probably the most profitable part of its business is actually the cloud. It’s generating huge amounts of cash, but effectively what it is doing on the retail side is using technology very efficiently and I suppose, it’s really their recommendation engine that is the key disruptor. All of these software service businesses, have been very exciting, but now they’re very expensive. Maybe it’s those businesses who are going to use those abilities more efficiently than their other competitors that are the most exciting.
IAN BARNARD: I saw 2000 and 2007 and my first thought was that, as one of the Icelandic fallen titans said, 'Sometimes money just goes to heaven’. One of the things you learn about these crashes and crises is that although we survive and companies continue and it’s not all finished and done for, there are things that just go away forever. There were bits of the financial infrastructure in the run up to 2007 that have now gone forever, particularly the high leveraged super-structured credit although some of that’s beginning to come back. I suppose the lesson of that is, you should always be diversified.
Perhaps the biggest challenge for investors now is that, although we know that these booms all came to an end, it’s very difficult to know when it is going to happen. I always think about Tony Dye, who ch. 01 was the CIO of Phillips & Drew during the 1990s and he called it right really early. From 1996, 1997 he was saying this is all ridiculous, it’s going to end badly and he was right, but in the process, he lost his business.
Where does this leave us now?
IAN BARNARD: We know lots of stuff is expensive. We know that probably, on a 10-year horizon, if you buy now, your expected return is going to be quite modest because valuations are quite elevated. But we also know that in these booms, you get this sort of parabolic run up.
From a valuation basis, we’re more 1998 at the moment than we are 2000. If you’re an investor the fear of missing out on two years of really high returns is really tricky and that is a challenge for all of us who are helping people with their own money. How do you balance that short-term feeling that there might be a lot more to come with that long-term certainty that probably, on a long-term horizon, this is not going to be a very propitious time to put a lot of capital into these asset classes?
JAMES PENNY: Just going back to the 2000s, I wasn’t in the market then, but I remember being on the internet, I was 14, looking at Ask Jeeves, the search engine. That’s not around anymore, but I remember the thousands and thousands of names of people that came out with an idea and wanted to float it in 2000.
People just bought it and gobbled it up on nothing more than an idea, yet the market would just buy into it and now, how many names are left? Maybe four, five, six, out of the thousands that listed. Something like 25%, 30% of the market in 2000 doubled or tripled at IPO and now, they’re not around anymore.
Everyone wanted to try their hand at this new revolutionary idea, which was the internet and despite the fact that it is revolutionary and it’s a massive part of our lives, out of everyone that tried their hand at it, most failed.
A world of disruption: business models are being torn apart, but who will be the winners?
VALENTINA ROMEO: The world of tech moves incredibly quickly. Where do you think the sector is heading?
NAJIB EL-RAYYES: I wrote a thesis back in 1998 about where I thought the internet was going and at the time there were an estimated 131 million users of the internet. At the beginning of this year, there are an estimated 4.4 billion users.
My thesis was about how it was going to be transformational for B2B and it was the B2B internet that was going to be the money maker. That’s wrong because actually it was B2C. What has happened is that on the B2B side the internet has become a commoditised thing. If you weren’t there you lost money. So, while some people made money at the back-end, it was not those at the front-end that were the eventual winners, it was the Amazons and those guys who were really the success stories and those are the ones who went straight to the consumer.
What we’ve seen is a huge change because the internet was very much something where you plugged into a wall and you had a big bulky computer and everything, but it’s actually the smartphone that has changed the world. When you look at what it took to get us here, technology made it possible, but it wasn’t a very smooth path. There’s an interesting chart I looked at earlier and it showed how long it takes to get to 50 million users: mobile phones took 12 years to get to 50 million users, the internet took seven years, Facebook took four years and Pokémon Go took 19 days. Something can go viral on the internet and within a few days on YouTube you could have 100 million views.
NIC SPICER: Cat videos. Just to take it up a level in terms of analytical rigour.
NAJIB EL-RAYYES: We’re at the point where it’s very easy, if you have the right idea, to make a change and see it happen in real-time, whereas before, it took so much longer to get there. Now the danger of that is that the companies who’ve spent years building a moat around their services and built a stake in a certain market segment are suddenly much more vulnerable because it doesn’t take very much for a new entrant to come in and disrupt things.
Look at Nokia, look at Blackberry. Everybody had a Nokia phone in their pocket. In 2007, it was incredible to go from the number one maker of mobile phones in the world to a very small percentage. It doesn’t take very much for the whole landscape to shift and that’s why you can predict the themes, but it’s very difficult to predict who the eventual winners will be.
NIC SPICER: The other example, in terms of disruption, is it is much easier to get to the end-consumer. Take something like The Dollar Shave Club. You used to have these consumer brands and they'd have their marketing team and the big consumer companies which effectively controlled distribution. Then suddenly, you had a way of actually reaching consumers on the internet and The Dollar Shave Club just built up a brand of selling razors on an almost subscription basis.
JAMES PENNY: The Dollar Shave Club shattered an existing market theory of selling a product and then selling the accessories for it at an extremely high price. That broke the mould, and that’s why some of the bigger players snap up those guys that are revolutionising their existing business model.
NIC SPICER: There’s also a key thing in terms of antitrust: up until now, the big tech providers have been able to buy their potential competitors, as you saw with Facebook buying Instagram and WhatsApp. Now it’s a question of whether they will be able to continue to do that because you can argue very effectively that it is not a good thing for society as a whole, if you have these tech titans who effectively can stifle competition. Competition is ultimately what keeps things fair for consumers at the end of the day. It’s the great leveller, the reason why capitalism works. If someone is earning super-normal profits, that’s not really a good thing for the end-consumer. Competition is very good at competing those profits away and effectively helping to get a better service.
Which brings us to the big question of how society is changing, and the implications of that…
IAN BARNARD: I’m always wary of saying, 'this time it’s different', but I am saying that what you’ve got at the moment that does make it a little bit different to 2000 and 2007 is a regime change going on. Financially, interest rates can’t go lower. They might not go up and it’s very difficult to imagine them going strongly negative for a whole bunch of reasons. The tailwind of falling interest rates has come to an end unless they rise.
That’s a financial thing, but on top of that, you have got the way in which the global debate has evolved. Taking the UK as an example, even the Conservative party has a much more ambivalent view about business and free markets today. And then you’ve got all the environmental story. I say that because clearly, something is happening.
At some point we’re going to do something about it. So, I do think the roots are deep and it’s been slow growing, but it is coming to a head now.
NIC SPICER: The key is, society is going to change massively and these innovations could be the next big thing in terms of driving productivity. But that doesn’t necessarily mean that now it’s a great time to be a tech investor. It’s a bit like investing versus what happens to the underlying economy. They aren’t directly linked. You can have amazing times for being an equity investor where the economy’s not doing that well, and it’s probably the same with tech. You can have these amazing developments going on, but that doesn’t necessarily mean it’s going to be a fantastic time to be invested in tech.
JAMES PENNY: Warren Buffett said tech’s going to be good for the consumer, but bad for the market.
Wall of money: the lack of return on fixed income is pushing capital into tech. When does the cycle end?
VALENTINA ROMEO: How do we define a tech stock today?
NAJIB EL-RAYYES: We are blurring the lines. There’s not going to be such a thing as the tech sector as such because technology will pervade every sector.
JAMES PENNY: Amazon’s a good example of that. People call it a tech company, or we could call it a consumer company, which one is it?
NAJIB EL-RAYYES: It’s a very difficult definition. When you look at Amazon, its AWS cloud business is easily the size of a top 100 company in the US, and if they spun it out it would sit there quite comfortably. Apple is the same with its wearables. Apple actually makes more watches than the whole of the Swiss watch market put together. So, where do these companies sit?
I’m a technology advocate. In the next 10, 15 years am I going to be using more fossil fuels or am I going to be using more technology? I think I’m going to be using more technology. If we use technology to push us forward and those old sectors are suddenly transformed by it, then that's a technology investment. The way we look at it is, we have a multi-asset portfolio, it’s only a segment of our portfolios, but we look for those fund managers who are the best players in those trends. It could be things like an aging population or a change in agriculture or a change in the way we use devices. Or driving, for instance, which is going to be very different in the next 10 to 20 years.
JAMES PENNY: One way it’s possibly similar to 2000 is the amount of ideas that are coming out of the woodwork. People are looking for them and getting ex cited about them. How many are going to be winners, how many are going to be losers. I just think that those companies will need more to IPO on than an idea on a piece of paper before people start to buy into them.
NAJIB EL-RAYYES: Agreed. But there’s so much private equity financing right now and there seems to be so much appetite for actually getting into what these new ideas and transformative ideas are and in a way, we’ve seen the first reaction to that in things like WeWork where, we’ve gone from a $50 billion-plus valuation to a fraction of that overnight as people started to delve slightly more deeply. You’ll get more and more of that and eventually, those investors will get burnt and it will affect the speed of deployment and the speed of adoption, because you don’t have that wall of money pushing those companies forward.
NIC SPICER: You get these cycles where there is a lot of funding, you can get funding very, very easily and then ideas proliferate. Inevitably, there are some really good ones in there, but there are some really terrible ones as well and then suddenly, financing costs actually go up . In 2000 obviously, it was just ridiculously easy to get equity financing and now, it’s ridiculously easy to get private money. There’s massive tolerance for losses, for very, very long time periods, but W eWork was just showing that it’s not infinite.
NAJIB EL-RAYYES: You’ve got an exacerbating element now, which is that you just don’t have the same potential to make money in fixed income. We mentioned earlier we’re sitting on negative yields and if you have that, you look for something else and that that translates into private equity financing. Then you have people who aren’t really aware of the risks or the potential downfalls of putting money into these things. You get a huge wall of cash and then, when you do get the shakeout, it will affect that industry for quite a while after.
IAN BARNARD: I suppose we are owning a bit less tech, but having said that, when I look at my list of worries, such as valuations in technology, I wonder, what does the sector look like? I’m much more worried about the strategies that are trying to replicate what fixed income used to give us. Applying huge amounts of leverage to a fundamentally low yielding private asset, as an example, or selling volatility on stocks in order to generate an income , that’s the money that’s going to go to heaven. There’ll be losses within tech, but it will come back. For me , it’s these enhanced yield products that are going to be the real victims of any correction.
JAMES PENNY: I’m a fund of funds manager, so at best I’m going to k eep it diversified. I want to give my clients exposure to growth and to tech. I believe there are some great opportunities and great advantages to owning tech, but I don’t want to overweight their portfolios too much, especially at this end where it is arguably, expensive. I want to make sure that I’m giving them the best opportunities across the board. So yes, it definitely has a space in the portfolio , I just need to make sure that it’s a measured one.
NIC SPICER: PortfolioMetrix are a discretionary investment manager, but we describe ourselves as a tech enabled discretionary investment manager because we have inhouse software resources.
I think much like James, what we’re trying to do is, we’re trying to build diversified multi-asset portfolios and control the underlying risk, but then also , select underlying managers who are very close to particular areas and have that expertise to actually go and find potential.
It’s not necessarily just in the big tech names, those are the easy solutions. It’s really being able to dive into other businesses, which aren’t perhaps quite as front of mind amongst every investor. We are allocating to smaller caps, mid caps and other asset classes where potentially, there’s a lot of value that isn’t so obvious, but therefore more exciting.
Can tech companies use their vast data resources to tempt discontented clients?
VALENTINA ROMEO: How do you see big tech challenging our industry?
NIC SPICER: Regulation is our best defence against big tech in many ways. The issue is not just technology, it’s the regulation and insurance and what happens if something goes wrong? Financial services is incredibly regulated. It’s not an industry where it’s okay to move fast and break things because, just like the healthcare industry, if you move fast and effectively kill people, you’re getting into a very, very serious area. It’s a completely different environment.
NAJIB EL-RAYYES: There’s been talk of robo-investing for a long time where an AI bot in the background makes the investment decisions. There’s also a lot of protectionism. Fund managers don’t want to lose their jobs. They’re quite comfortable how they are and that’s how they want things to stay.
There’s a resistance to adopting technology for those companies. In healthcare, we already know that when you use AI to look at scans, for instance, alongside a doctor, you have a 7% or 8% better outcome in terms of detecting cancers, than you would if a doctor was doing it on their own. That shows you that AI is moving into those spheres, so why can’t it move into financial markets? I’m not sure. The difficulty with financial markets is that people break them down into those metrics that they’re comfortable with. We talk about a whole bunch of different financial ratios that we make our investment decisions on, but a big driver for the market is, effectively, emotional.
JAMES PENNY: There’s always an emotional barrier, especially, in robo. I’ve been reading more articles in the last six months about robo-advisers folding up or bolting on advisory arms because people don’t trust their computer enough to hand over their pensions. They need to speak to somebody. They need that human element. At the consumer end, the products that we’re providing, they need to have that active human interaction with people before they’re willing to move their assets over.
IAN BARNARD: The question is this: is there a moment when the big tech companies will lend their brand to something in our market? An Apple Asset Management division? I don’t know, but the one observation I would make is that I see a combined tech and human effort. We are selling a promise and an important part of investment management is maintaining your client’s conviction in your view, which I think does require the most basic level of human interaction.
JAMES PENNY: In terms of Amazon, what’s interesting is the amount of data they have on each consumer and their preferences and what they do and don’t like. Can they harness that and push it into investment management to make decisions?
IAN BARNARD: They’d probably be very good at doing risk assessments. You could take the data you have and have a really nuanced view of what my real risk appetite is.
VALENTINA ROMEO: So, where do we go from here? Is there a new crash waiting and where is it coming from?
NAJIB EL-RAYYES: It would be lovely to have a crystal ball. I still think that we’re at the point where valuations seem to be slightly uncomfortable. They’re higher than people would like, but we had a reset in Q4 2018 and that proved to be a great inflection point. If you had piled your money into a bunch of tech stocks, on a lot of them you’d have at least doubled your money and stocks like Tesla, you’d have made significantly more than that.
Whether we get the same rebound or mean reversion in the next downturn, I’m not sure, but I still think that long-term the themes of those megatrends are really going to be disrupted and changed by technology. Technology is still a good place to be, but you have to be quite careful about not falling into the trap of trying to be in what’s the hottest thing right now. Maybe you buy the picks and shovels rather than invest with the miners themselves, so to speak, because I think the infrastructure required for a lot of these technology trends is the place where a lot of money is going to be made on the quiet. You might not make as much in the short-term, but long-term, I think it will work out.
NIC SPICER: I think in cycles. If you look at what you really wanted to be invested in and what you would have done very well in over the last 10 years, it would have been in the US, tech and the Faangs. Had you invested over the last 10 years in the Faangs, you would have done amazingly well, but what worked over the last 10 years might not work over the next 10 years. My hunch is that those companies that are not in the top 10 of the market cap listings at the moment are potentially going to be much more interesting.
IAN BARNARD: 1991 was a real estate bust, 2000 was an equity bust and 2007, 2008 was really a credit bust. If you were to say 'if this thing unwinds, how does it unwind?' I’m going to plump for something in the real estate space. The link to technology is that what technology does is it allows us to use hard assets much more efficiently and therefore. It’s an enemy of real estate as we are seeing in the retail space. We’re going to see it in some of the current logistics stuff, which again, can be disintermediated by drone technology. Technology is probably the enemy of hard assets. That’s how I think it might go wrong, if indeed it does.
JAMES PENNY: A lot of the theories in economic text books have been disproved. We truly are in an environment where nobody knows where we are, nobody has a crystal ball. Economists most of the time, get it wrong and in that type of environment, going back to the middle ground is key, as is diversification.
There’s a completely different conversation to be had for the short-term, pre-recession. A different conversation to be had after. If I could lock my clients' assets up for 10 years it would be a very different portfolio to the portfolio to navigate the next year. Diversification, in the short-term, and then disruptive tech in the long-term, I think, is key.
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