Partners
Value in a bear market
Private wealth management firm Orion has a superlative performance record coupled with a personal touch; a winning combination.
Image source - LBR
Value investors believe the Efficient Market Hypothesis (EHI) is all nonsense. The vaunted theory explains that the stock market always reflects all available information and there is no way for a sharp investor to discover hidden value in a company. Efficient market theorists also reasonably assume that investors as a whole behave rationally. The theory does have some credence in the market. Often managed funds have struggled to significantly beat index tracking mutual funds. Aberrations can be caused because of inside information but not otherwise.
The managers of Orion, a private wealth management firm, beat the stock index because markets are not as efficient as theorized especially in the long run. Orion Fund Management has achieved an annual return of 40.3% net of fees since its inception in July 1998. The all share index including dividends returned 25.3% in the same time frame. The elite fund manager, which only invests in companies listed at the Colombo Stock Exchange, has beaten the market by a whopping 15% on average over 13 years. A million rupee investment with Orion at its inception, by end last year was worth Rs64.1 million. Value Investors like Orion and Guardian Fund Management, which has a similar record on returns in the last 10 years, rubbish the Efficient Market Hypothesis' relevance to Sri Lankan stock investing.
Buying companies that are well run but cheap, because they are temporarily out of fashion with other investors and holding for a long period, called 'value investing', was promoted by Ben Graham who taught a class at Columbia Business School, almost a century ago. Berkshire Hathaway chairman Warren Buffet, a student of Graham at Columbia, is perhaps the most famous proponent now of 'value investing'. In fact Buffet has taken the value investing concept further with a focus on "finding an outstanding company at a sensible price" rather than ordinary companies at a bargain price.
But few have the privilege of managing long term funds. Some funds require investors to lockup their money for years but individual investors would be suspicious of such demands and secondly may find them impractical. Hedge-fund managers typically have a one-year lock-up and thus a more short-term approach to investing. The challenge facing Orion has been to find investors with a long term focus willing to voluntarily part with their cash for at least five years.
"In Sri Lanka people become uncomfortable with any investment over three years even when they don't have a need for the money, basically for no good reason," explains Alastair Corera, a Director of Orion who headed Fitch Rating's local unit earlier. "If you are in the long term it gives you that opportunity, it's less crowded."
Retail investors deserve much of the blame for short-termism, because of their obsession with today's share price and their frequent buying and selling instead of picking stocks for the long term. Stockbrokers, whose income is linked to trading, encourage frequent portfolio overhauling because they make commissions on every trade. Last year brokers also pumped the market full of credit and took it over the precipice.
"We depend on an undervaluation getting corrected over time," explains Premal De Mel who founded Orion nearly 13 years ago after leaving a job at John Keells Holdings unit Waldock Mackenzie. "For whatever reason some stocks don't get discovered by the market. Sometimes we invest and the stock remains undiscovered by the market for three years but in the fourth year when it's discovered you are more than adequately rewarded for the patience," explains De Mel of Orion's investment philosophy. "Because we buy in to an undervalued portfolio we expect the market gain plus the undervaluation to become adjusted over time," chips in Corera.
Orion analyses companies in forensic detail before identifying the 20 to 25 companies that can yield superlative results over a long term where it invests money under its management. Companies with a view on the horizon usually sacrifice profits in the short term. They are also different from the rest because of their greater focus on innovation, willingness to enter new markets and emphasis on good corporate citizenship.
Finding investors with the same outlook for a snug fit will be less of a challenge this year forecasts Orion because of the bearish outlook for stock. Orion has around 250 clients with Rs2.8 billion under management. Many are individual clients who have on average portfolios worth Rs10 billion or so. Forty percent of the funds under management are on account of companies. "These are companies that like to have some equity exposure and build it up over the years" explains De Mel who started Orion as a consultancy managing the private investments of relatives and friends.
The largest of the portfolios under Orion's management is over Rs500 million of a private company. Two other corporate accounts add another Rs700 million to the total. De Mel says there are a number of long-term individual accounts that have now surpassed the Rs100 million mark. Investors with a minimum Rs2.5 million can have Orion manage their wealth. However since the firm only invests in stocks it is careful and makes sure a potential client has adequately diversified assets. This analysis is crucial to avoid early withdrawals which may not generate returns that can beat fixed income options. "If you sold correctly at the start you have fewer issues managing during volatile markets," said Corera.
De Mel and Corera have a long history of friendship, having first met while doing their London A/L examinations in the late eighties. They both joined the financial sector afterwards but De Mel, the quieter but perhaps more entrepreneurial of the two, set up after eight years at JKH owned stock broking investment banking units. "We had been talking about this for a long time, this was on the cards," says Corera about his plan to join Orion. It was however inordinately delayed. "I would have left Fitch earlier, but Ravi (first CEO of the Lankan unit of the rating agency) said he is leaving and told me to hang on because 'you will have to take over'," he explains. Corera finally joined Orion in 2007.
Clients have two fee structures to choose from; a fixed 1.5% of assets under management, the standard fee also charged by mutual funds here, or 10% of profits earned subject to a minimum Rs24,000. On the profit share scheme Orion makes good any losses before it starts levying fees again. The firm charges no front end or exit fees.
In most rich countries private wealth management for the elite is the preserve of multinational banks. However in Sri Lanka none offer the service because banks see hapless savers as a cheap source of funds for their lending. In more advanced markets wider sections of the population invest their savings rather than put in low yielding fixed deposits, and banks have no option but to offer wealth management services or loose that large fee making opportunity altogether.
The wealthy here as a result have little choice but to manage their portfolios by themselves. Mutual funds, which pool all investments, often can't cater to the specific investment needs, like a capital withdrawal in a predetermined and planned way to pay for a child's higher education, for instance. Orion offers this flexibility and it encourages clients to "give us as much advance notice as they can," explains Corera so that the firm can realize the best gains on the portfolio. The firm is a registered investment manager with capital markets regulator, the SEC. Clients funds are held in individual trusts with HSBC.
They encourage clients to top up portfolios regularly. "Some people invest when the markets are good and pullout when the markets are bad," says Corera who immediately qualifies that statement saying that trend is now changing because the market is now neither going up nor down. By September Orion returns were ahead of the market which had declined 8% up to then.
Orion doesn't reveal its entire portfolio of 25 stocks but says they include firms producing consumer goods like beverage, Distilleries Company and CIC an agri business and service provider for the agriculture industry. Many of these firms have low price to earnings ratios. "If you get in to a low PE stock the danger is that it will remain low PE forever, but if its growth that will accrue to you nonetheless even if the stock remains low PE," explains Corera also adding they have exposure to chemicals and pharmaceutical companies and some banks. "It was last year that we started taking some exposure back in to the finance sector, there wasn't much before that. Even now it's not high," he says.
Orion is doubly cautious about increasing exposure to the financial sector because of large state ownership in many banks. This is despite valuations improving tremendously over the last year because of higher profitability and a cooling of stock prices. "The problem is that we are also seeing greater state involvement and then the question is; are they going to be singularly focused on profit or are they going to have a social agenda as well," opines Corera. "You need to factor this risk in to valuations, but if they get still cheaper maybe."
Overall Orion fund managers think the market may still be a tad overvalued. They say an ASPI of 5,000 to 5,500 may be appropriate. "That overvaluation is not across the board or uniform across all stocks," explains Corera. Unusually they don't hold much cash because value investing is not about 'timing the market' or moving ahead of a major correction or spike. "In 2011 we started becoming defensive and for the first time we started holding cash, not a lot, and bracing ourselves because we felt it was a matter of time before this happened," Corera says referring to the gradual slide in share prices in the second half of that year. Depending on individual client expectations, their stated intentions and age Orion held between 10% to 20% of client portfolios in cash. "What we now see is a re-pricing of the market, because many stocks had gone beyond their worth," explains De Mel of Orion's strategy which was justified by the market decline that took place later.
After the gloom set in, most investors have started unwinding their portfolios. Another way to survive the crisis is to obsessively focus on the long term. That trend is picking up.
Article Source: LBR