If the smartphone was the innovation of the past decade, and if we’re now in the decade of the cloud, the 2030s will be the time of artificial intelligence, Douglass says. “And maybe the decade after that would be the decade of longevity where we’re starting to make massive breakthroughs in terms of life expectancy.”
And if the fund manager is right, our future will also be totally familiar: “I still think people will be eating KFC in a decade,” referring to the franchise owned by Yum! Brands which Magellan has made seven times its money on. “Starbucks is a very, very unique opportunity in China, and I think you’re going to make a lot of money over the next decade.”
Douglass reveals that, in no order, the five best businesses in the world are Alibaba, Alphabet, Amazon, LVMH and Microsoft; he owns four of them.
“Eighty per cent of the stocks I own today, if the stockmarket closed for the next decade and I woke up in 10 years, I’d be very happy still owning those stocks.”
Hamish Douglass with Microsoft chief executive Satya Nadella. Louie Douvis
When it comes to current holdings like American hospital operator HCA Healthcare or Apple, he doesn’t have the same confidence levels because of policy risk and, in Apple’s case, the hardware innovation cycle.
“It’s turning into more of a services business and they’re doing a very good job of it. But would I be as comfortable on Apple as I would be on Microsoft? No, I wouldn’t.”
Breakfast at Bernard’s
LVMH has been a successful buy for Magellan, one of its newer positions that is predicated on the strength and durability of Chinese high-end consumption. Its chairman, Bernard Arnault, has been wildly successful building brands that complement the iconic Louis Vuitton. LVMH stock rallied 60 per cent in 2019.
“You know one of the things they were most interested in, Bernard Arnault in Tiffany?” Tiffany was bought by LVMH for $US16 billion last year. “Whether they had a patent on the blue box. He saw that the blue box had so much value, it’s like the ‘LV’ in LVMH.”
Arnault told Reuters after the deal was sealed in November: “We’re the owner of a colour,” the 70-year-old said. “It’s a pretty rare thing.”
“I think he’s a visionary. He’s a mercenary as well by the way, he’s a very aggressive businessman.”
Chinese consumption has been a theme discussed for a long time in the equity market, but Magellan did a lot of work before it could get comfortable with greater China exposure, both directly through Alibaba and indirectly through LVMH or Estee Lauder.
We wake up every morning and the market’s gone up, that cannot continue.
Hamish Douglass
“It’s become very apparent to me the wealth effects happening in China. It’s interesting because there’s so much uncertainty about the West and China at the moment,” Douglass says. “Businesses particularly branded higher-end consumption products the take-off curve that’s happening and how material it’s becoming to some of these companies’ growth, I think we’re still in an early innings in China in terms of what can happen. Especially from an investing point of view.”
Chinese governance is complicated: it often utilises variable interest entities, where an investor doesn’t have a direct interest in the underlying business in China, but an economic interest. There is also the relationship with the Communist Party to consider, legality, regulation, and how much of the spoils are shared with investors.
“That’s what makes the game so interesting and why I like our incredibly focused portfolio. We get to know these companies very well.”
Alibaba boss Daniel Zhang is a visionary, up there with Amazon’s Jeff Bezos and Microsoft’s Satya Nadella: “If you spend time with Daniel, he probably foresees the digitalisation in the world, and the digitalisation of government and business services and processes, as clearly as anybody I’ve witnessed.”
‘People are going to get torched’
Equity markets look pretty fully valued to Douglass after the incredible returns of 2019. “We wake up every morning and the market’s gone up, that cannot continue,” he says. “I want to caution people here as well. Markets have gone up 30 per cent in the last year, that means they’re more expensive than they were.”
While none of his businesses are trading at excessive valuations, the behaviour of the market and the search for yield lends itself to unfavourable comparisons.
“There are bubbles developing in certain asset classes, if you look through credit spreads and you look what’s happening in high yield, and you look what’s happening in the private equity, leveraged loan markets. You’re back at what’s happening in 2006 very covenant-light structures and if something goes wrong, people are going to get torched on these.”
Magellan’s investment strategy is dictated by quality businesses with wide economic moats, that have less risk than the market, and can compound returns. The fund manager aims to minimise losses in falling markets, and participate in the upside of rising markets.
“If I could give one lesson, you want to put your money in businesses that have high returns on capital, long-term competitive advantages and can compound their sales line at decent rates say over a decade. If you get those right and then you sit on your arse, the odds are you’ll do very well.
“Trying to trade things every time the share price goes up 20 per cent to flip into something else I think it’s a mug’s game.”
Nearly every time he’s sold a stock on valuation grounds it’s been a mistake, he admits.
Too many excuses
That doesn’t mean Douglass won’t change his mind, sometimes in extreme fashion. “Retailers and consumer staples were half our portfolio they’re a very, very small part of our portfolio today,” he recalls of the past decade. Some of this is attributed to the Amazon effect (he doesn’t own Amazon).
“I’m somewhat critical of our industry,” he says. “Everything works for a period until it doesn’t work.” This has led to blame shifting on account of investment style, as most investors tend to be value or growth-oriented and stick to those disciplines.
“When it’s not working for you there’s all these excuses: value’s out favour, don’t worry this will come back, and literally, they’re waiting for the one-in-10-year event where that may come back, but the world keeps evolving and adapting. You have to evolve and adapt with it.”