When cheap is expensive - globaladvisors.biz/inc-feed/20141003/when-cheap-is-expensive/ by Ingé Lamprecht Not all investment opportunities are created equal. JOHANNESBURG – In the search for great investment opportunities many investors and fund managers look for quality businesses that trade at a discount. But finding these shares can be difficult – good quality companies often trade at a premium and if it does not there may be all sorts of risk-related reasons that dissuade investors from piling in after the share price dropped. As one fund manager said in a recent interview: Buying a share just because it has fallen a lot is probably lazy asset management at best and at worst it is possibly arrogant. But how does one avoid investing in a cheap share only to learn an expensive lesson? Are there ways to sidestep the African Banks of the world? Unfortunately there are no guarantees, but there are ways to mitigate potential losses. Speaking to Moneyweb on a recent visit to South Africa, Matt Siddle who manages Fidelity Worldwide Investment’s European Growth Fund, said investors have to accept that they are going to lose money on investments. “The key is to limit the amount of money that you lose when something goes wrong,” he said. Like many South African fund managers his investment philosophy is focused around the premise of “quality at an attractive price”. While the “sweet spot” is to invest in top quality businesses trading on cheap multiples, there are not plenty of these companies around. The fund therefore also invests in “tactical opportunities” – quality businesses with improving fundamentals or poorer companies that are very cheap (see the graph below). Source: Fidelity Worldwide Investment But as far as “poorer businesses” are concerned, how do you separate the wheat from the chaff? Siddle said the first step is to make sure there is valuation downside on your side – the downside to historical low multiples must be limited. The second is to ensure that although it may be a low quality business model, there is no tail risk. Banks generally have got tail risks because if funding starts pulling away from the bank they need extra support. Their loans are generally longer term than their funding and if funding starts going away they can’t redeem their loans fast enough to repay and they need support. “That is what happened in the financial crisis.” Apart from the valuation, he also considers what could go wrong and how much money could be lost. Evaluating the downside risk is important. “I don’t like leveraged business models and I don’t like low quality banks cause these are businesses where if confidence goes, it is very difficult to quantify the downside.” The Banco Espirito Santo in Portugal is an example of a bank that everybody thought had almost two times the minimum capital ratio it required for regulatory purposes, but early in August it had to be bailed out by the Central Bank. Siddle said there was fraud involved and the capital ratios were nowhere what people have thought. The group had a load of intercompany loans, which had not been fully disclosed and once one of the holding companies experienced difficulties it fed through to the rest of the business. Siddle said it is important to understand the tail risks of the business model and where something can go spectacularly wrong. A utility for example is a low quality business but it is unlikely to go spectacularly wrong. While it is not a very high return business and it does not create a lot of value over the long term it is unlikely to blow up completely, he said.
Posted on: Fri, 03 Oct 2014 06:32:27 +0000
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