Insights from Maxsted and Neilson

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On 8 November 2013, Morningstar held its first ever Individual Investor Conference, aimed at retail investors rather than advisers or super funds. It was fascinating to watch the crowd of about 450. Few were dressed in suits or ties, and the majority could have been watching a movie or attending a casual concert, but they were more attentive than a crowd of professionals. Many took notes furiously for hours, filling page after page, desperate to learn more.

To its credit, Morningstar did not dumb it down. It was a day rich with information across many asset classes and structures, and I have attended fund manager and adviser days where I have learned less. Topping the bill were Lyndsay Maxsted, Chairman of Westpac, and Kerr Neilson, Managing Director and CEO, Platinum Asset Management.

Here are some of their more interesting observations (with my paraphrasing but with no editorial comment. I’ve tried to capture accurately what was said but without the length of word for word quoting).

Lyndsay Maxsted, Chairman, Westpac

Let me give some comfort on housing. First, there is no imbalance between supply and demand for housing in this country, and if there is, it’s probably lack of supply. You can have micro exceptions, such as inner city apartments, holiday homes, Gold Coast, these are vulnerable in a downturn. We also look hard at ‘one industry’ towns. But they are micro exceptions.

Second, Australians take their home borrowing very seriously. They want to pay off their debt so they can keep on owning their home. It’s a really important attitude.

Third, because of the significance of housing for banks, the credit process we go through is just as intense as for business loans. There are dramatic differences between Australian housing lending and the US. In the US, a large part of lending is done by brokers, and the person who ends up holding the credit risk is not the originator. Here, the loan goes onto our books and we do the credit assessment. We heavily stress test our book.

If you look at the levers for Westpac’s profitability, I don’t think there’s much more left in margins, and there’s not much gas left in impairments, due to where we are in the bad debts cycle. And nobody thinks credit growth will go up to pre-GFC levels. That’s a good thing, because it gives rise to a GFC at those high levels. Don’t expect revenue to come from there.

But think about the role wealth plays for banks these days as opposed to credit, think about where you want to play in Asia, that’s a growth story but whether it is profitable growth is debateable. The other piece is productivity and cost control. At Westpac, we lead with a cost to income ratio of 40 to 41%. Plus there’s the whole technology piece.

And if you look at the Big Four banks, it’s an amazing strength. Think of the customer strength, the distribution strength, the quality of the brand, all four banks are well-managed, there’s no reason why that should be eroded.

On future regulations, in terms of what we know, we have gone a long way towards what the regulators want us to do. There’s no leverage ratio in this country, and I hope it doesn’t come in. Liquidity still has a bit to go, so all of us are building up our liquid assets, depending on how they finalise the liquidity commitment facility and address the lack of government securities in this country. On funding, we’ve all made giant strides in terms of switching away from short term wholesale into retail deposits. On that journey, we’re 75-80% down the track.

Up until about 12 months ago, the biggest issue for the banks was Europe. In 2011 and 2012, the worry was whether something would happen overnight like a Lehman Brothers experience where one of the bigger banks defaulted. And how would that flow through global financial markets. Since Mario Draghi (of the European Central Bank) came out with the ‘whatever it takes’ statement, it has lessened the issue considerably going forward. I hasten to add it has not addressed the major issues. What has overtaken it is the whole QE piece. How is that distorting financial markets? We call it a ‘wall of liquidity’, but a lot of that liquidity is not going down into the underlying economy. It’s floating around in financial markets, and the word ‘bubbles’ then comes to mind. Where are they? We don’t think housing in Australia is a bubble, but we watch it like a hawk. But how do you come off this drug, and what happens? Nobody has been here before. What happens when the tapering starts? We saw what happened at the mere thought of tapering by maybe $10 billion of $85 billion a month.

I’m a big fan of superannuation. If we look back at what Paul Keating did, we have a lot to be grateful for. We need to make sure we don’t go too far along the risk curve in the search for yield and growth, and remember what superannuation is for. There’s been a lot of press on banking lending to SMSFs but it’s not a big part of our business. It’s very specialised and highly regulated.

We want a better, consistent environment in which to make our investment decisions. We have not had that through the minority Labor Government. That’s not a political statement, as ‘minority’ is just as important as ‘Labor’ in that sentence. We want to know when we make a decision, the rules won’t change.

The high Aussie dollar is holding back investment decisions. Is 75 to 80 cents the ‘natural range’? I’m a great believer that no matter what the RBA does, this is 95% what the US Fed’s doing, we’re dependent on that whole QE piece. With those provisos, we need an environment which encourages investment and attacks the high cost and high regulatory environment.

I’m very bullish on China, that’s got a long way to go (you’d expect that of a BHP director). The commodity boom is not over, although it’s over in the context of iron ore at $185, and the commodity boom for the support industries around mining is over, as that push to open mines, build ports and rail, that’s stopped. There’s still plenty of money to be made in mining.

The big issue for any mining company is commodity prices. Even BHP, the world’s largest miner, has little control over prices. In terms of dividend and profit streams, the advantage that BHP has is that it ran hard on capital expenditure in 2010 and 2011, on the back of the mining boom, and there’s no need to do that again. The good thing for investors is that money was not wasted. It was put into mines and ports.

Companies have to be careful not to change policies just because a group of shareholders want something at that point in time. What’s more important is consistency.

I think about sustainable competitive advantage a lot. What’s our UVP, our Unique Value Proposition? What makes customers come to us? And the flipside, what are the risks? Strategy is about where you are now, and where you want to be in the future.

Kerr Neilson, Managing Director and CEO, Platinum Asset Management.

We are interrupting the true behaviour of the markets by quantitative easing. We are removing the market mechanism for finding the correct cost of capital. We’ll end up with some huge distortions in the value of different assets. We’re seeing is already in property in places like London and Dublin, and it’s washing through to equity markets.

The world will grow. I expect emerging markets to grow at about 5%, developed countries about 2.5%, the world at 3%. The world is being driven by emerging markets, with developed markets now less than half of economic activity across the globe. The world is fine. The US has got a lot going for it driven by cheap gas. There’s a very aged car fleet and housing has improved. Banks are not lending as much as they could, and it must lift.

The two worst things we can engage in when investing is recency bias (over-emphasising near-term events), and extrapolation, assuming the recent trends will continue.

When investing, ask yourself, “What is your edge?”. What do you know that others do not. If you do not know more, chances are it is fully priced. There’s no point buying a good company that is fully priced, especially since many of us do not have the discipline to hold it through thick and thin. If you pay a full price, you have to sit with it.

We’ve been in business for 19 years, and in that time, a $1,000 invested with us would be worth $9,500. In the index, it would have gone to $2,500. But tragically, because of impatience and loss of faith, people have only earned with us on average about $3,500. Please think about your mentality.

I’d like to put to bed one terrible myth about Japan. The argument against Japan is that the population is aging. But the key is we live in a highly integrated global economic system. Many Japanese companies have one third to one half of their profits coming from abroad. The world is their market. That’s the opportunity.

The Aussie dollar is not exactly the cheapest currency. France’s minimum wage has been a concern to Europeans, it’s nearly twice that of Germany. Yet our minimum wages are higher than France. We’ve got some problems in terms of adjustment, the Aussie dollar has lost some of its big drivers.

We think we’re on the verge of a second great internet revolution. Most of you have not heard of the great companies involved. It indicates it’s still early days. In the last boom, we had the hardware suppliers, this time it’s the content suppliers and network groups. What is exciting about this is that your phone number is tantamount to a mobile internet address. Your phone is connected to 1.5 billion people. It is liberating emerging countries. In Africa since 2000, we have gone from 10 million connections to over 700 million. Think about the effect on things like payments and crop planning. This is happening everywhere.

The world is fine but it does not mean the stock markets are fine. When I look at the overall US market trading at 16 times, having rerated in anticipation of earnings that have barely come, that’s not particularly interesting. But when I delve into that market, it’s the composition and particular stocks that matter.

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2 Responses to Insights from Maxsted and Neilson

  1. Warren Bird November 15, 2013 at 3:22 PM #

    I was also at the Morningstar conference. I think Graham has captured the key points of the two best presentations of the day very well.

    The only thing I would add is that Kerr Neilson delivered his presentation with a tremendous positive energy, which was inspiring. It reminded me of the days when I had the privilege of sharing a luncheon session with Greg Perry, experiencing first hand the enthusiasm he brought to the table. There are few things more enjoyable than listening to men who have great insights and share them with passion, enthusiasm and clarity.

  2. Peter L November 15, 2013 at 11:39 AM #

    Nice article Graham.

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