Damian Cilmi:Welcome listeners to another episode of the Praemium Investment Leaders Podcast. I'm your host, Damian Cilmi, head of Investment Managers and Governance at Praemium. Today we're joined by Suhas Nayak, portfolio manager from Allan Gray. Allan Gray was founded in 2005, and is a specialist Australian equity manager, located in Sydney with FUM of $10 billion across institutional and retail clients. And about our speaker, Suhas Nayak joined Allan Gray as an analyst in 2011, has been a portfolio manager since 2016. And prior to this, Suhas Nayak spent five years at McKinsey & Co leaving as an engagement manager. He has a Bachelor of Science with honors from Caltech, and holds a doctor of philosophy and mathematics from Stanford. Suhas Nayak, welcome to the program.
Suhas Nayak: Thank You.
Damian Cilmi: So today we're going to talk about Australian equities, value investing, and contrarian behavior, and it's been an interesting period for value as an investment style with a growth factor dominated for an unprecedented five years or so. And then value making a bit of a comeback in 2022. But the picture in 2023 has been a little bit more mixed with investors herding once again into a few favorites. So, we're going to talk about herding contrarian behavior and your approach to all of this. But to kind of set the scene, just tell us about Allan Gray's, I suppose, unique investment approach to invest in and how you've organized your team to deliver on that.
Suhas Nayak: Yeah. So, Allan Gray is a long-term fundamental and contrarian manager. I think the long-term and the contrarian bits are the key features of the strategy. Being long-term can be difficult in this environment. In most earnings calls you get analysts who are always asking about the next six months, the next 12 months of earnings, and what could sway earnings here or there over that period. But our task is really to focus on what the next 3, 4, 5 years could look like. And so that can be difficult in this world filled with noise and information. The second part that could be difficult is being contrarian and doing it consistently. And why is it difficult? Well, generally means that you're going to be going after fairly unpopular stocks, things that most people will think are close to basket cases, and you're going to look embarrassed at times.
And so, it goes against most of our instincts as social humans to be in unpopular areas of the market and then be willing to be embarrassed every now and then. And so how do we organize ourselves so that the strategy can keep delivering that long-term focus and being contrarian consistently? It comes down to people and process, and I think on the people side, we try and hire people who are, have a bit of a science and engineering bent who don't have the baggage from other investment firms because, you know growing that capability within the firm tends to be quite important. And so we try and find these sorts of people who can separate fact from opinion and that helps us stay different, stay contrarian and stay long-term focused. And then on the process side, I think we try and make sure people act independently. And we ensure that all voting on stocks is done independently ahead of time. And we try and avoid that group thing that can, that can come to permeate firms. And yeah it could detract from this, the strategy.
Damian Cilmi: And that's an interesting point in itself, where you kind of want individual thought in a sense, but then you still want collegial behavior. And also, there has to be a common direction as well. So, kind of getting that bAllance right, it's very, very difficult, I imagine.
Suhas Nayak: It is. I think we want our analysts to have the freedom to explore and we encourage them to do that. And when we debate ideas, it's not about the analyst who's brought the ideas and hopefully they realize that it's not about them, it's about the idea.
Damian Cilmi: And so for many, going against the herd, and you kind of touched on that earlier it can be, it's extremely uncomfortable for humans generally , so what, why should advisors consider adopting this kind of mindset of seeking, I suppose, discomfort and going against the herd with their own investment decisions and how they position client portfolios how does that serve their clients in the long term?
Suhas Nayak: So, I think going against the herd lets you buy good assets at lower prices, and I think over the long run that can deliver outsized returns. When, when you're looking to buy an asset, even when you're looking to buy a house, you're trying to get a good deal. And you get a good deal when there are more sellers typically in the market than there are buyers. And that happens normally when people are a bit uncomfortable about the situation for whatever reason. And so, we're trying to find those opportunities in the market where there's a discount to what is fair value and, and there's a reasonable discount. So, you've got a little bit of a margin of safety when you are deploying that capital. And then I guess on the flip side of that, we're trying to buy to sell those good assets when prices match the quality of those assets. And so we're buying assets at a discount and then selling back at that in intrinsic value that we see, see. And I think that's, that's a way to deliver returns over the long run. I think the other feature of this is that we can be quite uncorrelated, and so there is a bit of a diversification benefit for clients over the long run as well.
Damian Cilmi: So, on that point for many, the, the idea of going against a herd, and you, you kind of mentioned that a few times it can be uncomfortable. It's not something that's very natural to humans. So why should advisors also have a look at adopting this kind of mindset for, with their own portfolio construction?
Suhas Nayak: I think going against the herd lets you buy assets at a discount and then hopefully sell them at, at prices that are closer to intrinsic value. And doing that consistently over a long period of time can deliver outsized returns. And I think that's what we try and do. Going against the herd means that often there are more sellers in the market than there are buyers in the market. And that often means that you can get a good deal when you're out buying a house, that it's helpful when there aren't too many other people competing for that asset. And I think that's the kind of philosophy we bring to equities as well. And over the long run, I think that can deliver returns with some volatility in the process, but it also can deliver quite a bit of diversification because we don't have a lot of overlap with other managers in terms of the names we hold. And that diversification can also help client portfolios.
Damian Cilmi: Yeah. And that's true looking at your portfolio holdings compared to many of your peers, there is a very different set of top names at a minimum. And I think it extends all the way through. And there there's definitely some benefits from that blending perspective not only in names, but also when those returns are going to occur. Would you say you're probably the deepest value manager out there in the market?
Suhas Nayak: Well, I think, I think there is very little overlap in the names that we have with other managers. And I think it is actually a prompt that we have when, when we see other managers hold some of the stocks that we have at large weights, we do wonder whether we're in the right places, because if we're trying to buy things that are cheap because they're unpopular and there's a bit of discomfort around then we may not want to be in some of those names. So it can be a prompt for looking at new stocks.
Damian Cilmi: Fair enough. And, and looking at those un uncomfortable stocks how do you differentiate between genuinely undervalued, all those are just simply underperforming and, may not re-rate in the future as well. Because that's a bAllancing act. You need the market to recognize what you’ve recognized, eventually, and have the herd catch up. Are there telltale signs that you could see on those stocks that do turn around?
Suhas Nayak: I wish there were unfortunately, I think with investing good managers, very good managers, get it right 60% of the time. But there's the flip side to that. Even those good managers get it wrong 40% of the time. And it's probably something that most people don't want to admit. But getting it wrong 40% of the time means that you are going to look embarrassed every now and then. And, are there ways to figure out which ones are going to end up on that 40%? Probably not. If there were telltale signs, those telltale signs would probably be priced in by the market and some of the opportunity would be lost. And so, there aren't metrics as such. I think one of the learnings we've had over the last 10 or so years is that when you are buying things that are structurally challenged and we do that from time to time, you really want to buy them very, very cheaply. And I think that is the one thing that perhaps over time we could make sure that we're doing that more than we have in the past.
Damian Cilmi: And does that protects you like in terms of an asset breakup at that point of time,is that where the protection kind of comes in? Are those really depressed, structurally challenge levels?
Suhas Nayak: Yeah, I think the asset backing helps. But I think the reason that you really want to buy them very, very cheaply is that structurally challenged companies because they have an imperative to survive. They end up using the capital that they're generating, even if it looks like a lot of capital relative to the share price, they'll use it to dig themselves out of the hole. And it doesn't necessarily come back to shareholders at the rate you would expect. And I think that is that is something we've learned probably the hard way of the years.
Damian Cilmi: Yeah. Lots of experience, I imagine, and very much through the team. And so let's just talk about certain sectors. And is there any sectors in particular that have been more uncomfortable than others? And are those sectors they showing some latent opportunities? Is there something structural around that there, or do these sectors kind of rotate, let's say over time and then new ones are unpopular?
Suhas Nayak: Yeah, we're bottom up builders of portfolio, so we look for individual stocks to put into the portfolio that look deeply discounted. But every now and then, there are particular sectors that have a collection of those stocks that look particularly interesting. And so, the portfolio looks quite tilted in a particular direction. Back during the GFC there was the REITs, they got really hammered. The portfolio went up to 30, 35% exposure to REITs, which is huge in the context of the market. A huge overweight but that's where the value was identified. And so we went in hard there. More recently the portfolios had up to 20, 25% in energy up until 20 21, 20 22. Because again, that's where the value seemed to have been built up, or the latent value.
And so, the portfolio from time to time does tilt towards particular sectors. We're now at the stage where maybe there isn't a clear sign as to which sector, the opportunities seem to be a little bit more idiosyncratic. But there are particular sectors that are generating some interest from a research perspective. So, things like office REITs are starting to look interesting, consumer discretionary, because everyone's afraid of the recession that's coming tomorrow.
Damian Cilmi: It's still a work in progress, but what does the negative sentiment says around office REITs and discretionary that’s guiding this very poor outlook?
Suhas Nayak: I think with office REITs, it's things like occupancy levels and declining occupancy levels. As you know, people work from home, and a recession would compound that because there would be less demand. And I think over the years, a lot of the assets have been written up to quite extraordinary levels because of lower and lower interest rates. And so those three things kind of working the other way may change people's view of the future trajectory of earnings.
Damian Cilmi: That's because there's a tendency to extrapolate. So, I think like on a work from home and obviously office attendance as everyone's kind of thinking, well, it's only 20% occupancy they're ever after.
Suhas Nayak: That's right. Yeah. And, and so that's the worry if occupancy suddenly drops by that 30, 40% because people don't need as much office space as they had wanted in the past, then there's going to be a lot of space and income streams for these office REITs are really going to collapse. And that's where I think the fear is starting to build. It's that kind of scenario that’s not yet reflected in share prices. But some of that trajectory towards that is starting to get priced in. And so yeah, it could get interesting and there is hard asset backing around particular buildings. And if there are good buildings and good locations, then maybe there's some value in some of them, and it isn't there.
Damian Cilmi: There’s some discussion now about CBD buildings about where they could get converted also into residential as well. And this kind of I suppose overlapping around housing shortages as well too. So, there could be a refurb or a re-engineering of some of those.
Suhas Nayak: It's true, although the repurpose costs are quite high. For instance, offices only have one or two bathrooms for floor. You need a lot of extra plumbing to get apartments out of them. But that's not the only cost.
Damian Cilmi: And on consumer discretionary as well too, I suppose this, this looming recession that we've been waiting for since, like probably back of 22, and now we're in third quarter of 23, it hasn't shown itself in its full form as yet, but is that put a lot of negative sentiment around discretionary?
Suhas Nayak: Yeah, I think the sentiment around the recession has rolled through different stocks at different times. And so, we've been trying to find those stocks that are pricing in recession the most, because if a recession happens, it's already priced into the stock price. If it doesn't happen, they're going to do well, and if it does happen, well fast forward a year or two and the recession's over as long as the assets are still good and the earning streams are more or less intact, then those stocks should do quite well from where they are today as well. So, there are some opportunities that we're finding in things like building products and some select consumer discretionary names where I think people are starting to think, well, earnings next year are going to be awful. And they may well be but again, it's that long-term focus and trying to look through that, see what's on the other side.
Damian Cilmi: And they have there's certain discretionary stocks and kind of surprised a little bit on the upside in the, in the last 12 months or so because the sentiment has been that bad and when it's come through, it hasn't been as bad as what everyone expected. So, you've kind of seen that in this last 12 months already, that kind of a behaviour.
Suhas Nayak: I think most recently Harvey Norman was one of those companies that delivered a sales number and a sales update that that didn't look so good. But I think there was a bit of a relief that it wasn't worse. And you know, that's happened to a few different few different names in the market. And it's not to say that the sentiment might not turn again when the recession that everyone expects happens. But yeah, these relief rallies are not uncommon.
Damian Cilmi: So, you're constantly probably having to defend very unpopular decisions. So how do you manage these concepts were with investors because it's not only uncomfortable starting, but then the positions that get entered into. So, so what kind of strategies and techniques have you developed over the years to dealing with investors about some of these very uncomfortable positions?
Suhas Nayak: I don't know if I'd go so far as to say strategies and techniques. I think we just are who we are and we, we try and make sure that investors understand who we are. And I think that right from the get go, they hopefully they understand that we're contrarian that we're going to be holding very unpopular things that we're going to underperform and test people's patience. From time to time. But over the long run hopefully they'll see the rewards of that. But I think being transparent around what we hold and being upfront about our mistakes through the cycle and through many cycles will hopefully are understood by our investors.
Damian Cilmi:And I remember reading one of your last updates around Lendlease and I think there was a very clear and transparent communication about your thesis on LendLease, to help investors understand exactly why you initiated that position, where you see the latent value. Any kind of summary thoughts about that Lendlease position?
Suhas Nayak: I think that where it trades today is below NTA, which is unusual for a company that is a developer and has a lot of its bAllance sheet written or booked at cost. And I think if I were to summarise the thesis in that respect, that that's where the value is it's to say that these things should trade at a premium to NTA and we're getting it at a discount. So there seems to be value, but there's also risk. And I think we're staring into what could be a property downturn, making it difficult for Lendlease to realise assets at good prices. And that can detract from some of the capital that they've already invested. And I think that's where the fear is, but hopefully that's where also the opportunity is.
Damian Cilmi: Yeah. Excellent. Alright, we might leave it there. That was an excellent discussion. Thank you, sir. It was a pleasure having you on the show and hopefully we'll see you again.
