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Fund Manager Focus - October 2013

Orbis Investment Management - London

Orbis was founded in 1989 to provide clients with performance-oriented global investment management based on the principles of longterm, fundamental and contrarian thinking. We continue to manage the same equity and absolute return funds offered since the firm's inception, and have selectively added new ones when we believed they served the best interests of our clients. While these principles remain unchanged since inception, we have continually reinvested in our people, processes and technology to build scalable and sustainable investment and operational capabilities.

Our approach to investment management and the firm's Core Values can be traced directly to the vision of our founder and Chairman Allan W B Gray. A graduate of Harvard Business School, Allan began his investment career in 1965 at Fidelity Management and Research in Boston. After eight years at Fidelity, he returned to his native South Africa to start his own firm, which later became Allan Gray Proprietary Limited. That firm is now the largest privately owned and independent asset manager in Southern Africa and continues to share a close business relationship with Orbis.

Orbis had $26 billion in total assets under management as at 31 March 2013 – how much of that was invested in US companies?

As of 31 March 2013, our total US equity holdings were $9.2 billion.

Is the London office where fund managers/analysts are based or is there research done from Bermuda for example?

It's important to understand that we do not have a single "research department". Instead, individuals belong to smaller, independent teams according to their area of responsibility and are based in several of our locations. We believe that global markets are best researched through a combination of global sector focus and regional or national market focus. Accordingly, our analysts are organised into independent research teams focusing either on global sectors (e.g. global financials, retail) or a specific region (e.g. Japan, US). In London, we have teams responsible for European and Japanese equities as well as teams responsible for global sector research, quantitative analysis and currency research. In Bermuda we have equity analysts as well as a separate team responsible for portfolio construction. In addition we have teams in the US and Hong Kong, responsible for research in North America and Asia ex-Japan, respectively.

What is your investment philosophy?

We seek to invest in shares of companies that trade at a significant discount to our assessment of the intrinsic value of the business. We believe that share prices ultimately reflect intrinsic value and we are prepared to wait patiently as our investment thesis plays out. We also recognise that even the best stockpickers are wrong about 40% of the time, so we seek to mitigate permanent losses of our clients' capital when this occurs. When executed in a disciplined and consistent manner over the long term, we believe such an investment philosophy offers the potential for superior returns and reduced risk of loss.

Would you describe Orbis as a value investor? A contrarian investor?

We prefer to describe ourselves as long-term, fundamental and contrarian investors. Our style does not fit neatly into any of the traditional "boxes" used to classify investment managers. While we always seek to identify shares that trade below our estimate of their intrinsic value, we are not "Value" managers in the sense of limiting our search to shares with low price-to-earnings or low price-to-book value multiples. We recognise that the inability to categorise us as what others might call "Value" or "Growth" managers may present a complication for clients when evaluating portfolios, but we must stress that our approach is inseparable from our objective of superior long-term investment performance.

Do you use screens?

Yes. Time is our most precious resource. To make the most of it, we use a structured research process to help analysts quickly eliminate unattractive ideas in the early stages and concentrate their efforts on a handful of their most promising ideas. Experienced analysts typically begin their search for investment ideas by using our proprietary stock-screening tools, with the objective of identifying stocks that trade well below intrinsic value. These include screens based on standard valuation metrics (e.g. price-to-earnings, price relative to tangible net asset value), internally developed quantitative models and flexible tools that each analyst can tailor to their specific needs. A variety of qualitative methods are also used to identify potential ideas. Newer analysts tend to initially work on stocks that have been identified by an experienced mentor, but they are expected to increasingly selfdirect their research over time.

Is meeting companies part of your investment process?

Yes, but direct contact with a company is usually undertaken only in the final stages of our research process. We believe that it is important for our analysts to form their own view of the key investment considerations prior to meeting with management. The initial research process could also involve meetings with companies who are either competitors or suppliers. On an ongoing basis, we routinely engage with the management teams of the companies of which we are shareholders (as well as their competitors or suppliers) and consider this interaction to be valuable. This could occur following the publication of company results or simply on an ad hoc basis, and could be either a private or a group meeting. The frequency of all meetings is generally at the discretion of the individual analyst, in keeping with our philosophy of individual accountability.

Do you prefer dividends vs buy backs or do you look at this on a case by case basis?

We look at this on a case-by-case basis. Where appropriate, our analysts will consider the role of dividends and buybacks in light of each company's unique circumstances and broader capital allocation context.

Is ESG/SRI a consideration?

Our analysts consider sustainability issues as part of our bottom-up investment process. Where relevant—but only where relevant—such matters will be explicitly mentioned in research reports and/or discussed as part of our investment process. For the same reason such issues are also considered on an ongoing basis as part of an analyst's monitoring of a stock after its purchase. Where an ESG factor materially impacts our investment thesis for a stock, we would engage with management directly —and our strong preference is to do so privately. We do this on a case-by-case basis, rather than under a formal policy, but in accordance with the overriding objective of acting in the best long-term interests of our clients. Similarly, we exercise voting rights in a manner we believe is consistent with the best interests of clients and do not delegate that voting decision to a third party.

What's an average position for the global equity fund?

Fifty core positions made up more than 80% of the Fund as at 31 March 2013. The average size of these 50 core positions was $210m as of that date.

Market cap cut off?

At the end of March 2013, around two-thirds of the portfolio was in stocks with a market cap of $10bn or higher.

Average length of a holding?

As long-term investors, we conduct our research with a three- to five-year investment horizon in mind. With the market generally more focused on the short term, our approach can uncover opportunities that others have missed or are simply not willing to consider. Investor sentiment can take a very long time to change course and the turning points are very difficult to forecast. When we decide to buy a share, it is often out of favour and may remain so for a long time before turning around, if ever. We are prepared to wait patiently for our investment ideas to bear fruit. At the same time, we continually reassess our positions to see if we are wrong. Over the last 10 years we have held a stock for a little over three years on average. This is somewhat shorter than our stated three to five-year horizon because stocks can sometimes reach our estimate of intrinsic value much sooner. In other cases, it becomes clear that we are wrong at an early stage. In both instances, we look to reallocate the capital to more attractive opportunities.

Anything you won't invest in? e.g. biotech or non-profitable companies.

We would say that nothing within our universe is explicitly off-limits, but we always aim to buy stocks below our estimate of intrinsic value and with an adequate margin of safety. As a result, we tend to find it harder to gain conviction in the intrinsic value of certain types of companies, e.g. those with short histories. In other cases, we find it hard to get comfortable with the downside risk, e.g. heavily indebted companies.

Price target when you buy a stock?

We don't set explicit price targets when buying stocks, but our analysts will always develop a detailed assessment of the company's intrinsic value, often under a range of scenarios (e.g. base case, bull/bear case). Our objective is to buy at a significant discount to that estimate of intrinsic value, with a three to five year investment horizon in mind. Our sell discipline is not driven by specific target prices or returns at which stocks are automatically sold. Instead, it is driven by an ongoing assessment of the discount to intrinsic value of all the stocks in the portfolio. New buy ideas will usually "push out" the weakest incumbent ideas with the smallest discount to intrinsic value. We do not set quantitative stop / loss limits, as we often find that a price decline makes a stock more attractive. Instead, substantial price moves normally cause us to review the stock's fundamentals and reassess our investment thesis.

Active share ratio?

Orbis Global's active share was 93% at 31 March 2013, and has typically been well above 90% for most of the Fund's history.

Which index do you use as a benchmark?

The Orbis Global Equity Fund's benchmark is the FTSE World Index.

US healthcare insurers comprise approximately 10% of the Global Equity Fund, what do you like about WellPoint, Humana and UnitedHealth?

At 31 March 2013, Orbis Global had 10.1% of NAV in North American healthcare stocks – predominantly US healthcare insurers. Although holdings in this sector have made a positive contribution to the Fund's relative performance since the positions were initiated, they were punished in 2012 due to fears about US healthcare reform implementation and its impact on future profitability. At 31 March 2013, on average, the health insurers in the Orbis Global Fund were trading at just eight times our estimates of 2013 earnings, or a little over half their long-term historical average. At these valuations, the market essentially assumed a collapse in the insurers' ability to generate cash flow in the future, an outlook we viewed as far too bleak and extremely unlikely. When weighing the challenges and opportunities presented by reform, we estimated that these insurers could continue to deliver double-digit earnings per share growth rates on average for the next five years and generate substantial free cash flow, the majority of which would likely be returned to shareholders in the form of dividends and share repurchases.

Energy stocks such as Weatherford account for approximately 9% of the global equity fund, what do you like about these stocks?

At 31 March 2013, Orbis Global had 9.5% of NAV in Oil & Gas stocks globally, the bulk of which was invested in North America. Although this is close the same weighting as that of the FTSE World Index, the stocks we owned in Orbis Global were very different. In general, we found more value in oilfield services stocks and smaller exploration and production shares than in the well-known majors such Exxon or BP. Ultimately this positioning was driven by bottom-up considerations. For example, Weatherford International in particular appeared undervalued on any assessment of its normalised earnings power. The company's operating margins were near cyclical lows and valuation multiples were depressed relative to history; we expected both of these to revert back to average over time. Weatherford was also extremely out of favour with the market after a long series of earnings misses and a restatement of its financial statements. Our view was that the bulk of the company's troubles were behind it and that its cross-cycle earnings power was not reflected in its share price. Weatherford also stood to benefit from strong secular trends. Oil has become harder to extract and this increases the demand for the technology and services that enable successful field development.

Within technology you favour networking equipment and semiconductor manufacturers such as Micron Technology as they have been "the worst performers in the sector", why do you favour these stocks?

It's important to remember that we pick stocks on a case-by-case basis and any sector-level exposures are an outcome of that bottom-up stock selection process rather than our intent to position the portfolio a certain way. Micron, which was the Fund's largest holding at 31 March 2013 at 5.9% of NAV, stood to benefit from the acquisition of bankrupt competitor Elpida, which accounts for 15% of industry capacity. We believed this would be a critical structural change that would consolidate the memory industry and improve profitability for the surviving players. We also expected Micron to benefit from a cyclical pricing recovery driven by rational capital spending and limited supply growth throughout the industry. The thesis is also predicated on a cyclical recovery in DRAM prices, which were sitting near cash costs for industry leaders and well below for marginal players. While the timing is uncertain, we believed the industry cycle was close to a trough and Micron was also much better capitalised and more resilient than it had been in previous troughs.

Any Canadian holdings?

At 31 March 2013, Orbis Global had 1.1% of NAV in Canada, almost entirely in shares of Lightstream Resources Ltd.

Recent sales and why?

Perhaps the most significant change in the past year has been the Fund's reduction in US technology holdings. At 31 March 2013, Orbis Global held 9.4% of NAV in US technology versus 20.5% at 31 March 2012. As always, this change was driven by bottom-up decisions on stocks such as Cisco Systems and Qualcomm. In the case of Qualcomm, the discount to our assessment of intrinsic value narrowed. With Cisco, we reallocated capital to more attractive ideas, notably Micron.

The views expressed above are subject to change without notice. There can be no guarantee that any forward-looking statement will be realized. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events, or otherwise. A Fund may buy, sell, or hold any security discussed herein, on the basis of factors described herein or the basis of other factors or other considerations. Fund holdings will change.

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