Keep it simple, stupid

SG Hiscock & Company
Andrew Gillies
Andrew Gillies
SG Hiscock Analyst
Lao Tze: “If you want knowledge, add things in. If you want wisdom, take things out.”

Complicated issues, expressed simply, demonstrate understanding. Our understanding of issues informs our decision-making. The confluence of our decisions is our portfolio performance.

Some people may call this reductive, but I think a complicated world often needs a simple lens. It’s why great players don’t always make great coaches – sometimes they know so much but can’t coherently convey their thoughts in an organised fashion. It’s no different in portfolio management. 

So it follows that we approach a world of complex issues with a simple framework. We are not ignoring complexity; we are distilling it and refining it to a decision. 

Let me use an example. Now we have effectively been dis-Mayed, let me echo the approach of my article last October in analysing the US-Sino Trade War.

If there were Ten Commandments for analysing geopolitical issues - or anything for that matter - this would be number one: don’t confuse your opinion with an analysis. Donald Trump has no idea what he will do on any given day, how am I going to have any idea what he will do? Herein lies a key realisation: there are no definitive forecasts in geopolitical issues. 

Suffice it to say that the only certainty is uncertainty; especially with the ever-mercurial “Donald” aggressively waltzing his fingers across his smartphone with the political nous of his cartoon contemporary. 

So with such volatility, little insight and multiple potential outcomes, how do we approach these issues?

Our answer is simple. When outcomes are not binary, we remind ourselves that portfolio positioning isn’t either. If we think something is 80% likely, we can manage portfolio weights to account for that. Conversely, if it’s 20% likely, we can position for that in a similar fashion.

In short, I ask myself the following:
What’s the probability?
What’s the consequence?

Once I come to a conclusion on this, we discuss:
What are we doing about it?
What if we’re wrong?

Let’s look at the Trade War, and how we apply the framework above.

Although it may have started as a Trade War, we think it is more than that now. Much like the Cold War, this is now an economic arms race to protect the interests of two nations. It would be nonsensical for China & America not to prepare for the worst outcome and hope for the best. 

It’s clear these issues represent structural differences between economic systems and political frameworks that are integral to the functioning of the Chinese and American mode de vie.

These differences are not amenable to resolution; subsidies to state-owned enterprises, government influence in markets, unfair and unequal investment rules and the respect of intellectual property are issues that have simmered away for years, and are unlikely to go away in the short or medium-term. 

The Chinese know this and are in for the long-haul. Actions of Communist party leadership deliberately echo the zeitgeist of the Opium Wars of the 1800s and the Long March. These are landmarks in the history of China, both of which are inexorably linked to their sovereignty and identity as a nation.

Xi Jinping and fellow members of the Chinese Communist Party have alluded to these issues both directly and indirectly, in speech and in action. By virtue of China’s political system, they can play the long game, and need not fret re-election in a democratic context like Donald Trump must. 

Speaking of the Donald, he has, rightly or wrongly, inextricably linked his performance as President of the United States to the stock market. For a long time, in general, the US stock market has outperformed global peers.

This has occurred for several reasons; however, at the centre of this outperformance has been a strong tech sector. Trump has a shorter term view than China, if not by foible, by way of the democratic process he must exist in. He favours a short-term outcome over a longer-term resolution. As such, tech is now the primary battleground for this War.

Looking beyond G20, Trump’s actions are now a sunk cost, and even if Democrats were to win the next election, they would inherit a position that’s harder to wind back from a political and economic standpoint – it’s the new status quo. 

Keeping in mind the tech sector in the US has been supported by the valuation of intellectual property, companies with no real assets have outperformed those that do. Moreover, there is little opportunity to get exposure to tech in other markets. What is the global contemporary of Amazon, Google (Alphabet) or Facebook? Funnily enough, one would look to Alibaba & Baidu, which are Hong Kong entities listed in the US.

Inherent in this valuation of intellectual property is the belief that it will be respected. China already makes a feeble attempt to pretend to respect these laws, but an unbridled disregard for IP would be ostensibly negative for technology businesses.

This is not just hearsay either, China has installed a tech board on the Shanghai Stock Exchange, looking to bring technology businesses back to the mainland. If these businesses don’t need to comply with US exchange listing laws, assuming capital is available in the Chinese market, this could be devastating to global IP protection.

For me, it’s simple: don’t be in a warzone when the shots are being fired. 

In terms of the portfolio, if we are worried about capital preservation, we shouldn’t be overweight tech. We think, even excluding the broader negative effects of this War, that there is a strange conflation of ideology and economics at play, where posturing is important and as such, the consequences are rising. We still don’t attach a high probability to these outcomes, but see it rising.

A specific example of this is Alibaba, a tech business listed in the US on the NYSE. This US listing is actually a Cayman Islands entity with no assets or earnings, just a management contract with the Hong Kong business, in what is called a Variable Interest Entity (VIE). Essentially, it’s a shell or holding corporation with nothing but a management contract.

In the technology space, the Chinese government has asserted VIEs are against the law, as in their view, it subverts the sovereignty of their internet. Simply, they want to have more control, and with an overseas listed entity, they are limited in this control. There are about 80 variable interest entities (VIEs) listed on US exchanges, JD.com & Baidu are two other large examples in technology.

Although the probability of China clamping down may be low, we see Alibaba’s action in listing on the Hong Kong Stock Exchange as a result of the tech board in Shanghai, and potentially the probability of the NYSE listing becoming unviable. When Jack Ma hedges his bets on something he knows like the back of his hand, we think we should too. 

Essentially, Alibaba’s NYSE listing, a US$416billion company, would be worth nothing overnight. This is an event where we see the probability as low, but the potential consequence as high enough to reduce our exposure. We’ve positioned the portfolio to ensure that capital preservation is front of mind, and have tilted our growth-oriented equities to businesses not exposed to this sovereign risk.

If technology is a warzone, this is like playing hopscotch in a minefield. 

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OUR PROCESS

We believe in buying great companies at good prices. We are firm believers in co-investment, demonstrated by our significant investment in our own funds. Our confidence in our investment approach means we always seed new funds with our own money. We have made the decision to cap our Funds Under Management at modest levels, to ensure that the funds retain greater flexibility to generate strong investment returns across varying market conditions. In order to identify the best opportunities for our clients, we undertake a broad fundamental research program which incorporates an extensive company visitation schedule. With an experienced team of investment professionals, our approach to analysing companies is designed to ensure no stone remains unturned.

We engage with a hand-picked team of external research providers to complement our insights in the macroeconomic landscape (both locally and abroad) and general investment trends. We also have an exclusive joint advisory arrangement with one of the world’s largest commercial real estate investors; LaSalle Investment Management Securities, LLC is a subsidiary of global property giant, Jones Lang LaSalle. This provides our property team access to LaSalle’s research capabilities.

OUR ENVIRONMENTAL, SOCIAL AND GOVERNANCE POLICY

SG Hiscock & Company has a formal board-endorsed environmental, social and governance (ESG) policy. This incorporates the key principles of the Australian Council of Superannuation Investors, as well as the framework provided under the United Nations’ Principles for Responsible Investment. SG Hiscock & Company is a responsible investor and we take an active approach to integrating ESG considerations into our investment decision-making process. We believe that the effective governance and management of business risks has a direct impact on a company’s intrinsic value over the long term and helps to reduce investment risk. In order to identify the best opportunities for our clients, we undertake a broad fundamental research program which incorporates an extensive company visitation schedule. With an experienced team of investment professionals, our approach to analysing companies is designed to ensure no stone remains unturned.

We engage with a hand-picked team of external research providers to complement our insights in the macroeconomic landscape (both locally and abroad) and general investment trends. We also have an exclusive joint advisory arrangement with one of the world’s largest commercial real estate investors; LaSalle Investment Management Securities, LLC is a subsidiary of global property giant, Jones Lang LaSalle. This provides our property team access to LaSalle’s research capabilities.