SIMON BROWN: I’m chatting now with Neil Padoa, a Coronation fund manager at Coronation’s Global Managed Fund. Neil, I appreciate the time this morning. When digging through the fund, the one thing that really struck me [is that] your fund isn’t a classic balanced fund. You’ve kind of shied away from the 60/40 idea of being 60% into equities, 40% into bonds. You are moving away from that sort of global asset allocation as it’s usually run. You are still managing to get the returns out of the fund. I suppose that really is in the cliché – it’s stock-picking and getting that part right.
NEIL PADOA: Hi, Simon. Good morning. That’s right. I think you made an important point in the beginning in that the traditional 60/40 balanced fund has played a valuable role for investors historically, especially those with a moderate risk tolerance. We think there’s a risk that the performance of the past is unlikely to be repeated in future. If you think of a typical 60/40 fund, it has 40% in fixed income, and historically that has played a very important role for investors.
Firstly, the returns through the cycle that that fixed-income portfolio gave you were actually decent. That’s because the starting yields were sufficiently high and they were ahead of inflation. That simply isn’t the case today. So, for example, the yield on the US 10-year Treasury is 1.5%. If you invest in that, that essentially locks in a negative real rate of return. So it’s exactly not what you want to do when you are investing.
Secondly, the stabilising effect that that fixed-income portion provided is really more muted. The lower the rates are, the less downside protection one has. Typically that fixed-income part of the portfolio has provided a shock absorber. When equities sell off, typically government bonds increase in value. The lower your starting yields are, the less that shock absorber can function.
So we think investors really need to move away from this 40% allocation to fixed income, and I think that’s what you referred to in our Global Managed Fund, where we find a much broader range of assets that we think are more attractive and perform a better role for the risks that investors face today.
SIMON BROWN: Looking through it, there are some absolute-return, inflation-linked bonds and the like, but I take your point. I suppose the critical component really was, as things were, when the rates were changing, it was [incumbent on] the managers to spot that and adapt accordingly.
I quickly want to touch on one of the stocks in your fund, which is JD.com. You mentioned that you’ve held it since it listed, which was about seven years ago – 2014 if memory serves. Obviously there’s been some pressure in China; we’ve seen tech crackdowns. But you’re still backing a tech stock in the China space.
NEIL PADOA: That’s a great question. A lot has changed in China. I’m sure your listeners are all aware of the regulatory onslaught; it felt like an onslaught at times. Week after week, sometimes day after day [there has been] a new regulation and really a quite intrusive regulation from the Chinese regulators and from the politicians in China. If we step back, it’s quite clear to us that I think the hurdle rate for investing in China has increased. The uncertainty has gone up and the risks have gone up. We wouldn’t debate that.
But there are a couple of things. Some of the regulations we feel have been quite heavy-handed. They could have been done more efficiently, but many of them are actually just regulatory catch-up to what we’re seeing in the US. For example, regulations around privacy, regulations around protecting users’ data. These are just the right things to do for users on the internet, and we don’t think it’s a game-changer for the economics of many of the Chinese internet businesses.
The third thing is that, if you look at individual companies, some are set to benefit from these regulatory changes and we think JD is potentially one of those companies. A core part of the regulations that have been coming out of China is an anti-monopolistic stance. They really want to ensure that these dominant tech platforms are treating their clients fairly and operating not in an anti-competitive manner.
If you look at the e-commerce industry, which is where JD competes, they’re actually the number two in that industry. Alibaba leads with about a 60% market share. JD is far behind at about a 20% market share. So by no means are they the monopolistic business in that sector. If you look at what they’re doing, they’re investing massively in infrastructure to fulfil goods to their customers. They employ all their staff, they treat them very well. They provide appropriate benefits. And really at the core what they’re doing is offering a wide selection of goods to consumers at a good price, a good quality – and they fulfil very quickly. So there’s great customer service. To us that doesn’t seem meaningfully at risk, even given the increased regulations that we’re seeing.
Then finally, if we compare the valuation to what we think it’s worth, we see a huge amount of upside. By way of example, if you exclude the net cash on the balance sheet and if you exclude its investments, we think the core e-commerce business is trading on less than 10 times earnings, which is extremely cheap for something that’s growing north of 20%. If we do the same exercise for a business like Amazon, which you think is actually a phenomenal business, the implied valuation on their e-commerce business is north of 30 times.
That just serves to highlight, I think, some of the discounts we’re seeing in these Chinese businesses, in particular something like JD, which we actually think is on the right side of the regulatory change.
SIMON BROWN: I like your point there. When the state is cracking down on monopolies, we’ll find number two, because that is the one actually going to benefit from that process.
Neil Padoa, Coronation fund manager at the Global Managed Fund, I appreciate the early morning.
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