February 26, 2018

Rupal J. Bhansali: Insist on the “And” Proposition

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A good stock call isn’t just about being right — it’s also about being different, about diverging from consensus. Rupal J. Bhansali, chief investment officer and portfolio manager of international and global equity strategies at Ariel Investments, described this concept as the “And” proposition.

“Contrarians insist on the ‘And’ proposition. They refuse to settle for sub-optimal compromises,” she explained at the 8th India Investment Conference. As a contrarian value investor, Bhansali rejects the conventional idea that investors must choose between low-risk and high-return investments. She values non-consensus thinking because it sidesteps convention and finds ways to transform either/or choices into “And” propositions that deliver both results.

Bhansali explained that some of her most successful investments were in companies that avoided the conventional wisdom of either/or tradeoffs. Her success has come from identifying firms that have mastered these “And” propositions before they were recognized and priced by the markets.

Michelin: Safety and Fuel Efficiency

Forecasts in 2011 anticipated a bleak year for auto component manufacturers, but Bhansali recognized that Michelin was using non-consensus thinking to avoid a difficult tradeoff. Tire manufacturers face a competing set of either/or demands: Consumers want safer tires that grip road surfaces more tightly, but tighter grips mean less fuel efficiency. So the conventional tradeoff sacrifices fuel efficiency to deliver safety. Bhansali and her team realized that Michelin had found a way to provide both safety and fuel efficiency, which meant consumers would pay more for its higher-quality product.

Meanwhile, the market considered tires a low-tech commodity that competing firms could easily copy. “We can buy a fake Louis Vuitton bag,” she noted. “Why can’t we get a fake Michelin tire?” Bhansali didn’t buy it.

She found that the flood of low-cost tires from China had little effect on Michelin because its manufacturing process required specialized knowledge and could not easily be reverse engineered. “Very few people can copy what they have managed to accomplish,” she said.

Ultimately, Bhansali’s investment in Michelin outperformed not only because consumers remained willing to pay for quality, but also because tires are consumable and must be replaced as people drive longer distances. “This is what you get when you understand quality in a way that others don’t,” she said.

Microsoft: Desktops, Laptops, and Tablets

At a time when conventional investors were looking at companies providing consumer staples, Bhansali had her eye on enterprise staples. The nature of software licenses, which must be regularly purchased, maintained, and renewed by businesses, meant that they were always in demand and rarely cut from operating budgets — just like consumer staples, but on an enterprise scale. “I can do without shampoo,” Bhansali joked. “But I can’t do without software.”

This perspective helped her recognize that Microsoft wasn’t compromising. The rise of tablets and other personal electronic devices left many analysts concerned about declining desktop computer sales. Either an increase in laptop sales would mean fewer desktop computers sold, or consumers buying tablets and other portable devices would hurt laptops and desktops. But Bhansali recognized that consumers used Microsoft software across multiple device formats, making Microsoft earnings less dependent on the fate of a single platform.

The Microsoft example demonstrates that value investors aren’t confined to niche investments in obscure corners of the market. “These are mega-caps we are talking about,” she said, insisting that value investments can be found across a broad spectrum of equities.

Apple: Picking Winners and Avoiding Losers

Bhansali’s discussion of Apple drove home an important reminder: Sound investment decisions need to meet two equally important objectives. Not only must they select winners, but they also need to avoid losers. After drawing parallels with Blackberry and Nokia, Bhansali said Apple was a company to avoid.

“In a short span of six years, Blackberry stock went up a hundredfold,” she said. But the market’s view of the company’s long-term prospects was completely different from how those prospects played out. New markets brought threatening competitors instead of profitable opportunities, and Blackberry’s competitive advantage — its ability to compress data for easier transmission across networks — eroded with the introduction of new network infrastructure. The consensus view on Blackberry did not understand how the quality of the company was changing. “It was fading quality,” Bhansali said. “And that’s kind of what happens when you misunderstand quality and overpay for it.”

Pointing to Blackberry’s glowing financial metrics during its rise, Bhansali asked, “Don’t we all think about Apple as a similar kind of company?” Apple, she said, is behind the curve on wireless charging, rapid charging, and screen technology, warning that it was “the poor man’s platform company.”

Being Different and Being Right

“Understanding quality is the differentiation that you bring to bear when you are a good research analyst,” Bhansali said. “It is not easy to understand quality. Even after you understand it, you’d better be non-consensus about it. Even if you’re non-consensus about it, it’d better be lasting.”

In her view, the most important aspects of value investing involve using the right lens and understanding the core business of a company. “You know as well as I do that Apple trades on 14 times earnings,” she said, noting that financial metrics are lagging indicators that are widely used to forge the consensus opinion.

“To me, the stock price is a validation,” Bhansali said, “when the consensus comes around to your point of view.”

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/ JDawnInk

January 26, 2016

Insights from India: Opportunities, Aging Gracefully, and Averting Crises

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Insights from India: Opportunities, Aging Gracefully, and Averting Crises

Right now, the economic outlook for 2016 is a matter of perspective. As Bob Browne, CFA, an executive vice president and CIO of Northern Trust, told an audience at the 6th India Investment Conference, the collapse of oil prices and equity market tailspin mean that this is when you distinguish yourself as an investor: A crisis from some perspectives could offer opportunities from others.

Manoj Pradhan, senior economist on the global economics team at Morgan Stanley and another speaker at the conference, saw plenty of opportunity ahead in the coming years. Pradhan observed that three competing points of view attempt to explain the current low-growth economic environment:

But from Pradhan’s perspective, secular stagnation is an unlikely explanation. He expects that productivity will recover and real interest rates will rise along with inflation. The forces at work will not only reverse current trends, but ensure that the next 30 years will look nothing like the last 30.

Aswath Damodaran, who is an inexhaustible source of insights into the valuation process, was also in Mumbai to discuss the life cycle of businesses. Every business is born, matures, and declines, he said, but some experience the decline faster than others.

As Damodaran pointed out, skilled analysts must view companies from a perspective that identifies where they stand in their life cycle, realizing that companies refusing to “act their age” can destroy value. Damodaran also emphasized the importance of balancing numbers with narratives, which is one of his lessons that bears repeating.

During the conference welcoming remarks, Sunil Singhania, CFA, identified five broad trends that would define 2016 for the investment industry, noting that financial professionals should prepare for increased regulatory scrutiny. John Kay, FSIP, a visiting professor at the London School of Economics and chair of the Future of Finance Advisory Council, shared his own thoughts about what regulatory action is necessary to avert another financial crisis. In Kay’s view, the financial system provides a vital service in the form of financial intermediation, but to ensure that this service continues, regulators must restore and uphold ethical standards for investment professionals who handle other people’s money.

Be sure to visit the Indian Association of Investment Professionals blog to read more coverage from the conference.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/Aayushjoshi

January 21, 2016

Today’s Market Is “When You Distinguish Yourself as an Investor”

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Today's Market Is "When You Distinguish Yourself as an Investor"

Investors’ nerves were rattled this week when oil fell below $27 a barrel, sending global equity markets into a tailspin and Russia’s ruble to an all-time low against the US dollar. For some, the rout evoked memories of the uncertainty that roiled the markets during the 1998 financial crisis.

But according to Bob Browne, CFA, an executive vice president and CIO of Northern Trust, the current environment is “nothing like 1998,” although investors would be well served to heed some of the lessons of that crisis.

“Throughout the past several months, and in particular the last few weeks, I’ve been reading and hearing various commentators starting to compare what is happening now to 1998, a year I remember well,” Browne told delegates at the recent CFA Institute 6th India Investment Conference in Mumbai. “I can tell you right off the bat: This is nothing like 1998.”

That’s not to say there aren’t similar opportunities. In the late 1990s, the world was very jittery, just as it is today. The 1998 crisis fed that uneasiness, first with the earlier currency devaluation in Thailand, the larger emerging market crisis, and then the collapse of Long-Term Capital Management (LTCM). “There was so much going on,” Brown said, “so much risk but so much opportunity.”

He reminded the audience of the vast potential offered by the turmoil. “This is the environment when you distinguish yourself as an investor,” he said. “The decisions you make in this environment are the ones that make you wealthy.”

Browne recounted “the infamous Russian 10s of 2007.” These were Russian government bonds, with a 10% coupon bond maturing in 2007. The debt was issued in 1997, so when the ruble crisis started in 1998, the bonds hadn’t been on the market for very long, Brown recalled.

As Browne tells it:

“Russian Federation debt post-Soviet Union started to have some trouble, and we did our analysis. I often tell credit analysts: ‘Know where you stand in line in case of default, who’s ahead of you and who’s behind you.’ It’s really quite important to know where you are in the hierarchy of priority. And we applied the same analysis to Russian debt compared to Ministry of Finance debt — the old Soviet Union debt that was issued before the break-up of the Soviet Union — and knew the Russian Federation would likely default on the Ministry of Finance debt. But the last thing they would default on is Russian Federation debt. So you can think of it as a typical waterfall, where you are in an operating company versus a holding company and which subsidiary had priority and real collateral. Russian Federation debt was that very valuable subsidiary with operating cash flow that was legally distinct from the Ministry of Finance debt.”

Soon the bonds drifted from 90 cents down to 75 cents on the dollar. And that’s when Browne’s firm got very interested. “We bought a little bit at 75 cents on the dollar and then the big move down to the 50s, and that’s when we bought a lot,” he said. “In fact — almost everyone on my team — not only did we buy for our clients’ portfolios, but we bought for our personal account. We had that much confidence in the analysis.”

And then the bonds went from 50 cents on the dollar, to the high 20s, to the mid 20s. “Losing 50% in two weeks is not a good result as an investor,” Browne said. “We did the analysis, but we couldn’t understand why the market wasn’t making the distinction. At 25 cents on the dollar, we doubled up, and then they went down to the high teens, and in a short period, we had lost a boatload of money both personally and for our clients, and we thought maybe we had to get out of this.”

But they hung in there for a bit longer, and over time the bonds got back to par and matured. “It was a rocky road,” Browne said.

So what are the lessons for investors today?

  • Timing Is Important: The Russian 10s of 2007 “turned out to be a very good investment, Browne said. “But it could have been a once-in-a-lifetime great investment if we just waited two or three weeks and understood the market dynamics a bit longer. And it could have been a disastrous investment if we bailed out at 18 cents on the dollar. . . . What advantage did we have — a very important one — over LTCM? We had long-only money. We were not levered. If you are managing levered money, the importance of timing and understanding the stability of your investor base is absolutely critical. At the end of the day, we could wait and just wait for the coupon to come in, wait the news flow to stabilize the situation. If you are getting a call from your prime broker at 11 o’clock and you have to deposit $500 million in additional collateral by the end of the day, that’s the only thing that matters. Your fundamentals analysis does not. Your approach to risk taking really does depend on the nature of the type of leverage you have or not.”
  • Understand Your Investor Base: “Make sure that your risk taking is aligned with that of your investor base.” Browne said. “Do they have the same horizon that you do? Do they understand your process? Do they understand your analysis? Will they give you time to see it work out? If not, you’re going to have a problem.”
  • Different Decision Makers Have Different Priorities in the Capital Markets: “You might think that we are all trying to achieve risk-adjusted returns and maximization of wealth,” Browne said. “You absolutely need to understand who are your constituencies internally and externally in the marketplace. The cycle of investing, what often happens — more so today than even then — you see this evolution where the risk takers put the trades on, then the risk managers take over. Either the CFO or CEO. Be conscious of that.”
  • A Further Lesson: “Think about the markets and what is going on,” Browne said. “Think about how different segments of investors are optimizing for different goals, and that those goals can change over time and the influence of investors can change over time.”

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/erhui1979