How Magellan bucked the trend in global equities

Australian Financial Review, Managed Funds Quarterly, November 2008 

September was about as wild as it can get for investors in global equities – but wild in two such contrary directions that the effect for Australians was almost neutralised.

 The MSCI World ex-Australia index dropped 10.8% in local currency terms in September alone – the worst monthly performance in six years. Those with exposure to financial institutions fared even worse, particularly if they held Lehman Brothers, which vanished without trace and brought the rest of the sector crashing down after it.

 But at the same time, the Australian dollar began a plunge against the US dollar, dropping 8.4% over the course of the month. While that’s not much fun for any Australian hoping to have a holiday in the States, it was a salve to global equity investors, since from where they’re sitting they got an 8.4% boost to returns. The two things almost squared one another off.

 Consequently, the median overseas shares fund in the regular surveys published by Mercer is actually up 1% over the quarter to September 30 (although the market itself has done much better, at 3.6%).

 One gets a sense of the overall carnage in the markets, though, when one considers that even after that free kick from the currency is taken into account, the median overseas share fund is down 17.6% in the year to September 30.

 Amidst the filthy one-year numbers of the 98 funds in the Mercer overseas survey, one stands out: Magellan Global, the only fund in the whole survey to have made a positive return over the last 12 months. It is up 3.4%. Admittedly, were it not for the currency gain this would be in negative territory too, but the fact is that all unhedged global equity funds sold in Australia (which is to say, most of them) had that benefit too and didn’t come out anywhere near positive. The second ranked fund, the Morgan Stanley Global Franchise fund, is 9.4 percentage points further back.

 So who are Magellan and how did they manage this?

 Magellan Financial Group was set up by Chris Mackay, a former senior investment banker at UBS, and Hamish Douglass, who used to run Deutsche’s Australian investment banking operations, in 2006. The business was listed in Australia, has a listed investment company, and launched a global equity fund in July 2007 to be its flagship product for retail investors and planners.

 “Our main aim is to minimise the risk of permanent capital loss for the people who invest with us,” explains Douglass. “We are very risk averse. We invest in a relatively concentrated portfolio [currently 22 stocks] of what we call the outstanding businesses of the world: businesses that give very high returns on capital and have long term sustainable competitive advantages. And we want to buy them cheap.”

 Magellan specialises in financial services, the consumer sector and infrastructure, but made a very useful call by selling down 80% of its exposure to financials in September just before the whole sector plunged. Its biggest holding – American Express – has been a drag on returns, but it has got so many other holdings right it hasn’t really mattered: Nestle, Wal-Mart, Google (bought, then sold just before its heavy fall, then bought again), Yum! Brands (the people behind KFC, Pizza Hut and Taco Bell), Procter & Gamble. It can go up to 50% into cash, and was at 28% at the end of September, but by and large has been actively in the market rather than sitting on the sidelines.

 “It’s a combination of active management, an extreme focus on quality, and buying in on a value basis,” Douglass explains.

 No Asian stocks make his portfolio, but the fund does seek out global businesses with heavy exposure to the region. 30% of Yum!’s business is located in China; Nestle and P&G also make considerable money there.

 At the other end of the scale are some hideous numbers. Currency gain or no currency gain, Bernstein Global Strategic Value – a much vaunted fund in the good times, with professorial investment theory behind it – has lost 33% of its value in a year. Had the currency shift gone the other way investors would be out on half of their money.

 For investors in global shares, the question continues to be what it has been for months: is this the bottom?