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Walter Aylett on not losing money, staying in cash, being small

‘It’s easy to think long term when it’s all your own money, a lot of our money is with our clients.’

HILTON TARRANT: Welcome to this Market Commentator weekly podcast, our series of interviews with chief investment officers, fund as well as portfolio managers. We’ll be interviewing them or the institutions they represent once every two months or once a quarter. Our guest this week is Walter Aylett of Aylett & Co Fund Managers. Walter, I think as a start it would be good to start at the very beginning, how would you describe your investment philosophy?

WALTER AYLETT: I think we’re just trying to not lose money, in other words we’re trying to preserve our purchasing power of every rand that’s entrusted to us and hopefully we can earn a real…it’s like an after-inflation real return or a 6% real return on the money that’s been given to us and that’s over a fairly long period. So we don’t think of one or two years but, say, three to five years. So over time if we can, say, get inflation plus 5% or 6% we’ll double our money every five years and that’s our goal, it’s quite a tough goal but we’re just simply not trying to overpay for any asset that we invest in. That’s our philosophy.

HILTON TARRANT: And it’s no doubt a tough one to keep adhering to?

WALTER AYLETT: It is tough but I think isn’t that what life’s about or if you believe in a meritocracy that you stretch yourself and you set tough goals. What’s tougher is learning not to lose money. Sometimes it’s quite easy to make money pretty quickly, not sustainably but you can do things like you can momentum invest if you wish or trade and gear-up but what is harder is trying not to lose permanent capital, overpay for assets, which will then affect that goal of doubling your money every five years. That is really hard to do.

HILTON TARRANT: It does seem as if you fit somewhere between the kind of investors who would almost buy anything that’s going up, momentum investors, whatever you want to call them, and the deep kind of value contrarian investors who seem to buy anything that’s out of favour with the hope that one day those prices do recover. Is that a fair comment?

WALTER AYLETT: We don’t like being labeled because I think we’re quite eclectic. If you look at our portfolios there are elements of what you’d call value investing, we’ve got a net working capital investment where we’re basically buying the company for its working capital and nothing else, which people would classify as a typical Benjamin Graham type value investment versus a growth share like Discovery, which we’ve always held in our funds because we just think there’s very little competition against a company like that and it keeps on innovating and it’s always looked expensive. So I think that we’re quite eclectic, we don’t fit into pigeonhole type boxes or value versus growth. But if you forced me to put myself in a camp, we would probably be in the camp where we don’t really like buying when everyone else is buying and we love buying when everyone else is selling but pessimism is wonderful for buyers.

HILTON TARRANT: And that discipline to be able to buy when prices are falling or when prices have fallen that’s the…

WALTER AYLETT: But also the trick is not to get caught because you have these so-called value traps and Telkom was falling and Hulamin was falling and Arcelor was falling, and you need to not buy it because everyone is pessimistic on it but you need to say why do I like this business, what do I think the long-term prospects are and then the question of quality has to come into the discussion and that’s where I think deep value investors never talk about quality. I think quality, particularly in a South African context, in other words does this company have pricing power, does it have a moat, does it delight its customers and enlarges that moat every year, is it doing just rational things. Telkom was extremely cheap, it was doing a lot of irrational things. So first prize for us is a quality business that when the uncertainty or the uncertain act happens we know the company’s got room to maneuver because we can’t forecast that uncertainty and you find good things happen to great companies and we like to buy companies where basically the cash flows are very strong, the balance sheets are strong, management have incentive to manage the company and not the share price, and have got strong balance sheets so that when opportunities present themselves they can take advantage of that.

HILTON TARRANT: It’s interesting to read your fund commentary and also your annual newsletter to clients, which was published earlier this year and I say interesting because it seems to give a lot of perspective that I think is often missing when we’re chasing these kind of weekly, monthly, quarterly reporting cycles where we get tied up, what did we do in the last quarter, what did we do in the last week, where your view seems to be very, very different and you do bring that perspective to where the market is, to where the macro picture is, not only here but globally as well.

WALTER AYLETT: Well, it’s quite easy to think long term when it’s all your own money, a lot of our money is with our clients. Secondly, I always draw an analogy between a golf game and investing, if you’re going to ask me after every hole that I’ve played how I’m doing, I’m not going to play golf pretty well but if you ask me after 18 holes how was your day? I can tell you I did well on the first three, the last three, the back three and I can give you a better story. I think that’s what our job is, it’s about staying on the fairway, it’s about the other person trying to hit it hard and going off the fairway. What we are just trying to do is stay out of trouble and that’s a lot of hard work, you can’t do everything, we’re a team of three, four people. So to try and act like you know what’s happening every week, every month you’re just fooling yourself and your clients.

HILTON TARRANT: Walter, in your commentary in March you highlighted a number of scenarios and you made the point that you continue to believe that investors have not yet adjusted to what you call the new normal. I’m willing to bet that in your commentary for June you’ll probably discuss a lot of these things again because it seems as if no one really knows what this new normal is, no one knows how it’s going to play out and there are a lot of people scratching their heads when it comes to things like QE, when it comes to things like the Eurozone, which seems to be erratic, unpredictable, changes from one day to the next. Is that a fair reading of where we are?

WALTER AYLETT: Well, I think we’re just trying to look through the windscreen and not through the rearview mirror. So the new normal, as you know, was coined by I think Pimco but those aren’t my words. But I think what I’m trying to say is that there are a lot of experiments taking place and they’re new experiments and we don’t know how these things will end. We are trying to think about the thing that hasn’t happened, in other words what no one is talking about. So everyone is talking about QE3, how we’re going to get off the bus and all those things but for me what’s more important is what haven’t we thought about. I keep on thinking wherever I go around the world and I travel a lot, I ask myself where is the money going to come from? In other words if you can’t raise capital, if you can’t raise debt and you’ve got to raise taxes to pay for promises that you made for the last 20, 30 years, how does this all come together? I look at the value of money, it seems to me…when you ask a World War veteran, who’s seen two wars and the Korean War and you ask him what’s changed over the last 80, 90 years, he’ll say it’s not the war, it’s not the inventions that have been made, it’s that money has no value. I just look at how people treat money, the products that they buy, the brands that they buy, there is just no logic and the way people are investing. How can a share like Tiger Brands two days ago would be at, say R289 and the next day be R306 and then back to R295 and lose 5%, 6% of its market cap in a day. To me that’s casino-type behaviour. People’s expectations, I think they are not ready for this 2%, 3% world, this world of sub-par returns because, as we know, the reversion to mean force in financial management is very strong and we’ve had extraordinary returns since 1982, courtesy of the bankers, they have dropped rates from 20-plus down to zero, minus two. That doesn’t help you anymore, so what replaces that? Those are my concerns, how do the companies that we invest in how do they deal with this new world that’s going to evolve, which I don’t know what it’s going to look like. So my logic is that if we’re patient and we buy companies when Mr Market loses its mind once in a while at good prices, those good companies with products that we need will take care of those unknowns. That’s the only way I think you can deal with these things but two years ago if you’d invested in Egypt or Syria – by the way, which is where MTN is – and Nigeria you just would not see these things that are happening at…you would not be able to forecast those things. So we want companies that can deal with these unknowns, these new things that everyone talks about, these new experiments. I talk about the central bank governors of the world being the dark horsemen of the Apocalypse because who knows how this all ends. I’m not an economist and I just think of ten, 15 years down the road when my children grow up and want to go to university and look for jobs, what will it look like? I don’t know.

HILTON TARRANT: Along with that patience obviously comes a build-up in cash because that patience means inaction, it means not acting even when fund managers by and large and I know I’m generalising but fund managers are paid to act, wealth managers are paid to act or seemingly paid to act because the perception out there – and I read a fascinating article in the Wall Street Journal last night – the perception out there is if my fund manager or my wealth manager is not acting it means he’s not doing anything, he’s not doing his job.

WALTER AYLETT: Well, by not doing anything you are making a decision and as long as you’re telling your clients how you’re going to do it in my opinion you’ve told them I’m not going to invest until the odds are in my favour. That’s what investing’s all about is the probability of success should tilt in your favour. Now, we tell our clients regularly if something has changed quite dramatically where we’re not going to use the money we tell them. They give us the money and the privilege that we have is when circumstances change very fast we can act very fast without having to pick up the phone and wait for the money. I’ll give you an example, last week I think it was, a company that we went over the 5% limit we had to notify that we were over 5%, which the company called Delta and I don’t know why someone was selling it at a ridiculous price but it felt like to me that they were a forced seller, maybe there was a withdrawal out of their fund or they lost the mandates, I don’t know, it doesn’t really matter but because I had the money on hand I could execute. But to have had that money I’ve had to be patient the last year or two and that’s the beauty about having dry powder in the corner. Now if you want 100% equity mandate, which is what we do have, we’ve told our clients, well, our natural default is to have 20% cash, that 20% cash will immunise with derivatives. Then they still get our stock-picking skills on the other 80% or 70% or 50% or whatever the number is but they know upfront. So I don’t think it’s true that we’re not making a decision and I tell you when you know you’re making a decision is when you’re left behind by the crowd and they’re all making lots of money and the markets keep on going up and you don’t go, you go sideways that’s a decision that you’ve made. But, of course, when things fall over you look very good and then everyone says what a great decision you made, now you’re worth every cent I’ve paid you. Again, and remember I keep on coming back from this perspective, all my money is with my clients, so why must I lose money just to keep short-term happiness. If I’m going to get fired I want to be fired for being conservative, I don’t want to be fired for losing money.

HILTON TARRANT: Walter, you spoke about size earlier, three or four people in the team, how important is it to have such a small team, you’ve mentioned the fact that you have powder dry, you have cash, you can react quickly because you’ve got that pile of cash sitting there. Fund relatively small, just over R500m, probably closer to R600m…

WALTER AYLETT: No, the fund is bigger than that because we run equity mandates behind that fund. That’s only the retail fund, so we’re closer to R1.5bn but sorry, I interrupted you…

HILTON TARRANT: How important is size? How important is it to be so small?

WALTER AYLETT: I certainly think it’s an advantage being small, I don’t think it’s an advantage being very big, big houses have lots of names of people shouting and screaming at each other to buy things, the loudest voice gets the most grief. In other words that’s the way they operate and there are more distractions, more committee meetings. We don’t have any of that and I think what’s more important than size is what no one talks about is that we choose our clients. That’s a huge advantage when you’re not in an asset gathering business, clients are coming to you, you’re making sure you match up, you’re in sync with each other and by default then they allow you to be long term in your thinking. If you’re in the asset game you’re going to attract short-term money and, therefore, you’re going to have to change the way you think. That’s the first advantage we have, we’re not cleverer than the big fund managers, we’re just trying to do things differently and win the race. The race that we’re talking about is to win a race you first have to finish and that’s the game we’re in. Secondly, our universe is small, Delta – I mentioned earlier on – has I think a R250m market cap, it’s not in the interest of any of the big fund managers to look at that thing, even if they’ve got a small cap fund. Now, Delta is quite a risky investment, it’s not a great company in the sense that it’s got a great turnover and it’s a growth company but there is a lot of value in the assets of the business, very unpopular at the moment and so far we’ve made no money on it but the likelihood of us losing money is low, so that makes sense to us. Now the big guy can’t do that and unfortunately what’s happening in the South African market is that the universe is getting smaller and smaller and smaller where if you look at our portfolios you could say, well, this looks like maybe a large cap fund manager but we don’t suffer from quarter-itis, we don’t suffer from being measured by consultants and if we are we discourage them, they know what they’re getting. We have deviated sometimes by 15% below the market, in other words our performance and it’s been tolerated but in a big house it would never be tolerated. You can see it in the commentaries of some well-known fund managers that are not doing well at the moment and they’re very good fund managers but the market doesn’t leave them alone, it kicks them while they’re down. I think that’s the advantage of being small and we have fun here, we don’t have all the other stuff the big corporates have. We’ve got other problems, we’re small and we’ve got to fight tooth and nail but at the end of the day it’s a good place to be and I think enjoying what you do and making money and fighting the big guys and taking some of their clients away is a good feeling.

HILTON TARRANT: Walter, what about offshore exposure?

WALTER AYLETT: Well, if you go back in our history we’ve always…I think my days with Tim Allsop at the Syfrets Prime Select Fund [at Syfrets we were always investing offshore, I think it’s safe to say we were one of the first offshore investors and so we’ve been doing it for 20 years. We’ve got quite a lot of offshore expertise and besides having our offshore fund, which is through the Nedbank stable, our equity fund is about 20% offshore, I think 25% is a maximum but the flows have kind of diluted us down a bit. We’re looking for good companies that compete against maybe South African companies, so like you could imagine an RTZ versus an Anglos, you can’t buy Rio’s here but you can buy it offshore or you could find a pharmaceutical company offshore versus, say, an Aspen over here. So we own Sanofi in our funds and we don’t own Aspen, and Rio’s might look more attractive than Anglos maybe. From time to time we do find shares that there’s just…you never have that type of exposure like a Microsoft for example. But they tend to be smaller companies, so we own a company called Berkadia, which is like a mini Berkshire and we’ve had Berkshire Hathaway in the funds and it’s really done well for us as a company, we know very, very well. Ja, I think it’s where we’ve got an edge offshore, particularly smaller to mid-cap companies. There’s a company called Lowe’s, which is kind of a Rembrandt, dare I say, and we’re building up positions in those companies, every time the markets correct they give us another opportunity.

HILTON TARRANT: Would you increase that exposure if there wasn’t a limit? Would you be more comfortable with a higher exposure offshore?

WALTER AYLETT: Well, our offshore fund which allows us to come back to South Africa, it’s a worldwide flexible fund, so technically we could come back to South Africa 100%. We are 92 I think or 88 I can’t remember the exact number offshore. So it’s unlikely, we would have very little exposure in South Africa.

HILTON TARRANT: Walter, just to close off with, what’s keeping you awake at night, what are you pondering on?

WALTER AYLETT: Well, it’s not the markets I can tell you that, for me it’s more where we have an investment in the portfolio, is there something that we’ve missed. We hate losing money, it’s overpaying for assets and always thinking about what hasn’t worked, what have I taken for granted because sometimes it’s your best ideas that lose your money. You try to think of all the psychological, emotional tricks that can be played on you as an investor and you try to create this checklist in your head, have I thought about this, have I thought about that. That’s what really keeps me awake, the markets certainly don’t keep me awake and I don’t really know what

Mr Bernanke and co are thinking, I don’t watch CNBC until 12 at night. I actually sleep pretty well.

HILTON TARRANT: Walter Aylett, our thanks to Walter, who’s with Aylett & Co Fund Managers.

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