Fundsupermart: Time to Be Brave

Updated: May 20

From Fundsupermart magazine


PETER ELSTON, Asia Strategist for Aberdeen Asset Management, has been in the business for a long time. We interview him to find out how he's made it this far.


Peter Elston has been in the asset management industry for 21 years. From Mercury Asset Manage­ment, he spent a short stint at Bintan Foods before founding Oblong Capital Management. He's now the Asia Strategist with Aberdeen Asset Management.


A graduate of Cambridge University, where he read Mathematics and Oriental Studies, Peter contributed articles to the South China Morning Post and is currently based in Singapore, where he covers the Asia market.


In an interview with Fundsupermart, Peter talks about how he started, his investment approach, and what he does when he's outside of work.


NICK TAY (NT): How did you start out in the financial industry?


PETER ELSTON (PE): I started out in 1988 as a graduate trainee with UK firm Mercury Asset Management.


NT: What made you decide to make a career in this industry?


PE: My father was in the financial industry, albeit in the public sector, so I was naturally attracted to it. Addition­ally, my background in math was something that drew me towards fund management, although as my career progressed I realised the limitations of mathematical tools as applied to fundamental analysis, and acquired a greater appreciation of the role of psychology, trying to understand the motivations and aspirations of company managers.


Frankly, I'm not a fan of such constructs as the Capi­tal Asset Pricing Model and the Efficient Market Hypothesis (EMH). I liked what warren Buffett's had to say on the sub­ject of EMH: if you're in the shipping business it helps to have your competitors believe that the world is flat.


NT: If you could do it all over again, would you have done anything differently?


PE: That's a tricky one. I used to be very dogmatic when it came to discussions of ideas with colleagues. While I'm now much more flexible, I'm not sure how I could have changed at an earlier stage. Some things just have to happen natural­ly. That said, recognising when one is in a position to have a strong opinion, to have an edge, is essential in this business, although one also has to keep asking, am I wrong?


NT: What's the driving belief behind your investment ap­ proach?


PE: The reason I share Aberdeen's investment philosophy is that I believe it is right to align one's investment time horizon with that of the companies in which one invests. Our business is about making predictions and profiting from them, though different fund management styles try to predict dif­ferent things. Some styles try to predict share price move­ments over very short time frames, say a few hours, using sophisticated computerised algorithms. Others try to predict the performance of markets over periods of a few months using various macroeconomic indicators. At Aberdeen we try to predict companies' long-term business performance, which, over long time frames,' share prices track.


This latter approach makes most sense to me, as it is aligned with the time horizon of the companies themselves. If a company builds a factory, it expects to get, say, ten years of returns from it, as an investor should from its shares. Eq­uities are long-term assets and should be treated as such.


The difficulty is that this is an approach which requires a lot of patience, particularly in the current environment in which good long-term returns have been destroyed by the falls in stock markets over the last couple of years. We are only now appreciating the extent to which economic growth over the last few decades was due to rising, leverage-fueled consumption in the developed world, coupled with low in­flation globally, thanks to the entrance into the global eco­nomic arena of China's huge, low-cost workforce.


But despite many of us having been badly burned, now is not the time to run away but the time to be brave. I'm sure it goes against one's basic instincts but drip feed­ing funds into Asian markets over the next twelve months will, we think, produce great returns over the long-term. Furthermore, one thing I can guarantee is that this bear market will end. And when it does, one does not want to be holding too much cash. The first move up will be big and fast, and missing out on it will severely damage long­ term returns.


NT: Describe your investment approach, from idea to execu­tion.


PE: Our approach at Aberdeen is simple and easy to under­stand. At its heart is the belief that good, honest managers will produce good results in terms of earnings over time. So what we are looking for when we analyse companies or meet management is evidence of ability and trustwor­thiness. This could be quantitative such as levels of debt relative to equity, interest coverage, returns on capital, quick ratio, or more qualitative assessments such as determining how employees are motivated to excel or what companies are doing that their competitors aren't.


Once we are comfortable with the quality of a company, which may take many meetings, we'll assess its stock valua­tion using various metrics. We're not necessarily looking for really cheap companies. The essential objective of this part of the process is to ensure that we do not overpay, which can wipe out the positive contribution from a correct as­sessment of long-term business performance. Technology companies would be a good example where this latter prob­lem can occur.


As for which sectors we prefer, our belief is that good managers, on the whole, can produce great results in any industry. What we have to assess is the extent to which factors outside managements' control, such as exchange rates, interest rates, commodity prices etc, or the long­ term trend of the industry, might nullify the efforts of the management team. We try to avoid industries that are high­ly cyclical or whose long-term growth we think will be low or negative.


Once companies pass our quality and value criteria, they will go into our country models. This gives us a chance to get to know the companies even better, before they go into our regional model.


We will keep a close eye on the share prices of compa­nies which meet our quality criteria but which at the time of meeting we deemed expensive. We will also revisit compa­nies which were either borderline quality or where we were undecided, as well as visit companies we haven't seen be­fore. Finally, we conduct due diligence every couple or so years on large index constituents that we do not hold. As for companies that we do hold, we are required by internal compliance guidelines to see them once a year, although in practice it is more frequent.


NT: Give us an example of your investment approach at work.


PE: A good example of our investment approach at work would be Malaysian counter Bumiputra-Commerce Hold­ings. This was a company that six of our fund managers met on four different occasions before it went into the Malay­sian model in November 2006 and into the regional model a month later. Since then we have met the company on twelve other occasions. In total, 21 of our fund managers have con­ducted 16 meetings with eight company representatives over three years. We know the company pretty well!


NT: Give us an example where your investment approach didn't work.


PE: As your question rightly suggests, our investment pro­cess is not perfect, nor have we ever claimed it such. In fact, we expect that it will fail to work, as measured by poor long-term performance, around perhaps a third of the time. But it's the other two thirds that have produced our 5% out­performance over the last twenty years.


A good example of our approach not working would be Ayala Land. This is a company we have held for the last fif­ teen years, during which it has produced an annualised total return in USD terms of -3%. Although this is not much worse than the total return of the MSCI AC Asia Pacific ex Japan index of -2% per annum, it is the worst by far among our stocks that we have held for more than fifteen years.


NT: In this current crisis, what's been happening in your per­ sonal investment portfolio?


PE: My portfolio is fully invested in three of our Asian funds, as well as gold. I have a long time horizon and a positive view on Asia, so Asian equity funds make sense. At the same time, I am concerned that the monetary and fiscal actions currently being undertaken by western governments in the face of extraordinarily weak economies may lead to a widespread loss of confidence in major fiat (paper) currencies, which would result in a big rise in the gold price. In fact, since the US came off the gold stan­dard in the early 7Os, the purchasing power of the dollar, as measured by the price of gold, has fallen by around 27 times. Although not itself a perfect system, the gold standard acted as a useful restraint on governments and banking systems. Without this discipline, we have seen debt levels in the US reach absurd levels and government spending out of control.


NT: Which funds are you currently managing and for how long?


PE: My role as Asia Strategist is to provide our fund man­agerswith a view on long-term macro themes that they can incorporate, if considered useful, into their bottom-up, company analysis. As many of your readers will know, we are pure stock pickers, meaning that we do not operate an active top-down country strategy, nor manage active cash positions.

We only invest in companies that we like, so run high­ conviction portfolios rather than those that hug or track a benchmark. Contrary to conventional wisdom, we believe that after a certain point, holding more stocks in facts adds to, rather than reduces, the risk in a portfolio, as one spends less time, by definition, analysing each.


NT: How do you select your own personal investments?


PE: I have become more boring in my old age, hence my holding mutual funds nowadays rather than stocks, but previously I held a portfolio of Asian small caps which I had picked on the basis of them having strong, long-term com­ petitive advantages. Many of them either went sideways or performed poorly, but there were 3 or 4 that went up sev­eral times, resulting in great performance for my portfolio overall.


In fact managing the small cap funds at my previous company and making personal investments in this space were instrumental in the development of my investment philosophy. This, in a nutshell, is to look for companies that have simple, identifiable and, most importantly, sustainable, competitive advantages and, when you find them, to stick with them. Patience and discipline are critical.


A good example of this is Hong Kong-listed Techtronics. This company was founded in 1980 and became a leading producer of DIY power tools for sale in retail chains in the US such as Home Depot. Its competitive advantages at first related to labour cost and expertise but, having begun life as an OEM manufacturer, it was gradually able to launch its own brands, further improving its profitability. I bought the shares at around HK$0.60 in the mid-90s.The shares did nothing for 3 years or so, then exploded into life, reachingnearly HK$20 in 2004 (I had sold it on the way up at around HK$12). Being exposed to the western consumer and the housing industry, the company's business has suffered recently, and the share price has fallen back, but those competitive advantages re­main intact.


NT: What's your proudest moment on the job?


PE: I can't think of anything in particular. I suppose that I was quite proud of the returns that my clients' small cap portfo­lios and my own personal portfolio achieved, as they were the result of a lot of hard work and an investment philoso­phy that, though not original, was one that I had gravitated towards on my own.


NT: What's your lowest moment on the job?


PE: Life during the Asian financial crisis got pretty depress­ing. Arriving at work, knowing that all the news that day would be bad, became very tough.


NT: The funniest moment on the job.


PE: There were plenty of those! Covering the Korean market at my previous firm brought plenty of smiles. I once took my boss to meet a North Korean Minister at his hotel suite in Hong Kong. Not really understanding what a pension fund manager did, the Minister tried to entice us to build a tuna processing plant in North Korea with the promise of a 20-foot statue of my boss in the local town square. My boss invariably was a mess, with dishevelled hair, shirt untucked, a cigarette in one hand and a can of Coke in the other. The North Koreans would have been very bemused by the statue!


NT: Tell us what you do outside of work.


PE: Watch Bloomberg or CNBC. Then sleep for 3 or 4 hours! On weekends, I either golf or go diving. FSM



Published in Fundsupermart magazine



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