At a recent dinner at Quay Restaurant in Sydney, to launch the 2017 Conexus Financial Absolute Returns Conference, Platinum Asset Management co-founder and chief executive Kerr Neilson was interviewed by Conexus chief executive Colin Tate. In the wide-ranging conversation, Neilson shared his views on everything from investing in China to philanthropy. This is an edited transcript.
Colin Tate: At the core of your process and philosophy is being contrarian, thinking differently to the pack. Investors are seeking certainty but you see opportunities in the geographies that are uncertain and cyclical, like China, South Korea and Japan. Why do you see opportunities in these markets? What is your process for communicating to clients that you want to invest in markets that provide the opposite of what they seek? And why is Asia a common thread among these opportunities?
Kerr Neilson: The idea of contrarian investments really does come down to behavioural finance. And we know from our history that behavioural finance is the core of taking the arbitrage against the crowd. We all know the academic work shows that most of the time the majority are right, but when it comes to individual stocks, many of them go through periods of change. It’s at that point that the market gets its pricing wrong.
So, what allows us to do what we do is that we’ve been doing it for a long time now, we’ve been doing it for over 30 years with a very good record. The international fund has outperformed the index by a factor of two over 22 years since we formed this company. That does give us some latitude with investors to say there’s a process here that has some merit.
When we talk about opportunities, what we are seeing is a concern about being close to the index, which is just driving people and more and more money into mimicking the index and then, of course, the [exchange-traded funds]. So, unfortunately, it’s not been an easy period for stock picking because you’ve had this [lack of] dispersion between the best performers and worst performers. Around the beginning of last year, that started to change and that’s when our performances kicked again. The dispersion hasn’t changed so much, but you’ve had this unusual situation where the US market has been on a roll for eight years, outperforming everything else, which is a 2.5 per cent deviation event, or close to that. What that type of thing does is compound concentration. So what we’re seeing now is the very opposite and that’s why we’re starting to make a lot of money. We’re sort of running 8 per cent above the index, this year to date.
And the index is not suited to most managers, so they grandly give the biggest physical economy in the world, China, a weighting of 3.5 per cent. On a PPP [purchasing power parity] basis, China and India have a value of something like $30 trillion, so there’s no relationship between the way people are managing money and the reality of the underlying economic situation.
CT: Some of the themes you have identified over the years take a very, very long time to play out. Why do you think having a long-term horizon or a long-term view is, in fact, important to investors, and if you do have a long-term view, how do you actually know when you’re wrong?
KN: Yes, the desire to be right can override good judgement. The long-term view is essential because of the points I made a little earlier. There is such a predilection towards momentum investing because that’s how you match the index.
You do not use price as an indicator of whether you’re right or wrong in the first six to 12 months; It is the behaviour of the underlying company that determines whether you’re on track or not. When we take a position very contrary to the market, everything’s pretty well written up, so there are milestones we use to determine whether the company is tracking as we had hoped. That is the best way to know whether you’re out with the fairies or in reality.
CT: You’ve built a business now from scratch to $24 billion under management. Perhaps you haven’t even been wrong very often. But knowing when you are wrong also speaks to another important trait of success, which is humility. Why do you think it is important to avoid hubris and can you give us some examples of the detrimental effects of the actions of the self-important?
KN: At one stage, I ran money for George Soros, and he has one of the most remarkable records of anyone, 34 per cent compound for about 25 years, with some leverage but not a lot. When you meet Mr Soros, who’s under attack at the moment, which I resent hugely because he’s a hugely generous person, what he will say within the first five sentences is that we’re all vulnerable to being wrong. He emphasises this endlessly because he says the nature of what we do is to challenge what is apparently reality.
When we look at our own team, what we’re trying to find is people who come to us without too much prior knowledge…individuals who have a deep understanding of an industry or something else but not necessarily market animals. They are better able to learn because they don’t start with the presumption, ‘Well, this is what we did at our other shop, I don’t understand why you fellows do this.’
But when you look at the team process, if you have an idea on a stock, you will spend weeks doing work as an analyst. So as a fund manager, why would you particularly know better than the person who’s spent time with the management of the company, time with brokers? And then we also use services such as GLG [Gerson Lehrman Group] to talk to ex-employees of companies or their competitors and that gives us huge insights about the company’s workings as perceived by real executives or senior employees, which gives us a pretty decent way of screening out market bias and a whole lot of other things.
So, when we read these reports coming in from our team, it is foolish to believe we are particularly gifted in knowing more than they will. What we can do is see if they’re going down rabbit holes and then we can pull them out and say, ‘Let’s do a bit more work on the periphery here because I think we’ve gone down this hole.’ Some analysts are very good at becoming extremely linear [but] as they become more certain about it, the more information on the periphery just gets buried.
CT: What is the source of happiness if money and material stuff don’t necessarily create it?
KN: Money does give you choices, and you can put some into purposes that might benefit a lot of people. If I think of George Soros, when I saw him last, he was really quite – and he gives billions away – he was quite despondent that for all his efforts, he’s now got these right-wing groups gunning for him. He didn’t raise that subject but what he felt was he could save so many starfish but not really the whole [bunch]…that you could do so much but you’re always frustrated because there’s always so much need.
CT: You have a long history of philanthropy and you’re now giving away around $9.5 million a year. I’m not trying to embarrass you but that’s a lot of money. Among the beneficiaries are students who receive financial planning scholarships. I’m interested to know why it’s important to give back but also, in particular, how it can shape the next generation.
It seems that whenever there is an indiscretion by a financial services company, it is always attributed to a rogue individual. How much should the education of the next generation of financial services employees be about ethics, responsibility and the fiduciary duty of managing other people’s money?
KN: The Neilson Foundation and Platinum each contribute $150,000 a year and we give 24 students the opportunity to get $12,500 a year. It’s beer money, I don’t believe it changes their lives. But it’s a bribe to try to get more people into financial services. The big change, I think, is this fee for service, a clear demarcation from the old style of financial planner. We think it is our duty to promote this new profession.
Over 10 or 20 years, you keep churning out 24 folk who have studied financial advice, so you start getting a small group of people who really are committed. And one of the things we do is drag a small group of those who are put up by the universities as their best students into our research department to spend about a month with us.
Universities do a great job but the stuff [the students] are learning is so different to what they experience when they come into our world, where we’re talking about businesses and the prices of consequence of a business, not the other way around. It’s not just the scholarships, it’s also that experience; they all, without exception, come out – and it’s not just being kind to us – they all come out absolutely bewildered by the delight of what they’ve experienced. It’s a very good thing.
CT: When we first met, many years ago, I was on the board of the Wayside Chapel and you were very generous with the rebuilding capital program there. First of all, I was astounded at how much due diligence you did for the amount of money involved. Not that it wasn’t a lot of money, it was very generous, but I was also aware that the process you undertook showed that you’re an engaged philanthropist. And I know that you were also training your daughters at that time to be more involved.
A moment ago, you mentioned that you like grunge charities, ones that are harder to find money for, less sexy charities, which I really agree with; how do you choose themes or organisations to support? Also, how do you justify art as something worthwhile to fund, rather than some kind of elitist pursuit?
KN: Grunge is the exciting part. By the way, there’s a myth, in my experience, that the average Australian doesn’t give money. I don’t buy that at all. I think some rich people in this country are not very generous but the average Australian I’ve always found to be extraordinarily generous and, particularly when there’s a crisis, they leap in.
[Back to grunge charities,] there’s a huge delight in feeling you’re making a contribution when it’s an emotive subject like health. Whether it’s cancer or whatever, it’s a much easier sell for the fundraisers. And our position, or the position I’ve suggested we should continue with, is to be very mean when it comes to medical research because it is extremely well funded. For cancer, every drug company, well, not every one, but for many of them, that’s all they do [is work on cancer treatments] and they get huge rewards for it. The market mechanism’s working perfectly there, so we give virtually nothing to medical. What we do is give money to things that are not attractive, like drug rehabilitation. For example, Triple Care Farm down in the Southern Highlands [assists young people dealing with substance abuse, mental illness, homelessness and family breakdown]. When it started, we gave them half of their budget and they turn over 100 kids a year. Now they’ve doubled the project.
And the consequence of that is they plan to get, I think, a 75 per cent rate of retrieval from the juvenile justice system. Back to the question of how to be happy…I mean, the idea of saving someone from a juvenile justice system can give you a thrill.
Women’s shelters: if you don’t have a house to go to and you don’t have financial independence, you’re [in trouble]. They’re hugely important. And then, Aboriginal children suffer from more problems with their hearing than other kids, for a whole lot of reasons, affecting their schooling. Supporting these sorts of causes is interesting to me.
The arts are important because they allow people to free themselves from the tyranny of what they were taught at school. When they see contemporary art – and we’re interested only in contemporary art – you start seeing performance, video, stuff that is so different to Degas or whatever. They were breaking boundaries in their time, but you’ve got to look at the guys who are breaking boundaries now…
The White Rabbit Gallery (founded and run by Neilson’s former wife, Judith) is now taking 1200 people a day. When we started, we got 50 or 60 people a day coming through and what that does, you get these school groups coming through and many of them are from less privileged backgrounds and many of them are Asian and the White Rabbit is only about Chinese contemporary art but, nevertheless, it’s Asian in concept or the Asian kids [relate] to it and regard it as their art.
They go in shuffling and thinking, ‘What are we going to be subjected to here?’ and ‘This is not a very good idea.’ And they come out like peacocks because suddenly they say, ‘My goodness, that’s what my folk are doing.. It is a unifying force, it stops them feeling oppressed, they start seeing that they come from a very worthy background.
CT: Thank you for sharing that. A couple of more prepared questions now. At Platinum, you employ many smart people. In fact, one might say you have surrounded yourself with smart people, probably many much smarter than you. How important are the structure, the environment and the culture of an organisation with regards to getting the best out of people?
And then, how do you get the best from your people? Do you give them freedom, do you encourage a culture of workshopping and refuting ideas, or do you give them great resources, opportunities, technology, or just truckloads of money? What is it?
KN: The really difficult thing is to find people who really want to invest and, as I say, you get all sorts of very bright people and we’ve had obsessive types and we probably still have. But the real problem you find is that there’s a desire not to be right but to make money. And that’s slightly different because you’re not obsessed with being right, you’re constantly checking your work and reconfiguring the way you describe it to your peers…
The first and last lesson is you’ve got to respect your people, pull them up when they haven’t done enough work. It’s about understanding what engages them. It is about reward but it’s most importantly about recognition for what they’re doing.
CT: One of the five tenets of your process is to seek absolute returns, not returns relative to any index or benchmark. What’s your opinion of the changing nature of the investment industry…What does this mean for active investors and absolute return in particular?
KN: I think the ETF is a marvelous product. The problem that anyone who uses them has to deal with is exactly the problem we face, which is when do I make a shift? When do I start selling this ETF and buying the other? It doesn’t free you; there’s a price you pay for making those decisions yourself. We have no problem with that, we love the idea of everyone going supposedly passive because it will unmask those who are masquerading as active managers and over time the field will narrow.
What we feel is a most important thing is that you do a lot of inhouse research. Some of you here are involved as analysts and if you listen to the quarterly conference calls, there are some quite good questions posed by the brokers. You read those same brokers’ reports, their negative bias does not come out in those reports, so there’s a whole lot of distortion being built into the system.
And then the best one, which I’ve already touched on, is that the biggest economy in the world in purchasing power parity is China (And that is a fact. There’s one weak spot in the manufacturing base of China and it is principally aerospace but China is making twice as many cars as the US, making eight times as much steel as the US.) To talk about this economy as if it’s some sort of second-rate also ran is just missing the point, and it has about a 3 per cent rating in the MSCI. So we love the idea of everyone going passive. We will have a wonderful time.
CT: Are you comfortable with the average investor having a legitimate allocation to ETFs as long as there is an alpha-seeking allocation as well?
KN: Well, if they’re good at moving the stuff around, why give us anything? But they’ve got to be good.
Delegate: You talk about China and I guess it’s something we’re all looking at, but the instruments available for investing into China seem to be a bit limited and potentially volatile. There’s talk about the VEIs, these variable equity income streams, but they’re slightly synthetic. Perhaps I’m overly risk averse but if things were to go bad and you didn’t have a tangible asset, do they seem to be more risky assets to you? Perhaps you could just talk a bit about how risky the process is of investing in China.
KN: I’ll diverge a bit. What’s changed in China, this whole restructuring of the surplus capacity industries, that’s a massive change because you’re now seeing the banks being paid back both interest and capital …
China is wanting results in terms of bringing order, and all this transformation of energy is a huge drive to this economy. The private sector is now 80 per cent of China’s economy but it’s not what people perceive. If I ask most people to guess how much of the Chinese urban population is employed by state-owned enterprises (SOEs)? It’s actually 20 per cent. If you talk to Andrew Clifford, our CIO, he will rightly tell you that it is the most dog-eat-dog capitalism you’ll see in any country in the world.
So, there’s a lot going on in terms of the private sector. We do not simply go after the old, tired SOEs, there are lots of private companies we can buy, either through the Hong Kong HKEX or through Hong Kong itself. And in terms of remittances out, we’ve not had any problems. I can tell you, against the popular view, that some foreign direct investors, like the automobile companies, have not been able to fully remit their funds. They won’t acknowledge that but that is actually what we’ve been told by people who have been caught in that position. But for equity investors, I think it’s not a problem.
The next question we keep getting asked is, well, how do you trust the accounts? When you’re running these huge companies with $10 billion, $20 billion turnover, you’ve got to have pretty decent controls.
And in our entire experience, 30 years investing in Asia, we think we can find one case where we’ve actually been deluded, completely deluded, by the accounts. We’ve had an experience that is very different to the general view that these companies are not reliable and it does come down to the cash: You need to know that the auditor has checked the cash with a head office of the company you’re dealing with. Not the Beijing office or the bank, not the local bank and so on.
But these are things you pick up over time. And then you have to know some of the social issues around supporting medical in the local region and stuff like that. Those are treated as CAPEX items and they are actually expenditure items. So you adjust your P/E ratios with that type of thing. I haven’t directly answered the question, but I don’t think investing in China is as difficult as it seems.
CT: Is your view that the financial services management industry is generally overpaid? Is it really hard for investors to find where you should pay people well?
KN: I mean, all of us in this room, I don’t think any of us can say we’re underpaid, with great respect. But there is difficulty in beating the market, it is not easy. And to produce a consistent – when I say consistent, a rolling performance that is a lot better than the market – it makes that extra 30 basis points insignificant when you start adding 6 per cent compound over 22 years.
I mean, it’s crazy to obsess about fees and, of course, what is required is more understanding by the administrative staff of government because they’re not helping this process, they’re actually aiding and abetting this idea of homogenising everyone down into silliness…
CT: I know you don’t like the billionaire tag and it sounds very tabloid; however, what do you think of the Bill Gates, Warren Buffett theory where they don’t want to destroy their children by giving them more than $15 million, and the rest is going to be given away in a pledge so that you actually, presumably, get fulfilled and happy by giving it away? I don’t know your answer on this, I’m asking you if you’re happy to share. What’s your plan for your billions?
KN: I think it’s a good plan, you know, with these foundations you could set up, they’re good because you’re required to give out 5 per cent a year so that’s a great thing…But my big problem is to find a project that really can make a difference. And that sounds like a whack but it’s not so easy to think of something that really matters. And that’s why I so admired George Soros. He’s attacked the problems of society, and all the stuff I’m doing is really just remedial work. It doesn’t really get to the question of how we connect with the more spiritual sense of the world, in terms of saying actually it’s not all about you the individual…
There’s a real message here that we’ve seen with the whole change in society about women’s positions, incomes, the [same-sex] marriage thing coming through now – society has changed. So there is the opportunity to make these changes and that’s what I’m trying to find, what is really worthwhile. And it won’t be about carbon or one of these sort of yesterday stories, because those things will be resolved. We’ve got to think past that, we’ve got to think about tomorrow.