In today’s consumer-driven world many people expect to get whatever they want as soon as they want it. An entire generation is growing up only knowing TV-on-demand, instant meals and one-click internet shopping. You don’t have to wait for anything.

But years of investing has taught us that rewards don’t always come quickly. Often you have to wait and sometimes great patience is needed.

This is one thing that really sets us apart from other fund managers – we are very long term in our thinking. For us the average holding period of a share in the Allan Gray Australia Equity Fund since inception is four years and we have held shares for up to eight years. In contrast, people investing in the ASX 300 hold a share for only around one year on average.

Why do we invest this way?

We think our long-term approach means we can take advantage of opportunities that aren’t available to those with shorter time horizons. Our estimates of a company’s value reflect our assessment of its normal earnings power based on long-term considerations, such as:

  • the nature of long-term cycles
  • long term returns on capital and margins in accordance with competitive position, and
  • the capital allocation track record of management over the long term.

To do this we use as much data as we can lay our hands on, that reaches as far back as possible, to try and form a holistic view of the company.

In estimating value we also think it is critical to contemplate how the value of a business might be impacted by more long-term issues such as:

  • potential regulatory and legal risks
  • contingent liabilities
  • financial liability balances and maturities
  • obsolescence risk
  • customer value proposition
  • changes in competitive intensity
  • changes in bargaining power with suppliers and customers, and
  • changes in competitive advantages

This involves thinking about potential probabilities and magnitudes in various scenarios. In some cases the only meaningful analysis that is possible is thinking about whether factors are skewed to the downside or upside individually and in aggregate. We also have to recognise that there can still be unknown unknowns, despite our best research efforts.

We use these assessments to take a long-term view of a company’s prospects and invest when we think the shares are trading at a discount to the value we’ve estimated.

There is a bonus that comes with a longer average holding period for better long-term annual returns: there are lower transaction costs and longer pre-tax compounding – both of which add to investor returns.

Our strategy in action

If we identify an investment opportunity that offers long-term value for the Fund’s investors, we buy those shares when they are below our estimate of their value. Our investment in Tassal Group highlights this approach.

Tassal Group is a fully integrated producer, processor and marketer of farmed Atlantic Salmon, based in Tasmania. We started buying its shares in mid-2009 when we assessed that it was cheap relative to its long-term prospects.

Whilst selling a commodity product, Tassal had a fairly strong competitive position. The company was part of a domestic duopoly, sheltered by their scale and the scarcity of domestic sites that are suitable for salmon farming. There were also some importation requirements which limited competition from imports, in addition to transportation cost and a limited shelf life. The domestic market was growing at a very good pace, with further runway available given low per capita consumption levels by global standards. Importantly the incremental capital required to fund the growth was unlikely to destroy value because of the barriers to competition.

Key long-term risks at the time were that the significant investments being made might not provide a sufficient return and that import impediments could be weakened. Short-term risks included potential disease or weather impacts amongst others.

As it played out the returns on incremental capital were only decent but not terrible. We are not always correct, but we were correct on this occasion that the growth was unlikely to destroy value over the long term and that the stock was therefore undervalued. The market eventually increased its valuation of Tassal Group and we began to exit in 2013.

The Allan Gray Australia Equity Fund’s holdings in Tassal Group between June 2007 and June 2015, compared with the share price for the same period.

Source: Allan Gray.

 

Our patience and long-term view helped reward our investors over time.

 

Tim Morrison joined Allan Gray in 2015. He was previously an analyst at Sydney-based fund manager, Dakota Capital. He has a Bachelor of Commerce/Law (Dean’s Honour Roll for Commerce) from the University of Queensland and is a CFA Charterholder.