Hamish Douglass defends Magellan’s pandemic investment strategy

Hamish Douglass has rejected criticism of Magellan’s investment strategy and warned that markets have ‘very little margin’ for error”.

‘There is very little margin for error’ … Magellan chairman and co-founder Hamish Douglass at his Sydney office on Thursday. Picture: Britta Campion

Hamish Douglass has rejected criticism of Magellan’s investment strategy and warned that markets have “very little margin for error”, with mutations of the coronavirus still posing the main risk.

After the release of Magellan Financial Group’s interim results, the chief investment officer and chairman of the global fund manager said the recent underperformance of its global strategy was caused by an “unprecedented repricing” of risk, but client feedback had been unanimously positive.

It came as Magellan reported a rise in profit amid strong growth in funds under management in the six months to December despite volatile global markets and a sharp rise in the Australian dollar.

Net profit rose 3 per cent to $202.3m in the half year, but was down 2 per cent after adjusting for one-offs. Average funds under management rose 9 per cent to $100.9bn.

Management and services fee revenue rose 8 per cent to $311.4m.

Magellan will pay an interim dividend of 97.1c per share, an ­increase of 5 per cent on the 92.9c interim dividend a year ago.

The share price fell 4.4 per cent to $48.85 after its results.

Magellan’s global fund aims to deliver 10 per cent per annum before fees through the business cycle — rather than outperform its benchmark — and to fall less than the market during drawdowns.

Magellan’s “downside protection” is consistently in the top 1 per cent of peers.

Mr Douglass said a strong rise in the Australian dollar “masked” the fund’s performance last year.

Its “underlying return” in US dollars was 11.2 per cent in the 12 months to December.

“So everyone was looking at December and going ‘what a disaster’ and all our clients are going ‘we’re pretty happy’ with the absolute performance and particularly with the downside per­formance that we saw through last year,” he said.

To protect against drawdowns, about 50 per cent of the portfolio is invested in defensive assets and cash. The defensive assets are mostly consumer staples and utilities stocks, which underperformed by about 10 percentage points over November and December.

He disagreed with the popular belief that there was a rotation out of growth and into value in late 2020 on the basis that growth stocks continued to outperform. In his view, investors sought more economic exposure based on their belief in the end of the pandemic.

“Realistically, I think people don’t really understand what the strategy does — unlike our clients — and people then focus on the MSCI and we get wild swings because our portfolio actually looks nothing like the benchmark.

“We are in 25 stocks in very different things — the MSCI is 1600 companies.”

Mr Douglass said he aspired to beat the benchmark over a seven-year period, but in the short term there would be “wild swings” when the fund was 20 per cent above or 10 per cent below the index.

“What people are buying is downside protection and consistency over time, and you need to understand that when clients build these portfolios, they have different styles and managers.

“Our strategy delivered for them when the chips were down, and other styles and strategies delivered for them in the past few months. Clients want those different styles in their portfolios.

“If we had underperformed during the market downturn, that’s when you should be asking the questions and I can’t speak on behalf of clients, but I’m really seeing no evidence at all that we have a sort of ‘client outflow risk’ sitting in our strategy at the moment.”

On the market outlook, Mr Douglass cautioned that there was “very little margin for error”.

“It’s very clear that we’ve got stimulus from the monetary authorities and the government at a level that is beyond comprehension and should be very supportive of economic growth, particularly in the US in the fourth quarter and maybe the first half of next year,” he said.

“We could get some very strong numbers and the market’s backing that, and China is in pretty good shape at the moment and we’re seeing that in commodity prices.

“But where there’s very little margin for error at the moment (is) in the scientific risk on the mutations of this virus. The mutation risk is very real.

“There have been some very important lab experiments that have been done that show this virus is very susceptible for an escape mutant to happen that would evade the current vaccines, and if that was happening we could see some real volatility in markets.”

Mr Douglass said his funds were “fairly fully invested but we’re pretty cautiously invested because this could go in any direction at any time and we’re not through it at the moment”.

“People think the vaccines are going to hold up and we’ll just re-code them. If only it was that simple,” he said. “We are trying to read all the scientific risk as well, and the escape mutant risk — nobody knows what the answer is to it, but it’s real. There’s a number of different scenarios … some of them are fairly small to the extremely ugly from a financial point of view.

“I’m not predicting it’s going to be seriously ugly, but if something turns against us in a mutation in this virus and our portfolio is pretty well positioned, and I think if it just continues without it, I’m pretty comfortable with the portfolio’s positioning at the moment.”