Why Hamish Douglass has reason to be worried

Magellan chairman and co-founder Hamish Douglass. Picture: Britta Campion

Magellan Financial Group chair Hamish Douglass worries global financial markets are trading on a knife edge and he is not sure which way the market will fall.

This year Australian stocks are up 6.9 per cent in price terms and the US market is up by 9.5 per cent based in large part locally on four factors: COVID didn’t hit Australian as badly as elsewhere; the Federal Government has thrown $232 billion at the economy to offset the lockdown damage; interest rates are at record lows; and iron ore prices are persistently high.

Market issues are clearly one factor in Magellan’s 17 per cent underperformance this calendar year.

This said, at Tuesday’s close of $47.77 a share the $8.8bn stock is trading at just over 20 times forecast which remains clearly in the upper quartile for global money managers.

The company has $106bn under management with roughly $30bn in retail and $75bn in institutional funds.

The potential game changer in coming months for Magellan will be its retirement product being worked through regulators to provide a solution to the retirement incomes concern highlighted by the market and Federal Government.

The superannuation scheme is good at accumulating assets but not so good at managing money in retirement and the Magellan product is aimed at overcoming so-called sequencing risks.

By way of example if you have $100 in savings and need $5 to live on then you want to earn that much to avoid losing too much capital because the lower your capital the more you need to earn to pay for the shortfall.

Regulatory delays are blamed for the delay in the release but it is due out soon.

Magellan is a bigger company than its flagship global and high conviction funds managed by Douglass with the former having around 25 stocks of which roughly half are defensive consumer staple and utilities including the likes of Nestle, Pepsico and McDonald's.

Douglass admits he missed the recent post-COVID rally which means lower performance fees but just where the market ends up long-term remains to be seen.

Over the past 130 months Magellan has underperformed the benchmark on just four months after fees and before fees it has outperformed every month on a three-year benchmark.

Last month the firm suffered $15 million in outflows from its institutional account which has $75 billion in funds under management.

The point being the outflows are small.

Magellan also includes the Airlie Australian equities management and a frontrunning infrastructure arm under manager Gerald Stack.

He has also diversified with a $155m investment in new investment bank Barrenjoey, $90m in Guzman Y Gomez and $20m in an infrastructure-based fintech.

In the scheme of things all three are small investments but ones that Douglass clearly hopes will grow.

In all the investments total $265m so if one or the other fell over it would not be meaningful for an $8bn plus vehicle.

Banking start-up

The Barrenjoey investment has attracted most publicity because the firm is a start-up full service investment bank, in an established industry with obvious vested interests.

It now has around 220 staff against the 130 at Magellan.

Barrenjoey is managed at Magellan by chief Brett Cairns who is on its board and Douglass – while he is obviously friends of some of key personnel – is having little to do with it.

He helped establish Magellan’s financial involvement which is for a 40 per cent economic interest with just five per cent voting control.

The reasoning being Barrenjoey is designed as being like Macquarie when it started a culturally different investment bank to others in the market working for an offshore boss.

The bankers own 50 per cent of the firm so they will control their own destiny.

This is clearly important for some bankers who have spent their careers managing relationships with offshore banks.

Douglas sees some potential links with Barrenjoey with staff maybe able to swap from one house to the other or joint trainee recruitment.

But for the moment the major issue is the global recovery from the pandemic.

Douglass has a few fears – starting with COVID which may mutate in such a way that the present vaccines are ineffective or at the very least the pandemic impact remains.

He says there is clear evidence of speculative excess as shown by bitcoin having a $2 trillion valuation based on the belief it will transform into new form of [payments unhindered by regulation, stocks like Tesla closed on Monday at $US714 a share valuing the company at $US685 billion or 1,211 times earnings.

Sometime soon it will have to start earning at $US40 billion to justify its multiples.

As the impact of the stimulus fades, the market has to ask itself a fundamental question ‘what has changed in the world to justify market valuations’.

Douglass’ own long-term view is to maintain sustainable rally the market has to get used to the idea that technology is creating new demand through products like air conditioners or dishwashers or motor cars that led people into the straight spending more money.

Today’s technology is creating more efficient markets which in turn is freeing up capital to boost liquidity.

Digitisation has replaced wide sections of the news world meaning newsagents are hard to find, newsprint is used less and more papers are read online. At the same time Airbnb is offering more accommodation choices and Amazon is creating better ways to sell products.

But none of the above is a fundamentally new product to drive consumption.

More efficiency is good – but at the end of the day what is new and different about what we are doing?

In Australia the issue is more profound because once the stimulus washes through what is driving sustainable economic growth?

They are fundamentally good arguments in favour of lower market valuations and when the stimulus finishes what has really changed.

Competition review

ACCC chief Rod Sims on Tuesday night joined with his UK and German counterparts in launching a campaign to ensure they have effective powers to stop anti–competitive mergers.

Sims works from the assumption that when companies combine they do it for synergy benefits gained through increased market power.

This gives them more pricing control and the potential losers are consumers.

The problem is once a deal happens competition regulators barely manage to offset the negative impact so the trick is to stop the merger before it happens.

None of this is revolutionary but the three merger jurisdictions highlighting the issue shows this is not just an ACCC power grab, it is seen as a common international regulatory complaint.

Separately the ACCC released its submission to the Treasury review of the part 3A access regime which is aimed to ensure when monopoly infrastructure exists its market power is clear and it should be declared and regulated.

The present laws on access is confused by basing the test on normal merger control market issues.

In his statement on the general merger control Sims said “the focus of competition agencies, courts and tribunals must be on the importance of protecting competition and preventing anti competitive mergers, otherwise there is a risk that merger control instead skews towards merger clearance and so damages our economy”.