Just as optimism and pessimism ebb and flow in stock markets, similar sentiments affect the share prices of individual companies, causing the price of shares to deviate significantly from their intrinsic worth at times. The temporary divergence between the inherent value of a business and the market’s perception and expectations of it, as reflected in the company’s share price, is the opportunity that we seek to exploit.

What creates these opportunities is investors’ inability to anticipate and fully comprehend change, compounded by such emotional drivers as fear, fashion and greed. While share prices frequently fluctuate in reaction to inconsequential news headlines and overreact to recent events of a salient, though transitory, nature, be they positive or negative, markets rarely respond proportionately to real changes in the intrinsic value of the business. Moreover, the plethora of market ‘noise’, together with the availability bias innate in human beings, causes investors to extrapolate – inferring simplistically that the trend line observed today will continue into tomorrow.

The key to Platinum’s investment approach lies in distinguishing companies with sound businesses that are undergoing creative destruction, from those that are facing fundamental challenges. This requires independent thought and practical business acumen.

Adopting a contrarian approach to investing means that we can periodically face trying times, because there can be a lag – months or years – before the market recognises the intrinsic value of out-of-favour companies. Strong discipline is needed to adhere to the investment thesis and remain unperturbed by market volatility in both good times and bad. We minimise “case drift” by ensuring that each investment is supported by a written report that lays out the investment case in detail. Note, however, it is equally important to recognise when an investment case is not playing out due to altered fundamentals in the business. In the event of a company failing to meet our pre-determined performance milestones, the shares are likely to be sold.

Our search for intrinsic value is simple in concept. Applying the concept, however, requires a methodical and disciplined process and a certain mentality. We have a methodology at work, and its robustness is proven by the long-term track record of our portfolios. 

We also do not follow any pre-determined asset allocation model, though an understanding of the broader socio-political and macroeconomic trends play an important part in our stock picking process. 

Screening

We use various devices to make sense of the huge universe of stocks available, including proprietary models that allow for the selection of companies based on specific parameters (or screens) across a databank of several thousand companies. The screens may be based on quantitative criteria, but may also be built on a qualitative hypothesis centring on, for example, certain industry trends. This process allows us to delve deeply into cross-comparative studies of companies around the world, thereby drawing up short-lists for further investigation.

Idea generation

Generation of themes and ideas is eclectic in nature. Apart from applying quant tools to look for signals of neglect, there is a constant input from observations of the changing socio-economic and political landscape as well as secular trends such as the technological disruptions of traditional industries and new consumer trends emerging amongst the growing middle class of some developing economies. 

Great store is placed on the cross-pollination of ideas and the importance of applying a global perspective to each company’s operations. Our investment team is structured with the specific aim of fostering an open and collaborative environment and to facilitate the free exchange of information and ideas between analysts with different geographic and industry specialisations.

Intensive research

Once a company has been identified as a potential investment opportunity, it is then investigated by an analyst in great detail and depth, harnessing all the resources available to us, including material from the company itself as well as its competitors, broker reports, industry studies and consultations with experts. Analysts also periodically make on-site visits to portfolio companies (and potential ones) as well as their competitors and suppliers.

It goes without saying that the quantitative and qualitative analyses of a company encompass considerations such as:

• what gives the company’s business a competitive edge and whether its success is sustainable; 

• the quality of the company’s management team, as measured by its past record, duly adjusted for the circumstances at the time, as well as statistical comparison with its peers;

• the company’s ownership structure;

• whether the company is financially sound, such as the extent of its reliance on debt financing and its ability to service its debt; 

• how much free cash flow the company is generating, how much and how likely its free cash flow will grow in the future, and how much of that cash flow will reach the hands of shareholders; 

• whether company’s intrinsic value (as determined by factors such as those mentioned above) is being over- or under-estimated by the market, as reflected in such metrics as the price-to-earnings ratio and price-to-book ratio, etc.

In reality, this information is largely available to all serious market participants, but it is the interpretive skill and mentality that make the difference.

The key lies not in the quant tools or valuation models, but partly in the mentality of a long-term investor, in contrast to that of a short-term speculator. As shares represent part ownership interests in a company, we think about each opportunity through the lens of one who is considering becoming a joint-owner of the business and demand from ourselves an in-depth understanding of – and conviction in – the business before committing any capital to it. 

Peer scrutiny

The research findings and analysis are distilled into a detailed report. This is then subjected to the critical appraisal by other team members who meet to rigorously debate the merits of the case. The purpose of these meetings, which can last for hours, is to expose areas of concern and potential flaws in each investment thesis, rather than to achieve a consensus. The final decision lies not with a committee, but solely between the analyst who is the promoter of the idea and individual portfolio managers.

The research report would highlight specifically the achievements expected from the company being proposed. These vary considerably, depending on the nature of the company involved, but, among other things, would include sales and earnings targets. Failure by the company to meet these targets would raise concern and, notwithstanding confirmatory price action, could result in the shares being sold. It is Platinum’s experience that when such targets are met or exceeded, the company’s share price tends to overshoot expectations. 

Portfolio construction & balancing

Each of our portfolios is assembled from a series of individual stock selections, with the weightings determined by the relevant portfolio managers based on their conviction in each investment case (subject to the limits prescribed in the mandate). A well-recognised index such as the MSCI All Country World Index is used as a reference to evaluate the performance of a portfolio in relation to the total market opportunity in which it invests, but the stocks that make up the index or the weightings of those stocks within the index have no bearing on the composition of the portfolio. 

We view portfolio construction as an organic layering process, not a formulaic procedure. At any time, there will be exciting new ideas, others that have made an initial contribution and stocks that are starting to tire as the market catches up with the company’s fair value. In addition to closely monitoring the unfolding of each investment case, care is taken to understand the interplay between stocks and themes within a portfolio, ensuring that the portfolio remains well-balanced as its thematic focus shifts from one area to another. 

When there is a shortage of compelling stock ideas, the cash balance will tend to rise (and vice versa). As such, after periods of a very strong run-up across a broad range of stocks held, a portfolio may hold significant cash positions. Likewise, when our research reveals companies whose prospects are improbably refulgent and extravagantly overvalued, short-selling (where permitted under the mandate) may be undertaken, aiming to manage portfolio risk as well as increase returns.


*The animated video above is a stylised representation of a complex process.

Managing market risk

We view risk primarily as the prospect of losing our clients’ capital, rather than any short-term volatility or tracking error (i.e. underperformance relative to a benchmark). Our stock selection process is core to the management of risk. In particular:

• As a result of our bottom-up investment process, the key portfolio risks are the specific risks associated with each individual stock in the portfolio. We view stock-specific risk as a function of our knowledge of the business and seek to manage this by means of meticulous research, robust peer review and ongoing monitoring. Our index-agnostic approach allows us to control the absolute risk of the portfolios.

• Our particular focus on companies that are out of favour with the market means that we purchase shares when their price is already discounted relative to their intrinsic value. Our experience has shown that the depressed entry price can inherently limit downside risk. 

• Appropriately calibrating the weight of each position within a portfolio based on the merits of each investment case is another important means of risk management in our process. We avoid excessive concentration in a portfolio and the diversification guidelines of our funds and mandates help to manage portfolio risk without unduly restricting the investment process. Under most of our mandates, the portfolio will seldom invest more than 5% of its net asset value at the time of investment in the shares of a single issuer.

• Within a portfolio, care is taken to avoid excessive exposure to areas that have a high co-variance. This may be considered by industry or country. Within a country, there are other considerations such as susceptibility to currency fluctuations, interest rates and government actions. At the industry level, consideration will be given to the nature of its structure, such as concentration, cyclicality, relative maturity, threat of substitution and so on. Regular analysis highlights the profile of the portfolios by geographic, industry, emerging market, liquidity and other characteristics.

• When the market experiences widespread excessive exuberance and undervalued stocks become scarce, we will increase our cash holdings and reduce our net equity exposure to protect the portfolio.

• Similarly, we may short-sell stocks and indices that have been identified as being extravagantly overvalued by the market (where permitted under the mandate). Short-selling may be employed as a means to limit risk by reducing a portfolio’s net invested position. It may also be undertaken with the aim of increasing returns by seeking to profit from a fall in the share price of a particular company or the prices of a sector or market more broadly, as represented by indices. Short positions in our portfolios are generally established through equity swaps, which are cash-settled non-deliverable contracts.

• Objective measures of a portfolio’s aggregate characteristics (in terms of growth, profitability, leverage and value) are conducted periodically.

From time to time, we utilise derivative instruments to manage risk, including (subject to mandate restrictions):

• selling index futures or buying index put options to reduce market risk in a portfolio;

• buying call options or warrants over a security to reduce the cost or potential downside of holding a given stock; and

• where we have identified stocks that we believe to be overvalued, buying put options over those stocks or short-selling them.

Managing currency risk

International equity investments create an exposure to foreign currency fluctuations which are affected by factors such as interest rate differentials, economic performance, trade flows, purchasing power parity measures, and government policies. Movements in foreign exchange rates can change the value of the equity investments measured in a portfolio’s reporting currency. It is a component of Platinum’s investment process to assess the potential returns and risks created by currency exposure and position the portfolios appropriately to attempt to capture those returns while minimising those risks.

The aim is for each portfolio to be exposed to the greatest extent possible to appreciating currencies and for its exposure to depreciating currencies to be minimised.  

We actively manage the currency exposure of our portfolios using foreign exchange forward contracts, currency swaps, non-deliverable forward contracts, and currency options, as well as spot foreign exchange trades (where permitted under the mandate).

More generally, our investment process involves assessing the indirect impact of currency on a business (e.g. the impact of currency fluctuations on a manufacturing company with significant export sales), and the potential for exchange rate movements to amplify or diminish the returns earned from our investment in a company when translated into reporting currency. Cash positions may also be held in portfolios taking into account the potential currency impact (as well as interest rate and credit risk considerations).