Magellan has abandoned its long-standing Chinese positions and cast a keen eye over financials as it attempts to weather an environment of more persistent inflation.
The manager has remained in the headlines on a near daily basis, with continued uncertainty around the return of CIO and founder Hamish Douglass, who took medical leave in early February. With outflows in recent months exceeding $20 billion – more than most fund managers in Australia hope to manage – attention has been heavily focused on the short-term performance of the strategy.
The Magellan Global Fund has always focused on holding “core” or “quality” names with persistent earnings and strong businesses, but it was a tough quarter for even the world’s largest companies. Each of Starbucks, Meta Platforms and Netflix suffered a significant selloff during the quarter, by more than 20 per cent each; 30 per cent for the latter.
Naturally, the fund’s underperformance continued unabated, falling 12.4 per cent during the quarter and 2.8 per cent in March, compared to 8.2 and 0.7 per cent falls respectively in the MSCI World Net Total Return Index. Commenting on the performance, the group said that the “quarter was characterised by outsized share price responses” but that they remained focused on the long-term.
In the medium term and beyond, we think investors should be prepared for market returns that are below those recorded in the past 20 or so years,” the report says. “The global economy remains structurally low growth and low inflation, resulting in structurally low interest rates.”
“What has changed is a steep rise in government debt and potentially a greater acceptance of central-bank-financed government deficits. Overall, the short- to medium-term outlook for markets is more uncertain than usual. As a result, the portfolio holds cash at 8 per cent.”
But one of the less appreciated comments in the latest quarterly was the fact that a significant amount of change appears to be occurring in the portfolio. With the new portfolio manager Nikki Thomas and CIO Chris Mackay clearly getting their feet under the desk, a number of underperforming positions have been removed as the fund adapts to a new, more persistent inflation environment.
Among those removed was one of the longest standing holdings and what may have been the biggest contributor to the fund’s underperformance: Chinese e-commerce giant Alibaba. Magellan has had a bumpy history with China, stung by the shelved IPO of Ant Group (the financial arm of Alibaba) and the mysterious (but temporary) disappearance of its rockstar CEO Jack Ma.
Douglass later conceded that he had allowed the fund’s exposure to Alibaba to creep beyond what might be considered prudent in order to attain a better position in the eventual IPO, and new risk controls were placed on the China holdings afterwards.
But Magellan’s managers highlighted concerns that “government policies such as covid-zero and regulatory crackdowns are likely to weigh on growth” with the US instead the best-positioned region for growth. The result is that the fund now holds no locally domiciled Chinese businesses.
The preference for US-centric businesses in what is an increasingly divergent world where Magellan predicts lower than average returns from equity markets is the first of their new “thematic” changes, with the group adding to their holdings in Visa and Mastercard, while buying into British multinational beverages company Diageo.
The second thematic was a reassessment of interest rate risk in light of the uber-aggressive policies now being implemented in the UK, US, Canada and even New Zealand. The group has responded by trimming exposure to a number of utilities and infrastructure businesses, whilst entering positions in banking and insurance groups US Bancorp and Lloyds “as their earnings benefit from increased interest rates”.
Finally was the “reshaping” of their defensive holdings amidst a “desire to increase the diversity of businesses in an environment of slowing growth”, likely in response to the growing risks of a high conviction approach. The result was the addition of hospital owner HCA Healthcare.
One of the more interesting pieces within the report was commentary around the history of “corrections” in some of the world’s largest companies. According to Magellan’s research, Microsoft and Visa have averaged 28 and 23 per cent per annum returns for close to a decade and suffered no less than 15 and 13 selloffs of more than 10 per cent in this time.
“While these near-term share price falls have been amplified in the current environment, the value of the long-term compounding of returns remains extremely attractive for advantaged businesses over longer horizons despite short-term volatility,” the report says.
Lachlan Maddock is contributing editor to Investor Strategy News (Australia)