Commentary
Foundations of Oldfield Partners
The current high valuations of indices play on two key inefficiencies in equity markets that led to the foundation of Oldfield Partners: the short-termism of most participants and their tendency to hug indices. We aim to avoid these inefficiencies by staying true to our process of looking to make investments based on valuations and building benchmark agnostic portfolios. When buying the S&P 500 today, an investor pays twenty-five times earnings for an average company on peak margins. This runs contrary to our approach as a team.
As value investors we are unwavering in our belief that the best way to deliver long term returns is to invest in a portfolio of lowly valued and out of favour equities. The last decade or so of investing could be referred to as the value winter. But summer will arrive. There are green shoots on the horizon as there have been on occasions through the last decade but as the valuation spreads widen the shoots become more pronounced and the probability of a thaw increases.
We saw signs of green shoots emerge in the quarter. The fund rose 9.0% in the third quarter of 2024 while the MSCI World Index rose 6.4%. The largest positive contributors to performance were, in order of impact, Alibaba (+56%, total return in local currency), Fresenius (+23%) and SS&C (+19%). The largest negative contributors to performance were, in order of impact, Samsung (‑25%), NOV (‑16%), and Heineken (-7%).
Where are we finding value?
Despite the overall highs of the market, we are still able to find good companies that are trading at respectable valuations, some are even very cheap by historic standards. Much like in 2000 there are companies that are unloved and out of favour. Some of these companies have generated good long-term returns for investors with a long-term mindset. A long-term mindset from the companies we invest in is not critical, but it helps reduce the probability of a value trap. Below are two examples of companies that reflect this, both of which have been added to the portfolio in the last 18 months.
Chubb, the strategy’s largest holding, is one of the largest property and casualty insurers globally. Over the last two decades Chubb and its predecessor ACE have generated an average combined ratio (the equivalent of an operating margin for insurance companies) of 91% and never exceeded 100%. Chubb’s track record of consistently generating low combined ratio is unmatched. The track record is because of a focus on profitably underwriting insurance over the long term. This is something not shared by all insurers who chase the cash they get paid by premiums and worry about the consequences later. Despite this success over the long-term Chubb trades on a forward price-to-earnings ratio of twelve.
Another example of this corporate long termism comes from Handelsbanken, the Swedish bank. In 1973, under the stewardship of CEO Jan Wallander, Handelsbanken created a profit-sharing foundation called Oktogonen. The principle was to build a strong culture of loyalty and shared responsibility among Handelsbanken's employees. Oktogonen worked by distributing a portion of the bank’s profits to employee’s pension funds by purchasing shares in Handelsbanken. The long-term focus was reinforced as Handelsbanken employees did not receive the benefits until retirement. Handelsbanken remains among the world’s most conservatively managed banks today with a valuation of eight times price to earnings and a dividend yield of nearly ten percent. Oktogonen retains nearly a ten percent shareholding in the company and reinforces the alignment of interests.
Chubb and Handelsbanken are representative of the sort of companies that we find attractive at Oldfield Partners: long term, fundamentally sound businesses that are trading at attractive valuations.
Samsung is another example. Although it was the worst performer in the quarter, the company continues its relentless focus on the long-term. Since we purchased the shares in 2011, they have provided a return of over twelve percent per annum in USD. Over the last few decades Samsung has manoeuvred itself from being a textiles business to the world’s largest memory chips business. The company continues to invest heavily to break TSMCs stranglehold on the logic foundry business. The company today has a market capitalisation of $280bn, $60bn of net cash and is expected to generate net profits of around $30bn this year implying a valuation of seven times price to earnings when adjusting for the net cash position.
Stocks for the Long Run
Equity investors often anchor their expectations to long-term historical returns of around 9 percent per annum (approximately 7 percent real), as popularized by Jeremy Siegel in his seminal work Stocks for the Long Run. However, it is crucial to recognize that long-term averages can mask significant variability in shorter periods.
In the two decades leading up to 1982 the S&P 500 delivered nominal returns of around 6 percent per annum, with real returns close to zero, while the period from 1982 to 2002 produced nominal returns of roughly 15 percent per annum (about 12 percent real). These differences were not driven by changes in earnings growth or dividend yields but by changes in market valuation.
In 1962, the S&P 500 traded at a price to earnings ratio of approximately 20 times, but by 1982, this valuation had contracted to just eight times. By 2002, the price to earnings ratio had climbed back to around 20x, reflecting the cyclical nature of valuations. We believe that the long run is not best defined by a period of time; but a period in which changes in valuations have little or no impact on returns. In this instance forty years was required to reach a long-term equilibrium with annualised returns around ten percent (five percent real).
Today the valuation of the S&P 500 is higher than 1962 and 1982 and mirrors the frothy valuations seen in 2000. We see this as a warning sign for investors. Whilst the mid-teens annualised returns of the S&P 500 have been incredibly enticing since 2008, we perceive them to be increasingly like the bull market that came to a head in 2000.
Why we are excited about the future
History suggests that the high starting valuation of the S&P 500 today, indicates a reduction in the expected ten-year returns to low to mid-single digits. Since the companies that dominate the S&P 500 also drive the MSCI World we would expect global markets to follow a similar path. However, at Oldfield Partners, we remain excited about the future because of the substantial valuation discount the strategy offers relative to the broader market. This currently stands at more than 50%.
Since the inception of the Overstone Global strategy in 2005 it has delivered earnings growth slightly ahead of the MSCI World, including dividends reinvested. However, the relative multiple change over the period has had a material impact on the return that investors have received. The Overstone Global strategy has fallen from 13 to 9 times price to earnings and the MSCI World has risen from 17 to 20 times price to earnings; creating a c.3% per annum relative underperformance for the strategy.
Let’s assume the earnings grow in the future in the same way as the past. If it takes twenty years for the valuation differentials highlighted above to mean revert, then we will outperform by 3% per annum. If the valuation differentials correct over three years as they did in 2000 to 2003 then we would expect outperformance over that period to be in the double digits.
The strategy is now trading at a record-low absolute valuation, further strengthening our conviction in its prospects. While we understand the impatience of investors who have seen value investing struggle relative to growth strategies over the past decade and a half, we believe the current opportunity for value investors is as attractive as it has been in nearly 25 years.
As Benjamin Graham said, "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." Long-term investing requires patience and discipline, especially when the market is driven by short-term sentiment. At Oldfield Partners, we remain focused on fundamental value and long-term opportunities, believing that this approach will ultimately deliver superior returns to our investors.
Transition in Management
We are pleased to announce that Sam Ziff has been promoted to sole manager of the Global Equity Strategy, with effect from 1st January 2025. A member of the team since 2013, Sam first assumed portfolio management responsibilities in 2016, and has been co-manager of the Global Equity Strategy since March 2024. In recognition, Sam has also been named Chief Investment Officer. Nigel Waller and Andrew Goodwin will step back from the firm in March 2025.
Commentary
Foundations of Oldfield Partners
The current high valuations of indices play on two key inefficiencies in equity markets that led to the foundation of Oldfield Partners: the short-termism of most participants and their tendency to hug indices. We aim to avoid these inefficiencies by staying true to our process of looking to make investments based on valuations and building benchmark agnostic portfolios. When buying the S&P 500 today, an investor pays twenty-five times earnings for an average company on peak margins. This runs contrary to our approach as a team.
As value investors we are unwavering in our belief that the best way to deliver long term returns is to invest in a portfolio of lowly valued and out of favour equities. The last decade or so of investing could be referred to as the value winter. But summer will arrive. There are green shoots on the horizon as there have been on occasions through the last decade but as the valuation spreads widen the shoots become more pronounced and the probability of a thaw increases.
We saw signs of green shoots emerge in the quarter. The fund rose 9.0% in the third quarter of 2024 while the MSCI World Index rose 6.4%. The largest positive contributors to performance were, in order of impact, Alibaba (+56%, total return in local currency), Fresenius (+23%) and SS&C (+19%). The largest negative contributors to performance were, in order of impact, Samsung (‑25%), NOV (‑16%), and Heineken (-7%).
Where are we finding value?
Despite the overall highs of the market, we are still able to find good companies that are trading at respectable valuations, some are even very cheap by historic standards. Much like in 2000 there are companies that are unloved and out of favour. Some of these companies have generated good long-term returns for investors with a long-term mindset. A long-term mindset from the companies we invest in is not critical, but it helps reduce the probability of a value trap. Below are two examples of companies that reflect this, both of which have been added to the portfolio in the last 18 months.
Chubb, the strategy’s largest holding, is one of the largest property and casualty insurers globally. Over the last two decades Chubb and its predecessor ACE have generated an average combined ratio (the equivalent of an operating margin for insurance companies) of 91% and never exceeded 100%. Chubb’s track record of consistently generating low combined ratio is unmatched. The track record is because of a focus on profitably underwriting insurance over the long term. This is something not shared by all insurers who chase the cash they get paid by premiums and worry about the consequences later. Despite this success over the long-term Chubb trades on a forward price-to-earnings ratio of twelve.
Another example of this corporate long termism comes from Handelsbanken, the Swedish bank. In 1973, under the stewardship of CEO Jan Wallander, Handelsbanken created a profit-sharing foundation called Oktogonen. The principle was to build a strong culture of loyalty and shared responsibility among Handelsbanken's employees. Oktogonen worked by distributing a portion of the bank’s profits to employee’s pension funds by purchasing shares in Handelsbanken. The long-term focus was reinforced as Handelsbanken employees did not receive the benefits until retirement. Handelsbanken remains among the world’s most conservatively managed banks today with a valuation of eight times price to earnings and a dividend yield of nearly ten percent. Oktogonen retains nearly a ten percent shareholding in the company and reinforces the alignment of interests.
Chubb and Handelsbanken are representative of the sort of companies that we find attractive at Oldfield Partners: long term, fundamentally sound businesses that are trading at attractive valuations.
Samsung is another example. Although it was the worst performer in the quarter, the company continues its relentless focus on the long-term. Since we purchased the shares in 2011, they have provided a return of over twelve percent per annum in USD. Over the last few decades Samsung has manoeuvred itself from being a textiles business to the world’s largest memory chips business. The company continues to invest heavily to break TSMCs stranglehold on the logic foundry business. The company today has a market capitalisation of $280bn, $60bn of net cash and is expected to generate net profits of around $30bn this year implying a valuation of seven times price to earnings when adjusting for the net cash position.
Stocks for the Long Run
Equity investors often anchor their expectations to long-term historical returns of around 9 percent per annum (approximately 7 percent real), as popularized by Jeremy Siegel in his seminal work Stocks for the Long Run. However, it is crucial to recognize that long-term averages can mask significant variability in shorter periods.
In the two decades leading up to 1982 the S&P 500 delivered nominal returns of around 6 percent per annum, with real returns close to zero, while the period from 1982 to 2002 produced nominal returns of roughly 15 percent per annum (about 12 percent real). These differences were not driven by changes in earnings growth or dividend yields but by changes in market valuation.
In 1962, the S&P 500 traded at a price to earnings ratio of approximately 20 times, but by 1982, this valuation had contracted to just eight times. By 2002, the price to earnings ratio had climbed back to around 20x, reflecting the cyclical nature of valuations. We believe that the long run is not best defined by a period of time; but a period in which changes in valuations have little or no impact on returns. In this instance forty years was required to reach a long-term equilibrium with annualised returns around ten percent (five percent real).
Today the valuation of the S&P 500 is higher than 1962 and 1982 and mirrors the frothy valuations seen in 2000. We see this as a warning sign for investors. Whilst the mid-teens annualised returns of the S&P 500 have been incredibly enticing since 2008, we perceive them to be increasingly like the bull market that came to a head in 2000.
Why we are excited about the future
History suggests that the high starting valuation of the S&P 500 today, indicates a reduction in the expected ten-year returns to low to mid-single digits. Since the companies that dominate the S&P 500 also drive the MSCI World we would expect global markets to follow a similar path. However, at Oldfield Partners, we remain excited about the future because of the substantial valuation discount the strategy offers relative to the broader market. This currently stands at more than 50%.
Since the inception of the Overstone Global strategy in 2005 it has delivered earnings growth slightly ahead of the MSCI World, including dividends reinvested. However, the relative multiple change over the period has had a material impact on the return that investors have received. The Overstone Global strategy has fallen from 13 to 9 times price to earnings and the MSCI World has risen from 17 to 20 times price to earnings; creating a c.3% per annum relative underperformance for the strategy.
Let’s assume the earnings grow in the future in the same way as the past. If it takes twenty years for the valuation differentials highlighted above to mean revert, then we will outperform by 3% per annum. If the valuation differentials correct over three years as they did in 2000 to 2003 then we would expect outperformance over that period to be in the double digits.
The strategy is now trading at a record-low absolute valuation, further strengthening our conviction in its prospects. While we understand the impatience of investors who have seen value investing struggle relative to growth strategies over the past decade and a half, we believe the current opportunity for value investors is as attractive as it has been in nearly 25 years.
As Benjamin Graham said, "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." Long-term investing requires patience and discipline, especially when the market is driven by short-term sentiment. At Oldfield Partners, we remain focused on fundamental value and long-term opportunities, believing that this approach will ultimately deliver superior returns to our investors.
Transition in Management
We are pleased to announce that Sam Ziff has been promoted to sole manager of the Global Equity Strategy, with effect from 1st January 2025. A member of the team since 2013, Sam first assumed portfolio management responsibilities in 2016, and has been co-manager of the Global Equity Strategy since March 2024. In recognition, Sam has also been named Chief Investment Officer. Nigel Waller and Andrew Goodwin will step back from the firm in March 2025.