Simon Hallett: A Bottom-Up Approach in a Top-Down World
Simon Hallett, chief investment officer of Harding Loevner, likes Nestlé, Dassault Systèmes, and Keyence.
Simon Hallett, the chief investment officer at asset manager Harding Loevner, spent a decade early in his career in Hong Kong. It was a good place for Hallett to learn about global markets. In 1991, he joined Harding Loevner, which is based in suburban New Jersey -- a long way from Asia. Hallett, however, did not take his eye off of international markets, which he still visits frequently. He leads the firm's investment team in looking for reasonably valued, quality growth companies around the world. "We look for fundamental growth: revenue, earnings, and cash flows," says Hallett, 59. "When it comes to quality, we mean having a strong competitive position, a low-risk financial condition, and good management," especially when it comes to sound governance and capital allocation. This research-driven approach has paid off over the long haul for the firm, which oversees $41 billion. Its funds lineup includes the $800 million Harding Loevner Global Equity Advisor fund (ticker: HLMGX). Its 10-year annual total return of 9.15% is in the top 25% of its Morningstar peer group. Barron's spoke to Hallett recently by telephone.
Barron's: What issues are affecting your markets?
Hallett: The big issue that has happened recently is a recovery in emerging markets. The selloff that we saw last year was fully discounted in the market by March of this year, despite quite a lot of instability in what I'll loosely call geopolitics. There does seem to have been quite a considerable return of confidence to emerging markets, so that's been a pretty big feature of the markets we look at. And we continue to see this dislocation between what is going on in financial markets, stock markets in particular, and the macro background.
How much attention do you pay to macroeconomic commentary?
We operate very much on a bottom-up basis, and we do company research. Part of the reason we focus so unremittingly on companies and their stocks is because we think that macro forecasting is extremely difficult -- and that even expert predictions are unreliable. Even on the rare occasions when they are reliable, the relationship between those top-down forecasts and individual securities is tenuous and perhaps nonexistent. So any remarks I make about our worldview are not necessarily reflected in our portfolios.
Do you have any examples of that?
Over the past five to seven years, we've had the strongest relative returns from places that we wouldn't have ventured very deeply into if we had been top-down forecasters. We've had a considerable part of our international portfolio invested in French and Japanese companies. Those holdings have averaged roughly a quarter of our non-U.S. exposure. But the kinds of companies that we are investing in are not at all representative of either the economy where they are domiciled or the market in which they happen to be listed. Clearly, they are very much French companies run by French executives, but they operate very much on a global basis. That's meant that their returns over the past five to seven years have been much in excess of the French market, and the same applies to our holdings in Japan. Being investment people, of course we have worldviews. We read widely and we travel widely. But we are disciplined enough to keep those views out of the portfolio. My views probably would have been, "Let's avoid everything in France, and let's avoid everything in Japan," and it would have been completely wrong.
How has the relationship changed between developed and emerging markets, particularly in terms of investing?
Over the past 15 years, what has really changed has been that the case for emerging markets as a separate asset class has been weakened. The case for emerging markets was that you got fast growth, and you didn't have to pay too much for it. And stocks in emerging markets had a low covariance with the rest of the world. So it was a separate class, and portfolios benefited from the diversification free lunch that you got from investing in emerging markets. But that covariance has risen pretty consistently over the past 10 years, and, obviously, that covariance went to one during the financial crisis. So that diversification aspect of emerging markets has diminished considerably.
What else has changed with emerging markets for investors?
Emerging markets as a source of very cheap, fast-growth companies has also diminished. People always think that you make money in emerging markets because the companies grow faster than they do in developed markets or because the underlying economies grow faster. People always confuse the two, and I am not sure that at the company level that's true any longer. The real way you make money in emerging-market stocks is by buying them when they are cheap, which is usually when people perceive risks to be higher, and then enjoying a reduction in the equity risk premium. Or, to put it another way, there is an expansion of price/earnings multiples, along with better growth. Despite the fact that emerging economies are still growing much faster than the rest of the world, revenue and earnings growth, at least in our portfolio companies, is actually slightly superior in our global and international portfolios versus our emerging-market portfolio.
Why are you slightly underweight emerging markets?
It's partly because the valuation premium there is on the high-quality companies to which we are naturally attracted. We hear a lot about how emerging markets are underpriced, and if you look at the valuation of markets as a whole, that's true. But then we look at where the cheap spots are, and they're the kind of companies we don't particularly want to invest in.
How do stock valuations look generally across all of the markets you invest in?
They look OK. I'm vague about it, deliberately, because valuation has always been an imprecise science. If we look at historical ranges, including Shiller P/Es, they look closer to the top. And we know that profit margins in the U.S., in particular, are at close to an all-time high. But the companies we invest in continue to have encouraging results, despite that background. So valuations look OK, as I mentioned. With interest rates as low as they are and under very little upward pressure, the value of a portfolio that has an earnings yield of 5%, or a P/E of 20, and with earnings before interest and taxes growing by 10% to 12% per annum, is very high. So the portfolios that we run are a little bit more expensive than they have been in the past, trading at roughly 20 times forward earnings. But they are not a great deal more expensive at a time when this kind of growth that I just described is a much rarer commodity. We think our portfolios are actually reasonably cheap, given the much greater financial superiority of these companies and their growth prospects.
In your global portfolio, your biggest country weighting is the U.S., which accounts for a little more than half of the assets. Is that the most attractive market globally?
If we end up being overweight the U.S., that is clearly what we are finding. But I don't want to understate what is happening in the non-U.S. world, which is that we are finding plenty of companies where earnings growth is really quite strong, despite all the doom and gloom that we hear about. It's not just political risk, but the inability of the non-U.S. world to generate economic growth. However, it's clear that the U.S. economy is growing much faster than everywhere else in the developed world.
Let's hear about a few companies that illustrate your stock-picking approach.
We've held Nestlé [NESN.Switzerland] since 1989, the year our firm was founded.
It's a classic example of a company that meets our criteria. Over 25 years, we saw a modest P/E expansion and pretty consistent earnings growth. In U.S. dollars, the stock's total return has compounded at about 16% per year in the past decade. The business is essentially unexciting, and I mean that in a highly complimentary sense. Their earnings are reasonably predictable. They have up years and down years. They have good years and bad years, but the range of outcomes is relatively low, and it's often out of fashion to own Nestlé. Over any particular time period, there is no compelling narrative associated with the stock, so it never becomes dramatically overpriced. We are sensitive to price, and Nestlé trades at about 20 times this year's earnings.
As a growth investor, you can't just buy and hold forever. You do need to be aware of price.
A very good example is Coca-Cola [KO], which in the late '90s actually traded at more than 40 times earnings, and it took many years to generate a decent return from that price level. Coke is a wonderful company, but you do have to be sensitive to price. That's one of the interesting things about Nestlé, which never excites people; it never becomes dramatically overpriced. We have never felt the need to sell our entire position, though we have sold a bit here and there over the years.
Do you expect Nestlé's stock to have similar returns?
Returns have to be lower than they've been. As I said, Nestlé's stock has had P/E expansion, and it's had a 16% compound return in dollars over a long stretch. It also has benefited from earnings increases and currency appreciation against the dollar. I don't think we will see that kind of multiple expansion from here that Nestlé has experienced previously, so I expect lower returns. If Nestlé can generate 8% to 10% annual returns, that should outperform the market.
Next pick, please.
Dassault Systèmes [DSY.France] is a French company that develops software.
It allows engineers to simulate the manufacturing process on a computer screen. Boeing used it to help develop its Dreamliner aircraft. Dassault is a company that meets the criteria we look for, and it has powerful technology skills. It is an example of how there is good technology outside of the U.S. Looking at our global and international portfolios, a lot of our technology holdings are almost by definition in the U.S., because the U.S. dominates the tech world. But here we are with a French company that's really managed to break out of the shackles there almost inevitably by virtue of being in France. They've successfully done acquisitions, and they've run the company very well. Dassault has become more transparent, and it is really an example of the kind of long-term growth we look for. Everybody is looking to make things more intelligently, and here is a company that provides the products to do that.
It trades at about 30 forward earnings, hardly cheap.
That's correct, which is actually in line with where it has been historically, and that multiple is justified. We have it trading at about 27 times forward earnings. It is not cheap, and it clearly needs to grow fairly fast to justify its current share price. But we believe the company can grow its revenue at a 10%-12% annual rate, and it has high margins. So this company is very valuable in a world of relatively low returns, and it is very well positioned. Consider what is happening in China. A huge thrust in the economy there is to get more intelligent about manufacturing with less capital involved, and here is a company at the forefront of that.
How about a pick in a different sector?
We'll switch to Japan, where Keyence [6861.Japan] is based. In many ways, it is a deeply Japanese company in that they talk about how they care about their customers and their employees and not too much about their shareholders. Yet, as a result of caring about their employees and customers -- and that includes incentivizing their employees -- they've generated extraordinary returns for shareholders over very long periods of time. We bought the stock in 2003, and it has generated about 10% annual compound returns, better than most Japanese companies. They have a very straightforward business: Japanese technology. They sell sensors and measuring equipment, and, as is the case with Dassault, this is very much a secular growth theme. If you are running a factory with more robots than humans, you do that partly by installing sensors and measuring equipment everywhere. With these secular growth trends, we pay attention to price. Similar to Dassault, this is not a very cheap stock, trading at about 27 times this fiscal year's estimated earnings. But it's a rare value in a world of Japanese companies that for the most part have fairly low returns. Keyence has a return on equity of about 10%.