Will semiconductor investors make a comeback?

Hi, I’m Joss Murphy, research analyst at FundCalibre. Today, I’ve been joined by Nick Clay, manager of the [TM] Redwheel Global Equity Income fund. Hi Nick, how are you?

[00:13] Very well, thank you very much. Thanks for having me on.

Great to hear. Great to hear. Well, let’s kick things off, Nick. You like to “buy the controversy and sell the consensus”. Can you explain that to our viewers, maybe with an example?

[00:27] Yeah, certainly. I mean, we think when investing that you kind of need to ‘lean’ the probabilities of things going right or wrong in your favour. And therefore, we find that when we’re trying to buy good quality companies at a decent valuation, the only time that really happens is when something is going wrong with those companies, and there’s some kind of controversy, and that’s where we’re forced to fish all the time.

So, a good example of that would’ve been at the beginning of last year and luxury retail. When the controversy obviously was the close down of China particularly, and that was obviously having an impact on luxury goods sales. But when you worked out and thought about what the range of outcomes for those companies were, it’s a pretty high probability that China wasn’t going to stay in lockdown forever. And therefore, if you could model what those companies might do when China reopens again, given that you’ve got the evidence of what happened in the West when the West reopened, [it] showed that your risk / reward in the valuation of the stocks at that point, were skewed to the upside and not skewed to the downside. And so, that gives you an opportunity to enter into stocks at an attractive risk/reward [profile]. And the same happens on the other side, when you have companies where the market has fallen in love with those companies, the market is totally in belief of success coming from that company, and yet again, there are a range of outcomes that could happen, and if the majority of those outcomes are skewed against you, then your risk/reward is not in your favour.

And one we sold at the tail end of last year from the portfolio was Unilever, for exactly that reason. It had done incredibly well over the course of the second half of 2022. And everyone is very expectant of the turnaround story at Unilever being successful and going across without any problems. And yet we think, when you look at the range of outcomes for that company and what they’re trying to do – the new areas they’re trying to move into – we think the chances of success are actually very low. And there’s a lot of evidence to show how difficult it is to do that. And even if successful, that it’ll probably cost the shareholder a lot more than they think. And yet, the valuation of Unilever got to the point where basically, success was being priced in and nothing else. And so, again, when your risk/reward skews against you, you want to sell it.

Of course, that’s difficult to do, yeah, [because] every time we’re buying something, we’re told we’re idiots for buying it because something’s going wrong, and every time we sell something, we’re told we’re idiots because everyone’s in love with those companies! So, it’s a hard thing to do as an individual. So, you need some kind of discipline to force you to do that, you know, and that’s what this process on this strategy encourages us to do.

Well that certainly makes sense. The fund aims to yield 25% more than the market. What is that level today and do you see it rising or falling from here?

[03:34] So, the disciplines that we have imposed upon ourselves [are] that we can only buy a stock for the first time in this portfolio, when it’s yielding 25% more than the market. Sometimes it can yield even more than that, but that’s the bare minimum it must yield. And that’s deliberate because we want every stock to yield more than the market. And we want therefore the whole portfolio to yield more than the market. Now today, the world market is yielding around 2.2% and the fund is yielding around 3.33 -3.5[%]. So, it’s yielding comfortably above that 25% premium.

And that is important because, again, going back to trying to ‘lean’ the statistics in your favour of trying to get things right and generate a decent return, one of the key characteristics when you look over the long term and market returns, is that the compounding of the income in the market, drives the majority of the total return of that market. And so, if we can compound a bigger number than that of the market, then that is statistically to our client’s advantage. And so, those disciplines imposed upon us ensure that the portfolio is always yielding more than the market; we’re always compounding a bigger number and that, over the long-term, will be to the advantage of our clients.

An interesting point. Historically, this strategy has outperformed in volatile markets as it did just last year. Why is this?

[05:04] So, in the short term, the reason why it tends to have a better downside capture, ie. it doesn’t go down as much as when markets fall, is mainly because at that point we were talking about in the first question where we’re forced to buy things when they’re already out of favour ie. a lot of the bad news is already priced in, that’s when we’re buying them – there is a controversy. And so, when things start to go wrong, what it’s already been expected by the market, and because therefore they’re better value than that of the market, they tend to not go down as much [as] when the market is panicking about something.

Over the longer term, the reason why the volatility on the strategy tends to be lower than the market is because we make up the majority of our total return from the compounding of the income.

When you think about your total return, you make it from compounding your dividends and you make it from the prices going up and down, the capital part. And those two things together give you your total return. Well, mathematically, the compounding of your income – your dividend [that] gets paid out to you every year – that is less volatile than the market just going up and down the capital. So, if you make more of your total return from the income, then definitively your total return will be less volatile than that of the market. And so, over the long-term it’s because of the way we make up the returns and in the short term, it’s because we’re buying our companies when they’ve already got some value protection in them because they’re already out of favour.

And kind of on all those points you’ve made today, where are you finding opportunities right now?

[06:39] So, I think one of the most exciting places is a hugely unloved area of the market, which is semiconductors. In technology, everyone has fallen in love with a very small handful of stocks. Your Apples, your Microsofts … Apple and Microsoft have now become the biggest two companies ever in the world, since 1978. Back then, it was IBM and AT&T and, you know, history has taught us the future didn’t actually pan out very well for IBM and AT&T when they were the most loved stocks in the world. And yet here we are again, Apple and Microsoft, this time they’ll be the ones that take over the world. And because of that obsession with a very small handful of tech names, it’s meant that other technology stocks we think are offer offering really good risk/reward.

And in semiconductors, the three stocks that we own in our portfolio are Qualcomm [Inc.], which does 5G technology, TSMC [Taiwan Semiconductor Manufacturing Company Limited], which does very high-end chips, and it dominates that as a monopoly – as does Qualcomm – and Samsung [Group], which effectively dominates the memory space, within your computers. And all of those three companies we think are on valuations today, which imply that they’re very cyclical – they are cyclical, but we don’t think they’re as cyclical as the market fears – and that over the long term they’re not going to be able to grow ie. they’re literally on very cheap valuations. And we think, structurally, there is still growth in semiconductors. We think they dominate their industries from a monopolistic position and therefore they’re the ones that are going to benefit from that. And in the short term, you are being offered the opportunity of that because everyone is focused upon the household names and not focused upon where the value in technology lies.

Well Nick, I’ve written those names down! And I just want to say thank you very much for your time today.

[08:37] Thank you very much and thank for your questions.

And if you’d like to find more information about the [TM] Redwheel Global Equity Income fund, please visit FundCalibre.com. Thank you.