Speaker 1:
From the library of the New York Stock Exchange at the corner of Wall and Broad Streets in New York City, you're inside the ICE House, our podcast from Intercontinental Exchange on markets, leadership, and vision and global business. The dream drivers that have made the NYSE an indispensable institution of global growth for 225 years. Each week, we feature stories of those who hatch plans, create jobs, and harness the engine of capitalism right here, right now at the NYSE and at ICE exchanges and clearing houses around the world. And now welcome inside the ICE house. Here's your host, Josh King of Intercontinental Exchange.
Josh King:
How do you know when to get into an investment? If you are Ray Kroc after World War II, you're working as a milkshake mixer salesman, and you meet two brothers named Richard and Maurice McDonald who have purchased eight of your multi mixers to make their shakes in their San Bernardino California restaurant in 1954. You end up buying the brothers' company and today at McDonald's NYSE ticker symbol MCD has a market cap of nearly 160 billion.
Josh King:
Let's take another example. If you're Howard Schultz, you're working for Swedish kitchenware manufacturer with a US subsidiary called Hammarplast where Howard is responsible for selling coffee machines in North America. And one of your accounts is a small company in Seattle called Starbucks that in 1981 needed a refill from Schultz of their plastic cone fillers. A lot happened after that, but eventually Starbucks sold itself to Schultz for $3.8 million, and today Starbucks has a market cap of 120 billion.
Josh King:
I mentioned these because, well, we're a year into the pandemic and I've found myself spending a lot more money for streaming services than did in February, 2020. I feel like Kroc and Schultz, buying a lot of milkshakes and lattes and wondering when to really invest. The global market for streaming is valued at about $50 billion in 2020, and it's expected to grow at a compound annual growth rate of 21% from 2021 to 2028, that according to Grand View Research. For me, pre-COVID, there was Netflix and Hulu, of course, but now there's Disney plus and NYSE ticker symbol DYS, which I signed up for when they put Hamilton onto the service. There's also Peacock, which I signed up for after I discovered Kevin Costner on Yellowstone. And I should also mention Discovery+ plus, which my friend, their COO David Levy just sent me a year of the service to test out. And yeah, David, I'm enjoying binging on Chip and Joanna as they remodel houses all over the planet on Fixer Upper.
Josh King:
And there's also Peloton, which I fork over $50 a month for for my bike and my tread, which is basically another subscription streaming service. But as my wife regularly criticizes me, I usually watch documentaries on yet another streaming service HBO Max out of one eye, while I'm trying to keep my eye on my aerobic output with Hannah Corbin on a 45 minute seventies disco ride with the other eye. And it's disco, which leads me finally to Robert Stigwood and the HBO Max documentary How do you Mend a Broken Heart? Stigwood, born on the Spencer Gulf of South Australia knew a good investment when he saw one or maybe three. Three brothers Maurice, Robin and Barry Gibb, also known as the Bee Gees, used their pro prestigious talent and R&B falsetto vault from gigs and clubs and festivals around Sydney to international fame with their 1977 soundtrack for Saturday Night Fever, which sold more than 40 million copies worldwide. At last estimate, McDonald's, which officially stopped counting hamburgers sold in 1994 when they hit the 99 billion mark, is set to have sold more than 300 billion burgers by now. And how will that increase across the quick serve restaurant continuum when plant-based burgers, sausages and shakes, fill their menus?
Josh King:
Just as Robert Stigwood watched the three brothers Gibb sing in precise, three part harmony in the mid-1960s, and decided that they merited a long term investment, how do you look at talent, evaluate trends, foresee the future and make bets on your own intuition of what's ahead? Active investors not only take quantitative and fundamental research into account in their due diligence, but focus on additional factors, understanding the regime and regulations the business is operating in, the various currency risks that may exist, the geopolitical relationship with its neighbors and what their role is as a part of the global economy, they're all crucial components of a solid investment thesis. It's analogous to adding another dimension to a chess board.
Josh King:
Our guest today, Hamish Douglass, is Chairman and Chief Investment Officer of the Magellan Financial Group, a top 100 Australian Stock Exchange listed company that seeks to grow and safeguard the wealth of its client by investing in companies across the globe and in Australia. He spends much of his time looking at market leading companies around the world to invest in his concentrated equity strategies. We'll ask Hamish about his story, Magellan's history, and what the investment landscape looks like from down under. Our conversation with Hamish Douglass is coming up right after this.
Speaker 3:
Whether it's markets, exchanges, or networks, connection makes everything possible. The connection between data and technology, innovation and expertise, and most of all, between people and opportunity.
Speaker 3:
For over 20 years, ICE has transformed markets products and processes to make things work better, faster, smarter. From modernizing energy and commodity trading to revolutionizing the bond markets. Whether it's the world's largest stock exchange or the dream of home ownership, we do more than see the big picture. We create it. You may not know our name, but we bet you know our network. ICE. Make the connection.
Josh King:
Our guest today, Hamish Douglass is Chairman and Chief Investment Officer of Magellan Financial Group, an Australian funds management firm that oversees more than a hundred billion Australian dollars in global equity and infrastructure strategies for clients around the world. Hamish, welcome inside the ICE house.
Hamish Douglass:
Josh, it's great to be with you, and what an introduction.
Josh King:
So let's get this disclosure out of the way, right at the top. You are an investor in Intercontinental Exchange. And while we're not going to about that much about that investment, do you think ICE's expansion into mortgage technology is akin to McDonald's introduction of the McPlant burger in 2021, always trying to stay one step ahead of the curve?
Hamish Douglass:
Well, I'm probably a little bit more optimistic on ICE's step into the mortgage market. We are incredibly optimistic if we take a 10 year view on that. Obviously in the shorter term, there are mortgage cycles. But what ICE is doing to digitalize that mortgage market in the United States and then create a marketplace or an exchange, and then create data and a data business off the back of that, it's an enormous opportunity. And in the nature of those businesses, when they form, they get to near-monopoly type positions, maybe an oligopoly, but very concentrated. I'm not sure the plant-based burger market is going to be a monopoly.
Hamish Douglass:
McDonald's, which we have an investment in by the way, we should disclose that, and we are huge fans, but I don't think plant-based burger is going to get the returns on capital that you're going to get out of maybe the mortgage market, in digitalizing, the mortgage market but both are very interesting. But there are lots of people are going to have plant-based burgers. McDonald's is much more about its brand and distribution rather than just putting plant-based burgers out there, but let's see where plant-based burgers go in the medium term.
Josh King:
I read a recent interview of yours, a lunch interview over a burger at Mackey's. Is that still one of your favorites haunts, or do you just do that for your media interviews?
Hamish Douglass:
No, McDonald's, it's actually one of my favorite haunts, I go there frequently. But also we've got investments in others. I must mention Starbucks as well. So I'm traveling, I have to go to some Starbucks stores. Kevin Johnson will be very disappointed if we didn't.
Hamish Douglass:
Yum! Brands, we own over 6% of the company and of course they own KFC, Pizza Hut, and Taco Bell, and Magellan Financial Group has just bought a stake in a Mexican fast food chain in Australia called Guzman y Gomez. So you may, in Australia... It competes for my time. I may be getting a few burritos and a few Big Macs and maybe a coffee from Starbucks, but I frequent them all.
Josh King:
If you think of the journey that Kevin Johnson has been over the past 12 months, Guzman y Gomez, and also all the restaurants of Yum! Brands, what's been your takeaway about how their management teams and their frontline workers have adapted to serving customers in a pandemic state?
Hamish Douglass:
I think across the board, these companies have been absolutely remarkable, and probably exceeded my expectations. And really, I think what they've done is they've enabled digital engagement with the customers. They've engaged at scale in a digital way, which is contactless both for ordering, whether you do it via delivery through the delivery platforms or pick up curbs side or drive through pick up. To do that at scale, and to move your business from 10% digital to 30% plus digital in a 12 month period has been extraordinary. A lot of the food courts in these restaurants, their dining areas have been closed. Yet, they've recaptured a lot of their sales via I digital engagement. And in your introduction, you were talking about digital engagement in streaming and other things, but for restaurants to turn a physical experience into a digital experience, at scale, has been truly remarkable at the speed at which they've been able to do this.
Josh King:
As part of your end-of-year strategy from, Magellan's MFG Global Equity portfolio, notice 28% of the total strategy assets of the 44 billion is focused on the internet and the eCommerce sector. Does your research show an uptick in people like me binging on the Bee Gees on HBO Max while I notch up another 45 minute class in my Peloton?
Hamish Douglass:
Yeah, well obviously eCommerce and technology and digitalization has been a very big part of, of what we've been doing for many, many years. We've had very long term positions in Visa and MasterCard, which we've made an enormous amount of money. And if you think about what the world, the world is digitalizing, it was physical cash. We're moving out of physical cash into digital transaction. COVID has actually been an acceleration, particularly in the United States, from people using cash to now tap and go. People don't want to actually touch the cash. You talk about streaming services, there's been acceleration in streaming services. As you said in your introduction, people have been locked down and it's accelerating the switch around your paid television bundle, where that's now getting unbundled, and people are creating their own streaming bundles. The same as the digitalization of the music world was happening before this. It's happening all over society at the moment and identifying where those trends are happening, who the leading players are going to be, forecasting how you think the industry's going to play it out.
Hamish Douglass:
There are some industries where things will get digitalized, but it's very hard to work out that there are going to be great economic returns. There'll be lots and lots of players. So just because an industry's changing, the airline industries are classic. If you went back to Kitty Hawk, when the first plane flew and you wanted to put all your money into airlines over that period, I think in aggregate, all airlines have never turned a dollar. They've actually lost money in aggregate over their whole history. So just because there's going to be a lot of growth and a lot of digitalization, you need to be very careful that you understand the business models and you get in businesses that are going to earn great profits and returns on their capital over time.
Josh King:
Talking about getting into companies and watching how they evolve over time Hamish, we had John Pettigrew, the CEO of National Grid. That's NYC ticker symbol NGG on the podcast awhile back. Also, something that I think your colleague Gerald Stack has invested in in the Core Infrastructure portfolio. Back then, we were talking about the California wildfires very much impacting the infrastructure focus. This year, we're just on the effect of this freezing cold in a hot state like Texas. What lessons should we learn about stunned sea turtles in millions without power and water and what that means for infrastructure investments?
Hamish Douglass:
Yeah, well obviously, grid stability is a very, very important issue, but you're asking, actually, a multifaceted question. We really think about when we're investing in infrastructure also around the regulatory environment that that infrastructure is sitting in. California is just a very unique state where if there is a fire caused maybe by an electricity line, that the electricity utility can have unlimited liability for that risk, where in other states where you get a active guide where there's a spark on an electricity line that the cost of that can be recovered by future rate increases. So we are very focused on the regulatory environment, how low risk we think that that environment is. The grid stability risk is really around public policy.
Hamish Douglass:
Around that, obviously Texas wasn't foreseeing this type of event that would happen. I suspect there's going to be large investments in their grid moving forward as the owners of utilities increased investments. Actually a very positive factor, but they're going to have to invest more money and they're going to have to look at how that gets paid for. Is it going to be the rate pays or are there going to be tax subsidies or other issues to help paying for that investment? And of course, depending on how that investment is allowed would affect how we would view the utilities in those regions.
Josh King:
That's the regulatory environment, let's pivot a little bit to the geopolitical environment Hamish. Four years ago, about this time, the always cordial 100 year relationship of mateship between Australia and the United States going all the way back to the Battle of Hamel was put to the test over a telephone call between your prime minister, Malcolm Turnbull, and our new president, Donald Trump. Do you have a sense that mateship will be mended as we enter the Biden era?
Hamish Douglass:
Look, I do think we're in the new world. I think that the chance of Australia and the United States having a phone call like that with President Biden, I think he's a very, very low probability. We've been allies for probably one of the strongest Allied relationships of anyone with the United States, maybe the UK and Canada would be up there. I think we're the only nation who's fought alongside the United States in every war of the 20th Century. I think we're the only ones who stood side by side with the United States. I think in the end, when president Trump had these facts pointed out, he actually reversed course. And we were one of the few nations, even after that initial thing where Trump was roughing up every sort of ally Australia then got on the right side, because I think even Trump valued the longstanding nature of the relationship. But do we think president Biden is going to, in any way, jeopardize the relationship between Australia and the United States or any of its key allies? No, no. I think we're always seeing very strong signals from around the world with a lot of people having quite a degree of relief. Australia, hasn't been on the wrong end of this. We were are on the wrong end of one phone call.
Josh King:
Australia is typically blessedly removed from so much of politic drama that swallows up the United States and Europe, Hamish. But the 2019, 2020 bush fire season brought issues of climate change front and center to Canberra in a country famed for its natural wonders, beaches, coral reefs. How much were you aware of the environment down under, as you grew up in Australia?
Hamish Douglass:
When I was growing up, we were at the beach and we had beautiful, clear skies and everything else. We probably thought we had the perfect environment, but certainly when you speak to my children's generations and things, it really is the number one issue at people who may be 20 years younger than we are. It's an issue that I think of is a very serious concern, but I'm a believer in technology. At the end of the day, I've got a lot of faith in technology and I believe humanity's going to solve this problem. We are in a race, but it's going to be technology that solves this problem. It's not going to be taxation. And that's maybe where the politicians got it wrong to start with. It was all economists who were driving solutions, where ultimately the solutions are going to be technology driven solutions.
Hamish Douglass:
And we are bending the curve very dramatically on key technologies. Ultimately green hydrogen, I think, and nuclear, is going to have a very big role to play here in decarbonizing the world. As people say, it's probably quite easy to get 80% reduction in carbon emissions from changing your electricity grids to renewables. That last 20% to get grid stability is really, really hard and really, really expensive. And we're going to need, really, some ingenuity on technology innovation to be able to ultimately solve this problem. But I have faith in humanity and I have faith in the intelligence of people who are undertaking R&D that will make breakthroughs.
Josh King:
We had former Secretary of State John Kerry on this show late last summer, I think early fall as he was at the New York Stock Exchange, launching a carbon based ETF. And now he's certainly in a position to influence the future direction of global carbon pricing policy. What do you think the role of the markets has to play in addition to technology in solving the climate issue?
Hamish Douglass:
Well, certainly, if we've got... There's two issues in markets. One is if we've actually got a carbon market and the market's then set an efficient price for carbon trading. We haven't got a global carbon trading market, but we've certainly got a deep carbon trading market in Europe, and the markets can absolutely price that risk and they can hedge that risk as well and they can make those carbon credits go to their most efficient sources. So the markets have a role to play there, but the markets are all also capital providers. And the markets will actually sort out which of the right business models and the right technology for solving this issue. There's huge amounts of money that are chasing ESG factor investing at the moment. And you're seeing some dramatic rises in share prices of carbon renewable style businesses. Frankly, I think there's some enormous bubbles occurring there.
Hamish Douglass:
And often when you get in these early stages where we don't really know which is the right technology at the moment, and there is a lot of capital being rushed into this area that they want to be on the winner. You just want to make sure that you're not investing in the airline. You want to buy the television network, the next television network that's going to be going to be developed. But at the moment, the markets, I would say because it's still early stage in the developments, aren't distinguishing between the businesses that are truly going to be the winners and where the fad investing is. And Benjamin Graham who wrote the Intelligent Investor said, "In the short term, the market is a voting machine, and in the long term, it's a weighing machine." And there are going to be people who make very good money in this area, and there are people who are going to lose a lot of money in this area. Our job is to distinguish between the winners and losers and not get caught up in the short term speculation.
Josh King:
Talking about sorting out the winners and the losers, Hamish, I think if we've got our history, right, you founded Magellan in 2006 with your co-founder Chris Mackay. Walk us through why the two of you came together and decided to build an investment management firm.
Hamish Douglass:
Yeah, well this is actually a very interesting story, Josh. I left university in 1990 and I joined a firm called Schroeders, which was a UK investment banking firm that had a business in Australia. And I was very fortunate, I joined on exactly the same day as a gentleman, Chris McKay. We had a lunch with the two Chief Executives. He was older than I am. He came from a previous career. And then I was very fortunate, I sat next to him and we were in the investment banking division, which is the M&A division of Schroeders in early days. And in the first week, Chris put 20 years of Berkshire Hathaway reports on my desk. And I'd never heard of Warren Buffet. I was the young eye, I'd graduated at traders.
Hamish Douglass:
And I sat down and read all these 20 years of annual reports. And with Chris got enamored with Berkshire Hathaway and Warren and Charlie. And we used to go to the annual general meeting every year, Chris and I used to always swap investment ideas. And then we went on a 15 year excursion in investment banking. And Chris had stepped down in 2005. He was Chairman and Chief Executive of UBS in Australia and New Zealand, and he just wanted to invest. And I said to him in the beginning of 2006, "Chris, why don't we set up an asset management firm and do what we've always talked about?"
Hamish Douglass:
So we went on a journey for 15 years talking, going, seeing Berkshire Hathaway. And after a 15 year career in investment banking, finally took the plunge and we set Magellan Financial Group up. But it was after a long term relationship that Chris and I'd had... We'd actually gone to separate firms.
Hamish Douglass:
I went to Deutsche Bank and I was Co-Head of their global banking business in Australia and New Zealand. Chris went to the top of UBS and we stepped out and we set Magellan up. And when we set it up, we did something incredibly unusual. We had four men in a... Well, four people. I think there was one lady and three guys. We had a serviced office, and we went and raised $100 million to set the firm up. We actually recapitalized a company that the controlling shareholder was Malcolm Turnbull, who was actually the Prime Minister. He went on to become the prime minister of Australia and had that famous phone call with President Trump and Malcolm and Lucy Turnbull were friends of Chris and mine. So we rang them up and recapitalized this company, and we raised $370 million for a fund at the end of 2006.
Hamish Douglass:
So here were two guys who had never managed any money who then went and raised nearly half a billion Australian dollars, probably 400 million US dollars with four men in a serviced office with no track record in asset management. But obviously, we had very deep careers in investment banking. We're very well known. And that was the history of the firm, or the start of the firm, which was a very, very unusual way to start a firm. But Chris and I were enamored with the whole investment process and had been for many, many... For a decade and a half. And Chris's starts, he would put it was probably two and a half decades at that point.
Josh King:
A slightly earlier generation, we had Steve Schwartzman on the podcast late last year, talking about the way he founded his firm, Blackstone with Pete Peterson and it sounds very similar. Guys very experienced in investment banking had made their careers, could have hung it up, but decided to put their shingle out and basically got some real estate and said, "Where are the customers? We got to go find the customers." Hamish, people often imagine New York or London when they think about service capitals of the world. Magellan takes that notion literally turns it upside down. You serve clients from all over the world from a headquarters that's just a couple minutes away from the Sydney Opera House. Why do you think so many international clients turn to an Australian asset management firm to manage their portfolio?
Hamish Douglass:
Yeah. At the end of the day, we're located in Sydney because that's where we were based. We grew up here and that's where we're based. What I would say to you is if you really want to do something on a global basis, you need to think globally. Sitting in New York, doesn't give you some magical insight about what's going on in Beijing, or what's going on in London. And the same of being in London. And the same as being in Sydney. You truly have to travel globally. Think globally. You have to think about China. You have to think about Japan. You have to think about risks in Latin America. You have to think about what the Fed's doing. You have to think about what the ECBs doing. You have to think about Brexit. And location, doesn't actually give you an advantage.
Hamish Douglass:
And to some extent, I would say that location, particularly in the Northern hemisphere from time to time, has been a disadvantage for some people because you get very colored in your views by internal political issues. So during the 2011, 2012, during the European sovereign debt crisis, we observed it from afar and said, "This is like watching the Anglosaxon Northern hemisphere group Think Society at work." Just because the Euro was flawed it was going to collapse. And we looked from the outsider's point of view and had a very different view that it was very likely that the ECB and Merkel would intervene and the Euro wouldn't collapse. And we had very, very different results for that insight that we weren't caught up.
Hamish Douglass:
The great advantage we have being in Australia, is Australia is irrelevant from a global perspective. So we can get emotional about our political environment about what's going on in Sydney, but it doesn't matter. It just doesn't register in how we think about global investing. But if you are colored by your political [inaudible 00:27:15] in the United States, getting the US economically right, is very, very important. We're not swayed about a political view in the United States because as I say, we're not voters. We can take just a completely impartial perspective on the United States. But I don't think we've got an advantage over China. Everyone goes, "Oh, well, you must have an insight on China." And we spend a lot of time thinking about China. People think it's next door. It's 10 hour flight to China from Australia. The people in New York go, "Oh yeah, you're so close to China," and we're going, "Well, it's not exactly around the corner."
Josh King:
You mentioned China, you mentioned the political environment in the United States. What's happening at the Fed up in Europe, Brexit, the European Central Bank. Magellan has been able to attract an impressive array of individuals who've served as consultants and advisors to the company because you and Chris, it's not all right in your head. This includes the woman who's currently our Treasury Secretary, Janet Yellen, the former CIA Deputy Director, Mike Morell, the former Federal Reserve Governor, Kevin Warsh, among other. How do these high profile thinkers, thought leaders, impact your investment process? And why are these external perspectives so important for you to have?
Hamish Douglass:
Yeah, well, it's a very, very good question, Josh. We've been very, very fortunate that we've had people like Janet and Kevin and Michael who have acted as consultants to Magellan. We really trying to get insight. So where we're thinking about the big topic of today if you're in financial markets is, "What is the inflation risk in the economy?" There's massive stimulus being injected in the United States and is the Fed going to have to increase interest rates in response to rising inflation?
Hamish Douglass:
We could have a view, we could listen to that. But speaking to former Fed people on that issue has been incredibly important. Actually, it was very instructive during the beginning of 2019. We had been concerned for a number of years that the Fed was tightening monetary policy and what that would do to equity markets around the world.
Hamish Douglass:
And, actually, speaking to Kevin and Janet actually helped inform our view that the Fed was likely to stop this program. It wasn't any inside information. It was just getting, they weren't inside the current flow, but they were giving their assessments, and they were different assessments around how they would think as a central banker around that issue. So we could read the newspapers and we could speculate, but they really give us a different perspective about that. So it's another point of data for us, we try and build up an expert network. And we are not going to get all these decisions right, but we to be as informed as we can be in making those decisions, because often there's a huge amount of noise going on and we have to make a decision. Do we buy, sell, or hold?
Josh King:
Talking about the decision of when to buy, sell, or hold. Hamish, we were talking about Warren Buffet and Charlie Munger earlier. One of Buffet's most well known maxims is that, "Investors should be fearful when others are greedy." The rule is tied to the Buffet Indicator, a simple ratio that divides the total market capitalization of US stocks by the total value of the country's GDP. Current estimates put the US market cap almost twice the size of the US's estimated GDP. How do you approach rising valuations in the equity markets?
Hamish Douglass:
Yeah, well, I think it's multifaceted there. I think another thing that you are missing from Buffet as well is that, interest rates are the gravity of markets, which is one of his other famous quotes. So when interest rates are lower market values rise, and when interest rates rise market values fall, so it acts like gravity. We're in a world of almost zero interest rates at the world. So if interest rates were to stay at these levels for a very long period of time, you would expect higher valuations and you would expect that ratio that Buffet famously quotes. So I would also argue that we're in a world where the world has rapidly digitalized and globalized, and there's a much greater share of earnings in the S&P 500 that come from global sources. So just dividing the S&P earnings only by the US GDP when there's a whole lot of earnings from Google and Facebook and Apple and Microsoft, these largest companies in the world get a large proportion of their earnings outside of the United States.
Hamish Douglass:
I think you need to think of maybe adjusting that multiple there. But Buffet is absolutely right. "You should be fearful when others are greedy and greedy when others are fearful." And I think we are in a period of time of absolute euphoria at the moment. We have Bitcoin and it changes on a daily basis. I think it was down 9%, I don't know, when you put this out and Janet Yellen made a few comments yesterday. But it's $1 trillion of value sitting in Bitcoin, of something that has no intrinsic value at all that promotes illicit trade in goods that consumes enormous amounts of electricity. And ultimately, what will the regulators do? It's a bet that the regulators won't ban Bitcoin. And if it becomes big enough, obviously it's being bet that it's going to be something that's transacting every day.
Hamish Douglass:
But I think there is very deep policy issues allowing it to become something that transacts too much. And ultimately, if the Fed clamps down on the ability of Americans to transact in Bitcoin, and that's foreseeable, if that was to happen, Bitcoin could plummet 90%. And there's a trillion dollars... That's a material amount of money that is sitting there. And I could go through cases where there is almost Fad-like investing in areas that look crazy to me. But then when you look at other areas of the market, it doesn't look crazy if low interest rates are going to prevail so it's actually a very complex market at the moment. So there are areas where there's euphoria that we are fearful and we'll let others be greedy. And there's some areas where money, where people are moving away from at the moment as they're moving into these trendy areas, and there's some value there. And that's what we try and do. We try and be in areas where the crowd isn't.
Josh King:
Being in areas where the crowd isn't, it's such a balancing act, Hamish. If a portfolio is too aggressive, a client may face dry downs that are unacceptable, but if it's too conservative, it may not grow enough. Your Magellan Global Equity strategy boasts an impressive long term upside/downside capture with the 10 year numbers showing a hundred percent upside capture and only 40% downside risk. How do you think about protecting capital and risk management in that environment?
Hamish Douglass:
The statistics we've had of capturing 100% of the upside and exposing to 40 to 50% of the downside are quite remarkable statistics. And it's very focused on our risk management here. We are running a strategy, and I don't want to confuse people here that... In broad sense, it runs about 80% of the market's risk. We actually run two different portfolios in the one strategy. We actually run a defensive portfolio that may own things like McDonald's and utilities and consumer staples and hold some cash. And when something goes wrong, we get a huge amount of protection about being in those assets. And they offset risk for us investing in something like Netflix or Microsoft or Alibaba that can be volatile. So we've got a growth portfolio and a defensive portfolio, but then when we tune the whole portfolio together, we cap its total risk to be less risky in the market.
Hamish Douglass:
We fundamentally believe in Buffet saying where he says, "To finish first, you must first finish." And so in periods of euphoria, we get a lot of participation on the upside, but at the moment, our defensive equity portfolio is exactly the wrong place to be. No one wants to be in anything defensive at the moment. Everyone's going for economic recoveries and digitalization stories and renewable stories and commodities and everything else, and we just have to let people do that. Because at the end of the day, a day of reckoning always comes and we have no fear of missing out in the short term. But it does come down to risk management, and we think we are very thoughtfully constructed a portfolio where we're taking fairly concentrated positions. It's a 25 stock portfolio, but it is very, very balanced between growth and defense at the same time.
Hamish Douglass:
And people can do this by thinking about how they build their own portfolios, but just when everything's going euphoria and Bitcoin goes up another 10% in a day, you don't have to join the party at the end of the day. But nor should you be envious that your neighbors made a lot of money on that day either. And that's often one of the things. And I had a very interesting phone call for one of my very good friends who said that his 90 year old mother would like to get my opinion. She would like to know whether she should invest in Bitcoin. And there are some warning sides when you're getting people maybe in their 90th year, they're not taking the longest term perspective, thinking that their friends are now talking about Bitcoin.
Josh King:
After the break Hamish Douglass and I will talk deeper about Magellan's approach to investing. Discuss some of the trends and issues that are shaping our world today and learn what's in store for the future. That's all coming up right after this.
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Josh King:
Welcome back. Before the break, we were talking with Hamish Douglass, the Chairman and Chief Investment Officer of Magellan Financial Group. He and I were discussing his background, the history of the firm and its approach to investing. Hamish, Australia begins its COVID-19 vaccine rollout this week with frontline healthcare workers and senior citizens, like that 90 year old mom being the first in line to receive the jab. In a recent portfolio update, you highlighted some of the things that you're keeping your eye on that could hurt the virus efficacy, and also potentially pose a risk to robust recovery and capital markets. What should market participants be looking out for and what are the threats that are worth examining more closely?
Hamish Douglass:
Josh, this is a super important question. I would say that market participants largely have moved on from the virus. Everybody's just waiting to get their jab in the arm, everybody's reading data of how effective these vaccines are. And against the current variants, they are very effective in preventing some severe, severe illness. So everybody's moving onto the economic recovery and particularly looking at the Biden fiscal plan and what J Powell's going to be saying in relation to monetary policy. And people are getting very, very excited about where we're off to the races here, but I think people are simplifying the nature of viruses. And what they're simplifying is the mutation risk here on the virus. And I would say there is...
Hamish Douglass:
We read a lot of scientific papers and just like we have advisors on monetary policy and we have advisors on China and geopolitical risk. We reach out to a lot of people on the scientific side during this pandemic. And what I would describe to you is that the vaccines are like a massive combination lock. So the vaccines have mapped the whole spike protein, and what it's done is created enormous amount of antibodies in other immune responses. And what the virus does is that to replicate the virus, it copies itself, and every now and then when it copies itself, it makes an error. And a lot of these errors completely don't mean anything at all, but every now and then one of these errors in copying unlocks one of the combinations of the antibodies that are being produced, it effectively gets around part of the defense here. And this is just a random place in nature. And the risk is that you get enough mutations where there's something called an escape mutant that the whole lock gets unlocked and the current vaccines are rendered ineffective.
Hamish Douglass:
And there's two studies, I would just like to say, that most people have never read and I think most people in the markets have never read because they've moved on. Last week, actually, in the New England Journal of Medicine, there was a very interesting study in relation to the South African variant that that has got a mutation on a very key part of the binder-receptor domain of the spike protein. And what they did is they got serum from people who'd been vaccinated with the Pfizer vaccine after two doses. So these people actually had the full antibodies and other defenses that the Pfizer a vaccine had given them, and then they exposed that serum to four different mutation strains. For three of them, really, compared to the original Wuhan strain, the vaccines were 100% effective. But what they found with the South African strain is two thirds of the antibodies have been knocked out.
Hamish Douglass:
So two thirds of the combination lock has been blown up by the mutation in South Africa. But one third is still holding and the door is still shut. So the vaccines are still stopping people getting severe disease to the South African mutation, but two thirds of what the vaccines were doing has been blown apart by the mutation. And that is a really, really important observation. So everybody's just reading that the Pfizer and Moderna and J&J are stopping severe infections in South Africa. That is true. And we know that, but we also know that with a few mutations, they've been severely compromised already, these vaccines. It is just a... It's like a lottery ball spinning around now. Every now and then another part of this vaccine will get unlocked by mutations here.
Hamish Douglass:
And what's interesting, there was another study that was released in the end of December, that was a lab experiment. And the lab experiment effectively took the original virus from China that hadn't mutated yet and they exposed it to a very powerful cocktail of antibodies that have been got from recovered patients who had had the virus. And what they wanted to do is expose the virus to the powerful cocktail of antibodies and see how the virus would change. And see if it could evade that. What happened after 60 days, it hadn't mutated for 30 days. After 60 days, this variant in South Africa appeared in the lab. E484K is the mutation's [inaudible 00:43:28]. And it had nearly exactly the same effect. It had a sixfold reduction in efficiency, but it was still enough, there was still enough antibodies to hold off infection. And exactly what we're seeing.
Hamish Douglass:
But what people haven't read, because people don't read these studies, 12 days later in that lab experiment, two more mutations occurred in the lab and the lab's different to what's happening in nature. But in the lab, two more mutations occurred at another point in the spike protein, and when they occurred, in 100% of samples, the antibodies had been completely evaded. There was no defense against the new virus, the new mutation. So I think we've just got a ticking time bomb here. I don't know whether it's going to mutate in such a way that evades these vaccines. Everybody's assuming it's not going to happen, and everybody's betting on the strong economic recovery. But in the next three to six months, if we find a mutant strain that gets around it, it will become the dominant strain and it will start spreading around the world. And then we have to ask, "What are we going to do?" We hope we can recode these vaccines, but we're going to have to start again because everyone who's vaccinated has no defense against the new mutant strain and everybody needs to get vaccinated.
Hamish Douglass:
And there is some scientific chance, depending on the nature of the mutation, that you can't recode a vaccine for it, so the vaccines as a solution could be dead in the water. I'm not predicting, all I can say is we know how much has already been evaded by the mutations. We know it's mutating every single day. And nature is going to take the course that nature takes, but markets are completely ignoring this risk. If we wake up in three to six months and find the vaccines are no longer working and everybody's bet on black, that is a fairly risky thing to be doing. I think people are just oblivious to the science of what's occurring here.
Hamish Douglass:
And of course the public health policies, right? We need to get everyone vaccinated because the more people we get vaccinated, we're going to slow down the rate of mutation, and slowing down the rate of mutation reduces the probability of this event happening. But scientists say, "Give it enough time." It's almost a hundred percent probability it will happen at some point. But we hope that it's very, very, very contained at that point, and therefore you contain the virus that mutates and make it a very localized issue. So I just think people are oblivious to the virus risk at the moment. We assumed it's all over... We're just waiting to get the jab in our arms.
Josh King:
Yeah.
Hamish Douglass:
Everybody's now focused on just getting vaccinated and therefore this is all over.
Josh King:
A lot of discussion over the last couple days, listened to a long interview with former Deputy National Security Advisor, Matt Pottinger yesterday, about the length of time it took for US authorities, the US CDC, to get linked up with the Chinese CDC about the origins of the virus in Wuhan. A couple of weeks ago, Hamish, President Biden and President Xi Jinping spoke on the phone for the first time since the election. Many foreign policy experts believe the relationship between the US and China is at its lowest point since the communist revolution. The relationship has, certainly, geopolitical and economic consequences for its citizens, but also for the rest of the world. And I know you're a 10 hour flight from China, but how are you thinking about this evolving rapport between Biden and Xi Jinping, and what should market participants be paying attention to?
Hamish Douglass:
Well, Josh, it's a super important question because at the end of the day, China's economy is continuing [inaudible 00:47:12] to evolve. And our view is the economic rise of China is actually not going to be stopped, whatever sanctions and other things have put on place. If you take a 10 to 20 year view, it is one of the few large scale economies in the world that continues to grow at a very satisfactory rate. And it's already the world's second largest consumption market, it will become the largest consumption market. It's now the world's second largest capital market. It will probably become the world's largest capital market in the future, so the choice of just not participating at all could be a very, very costly choice. But when you want to participate, then it's a complex equation because you're right, there is a ongoing tension between the United States and China, I'd say many Western countries and China.
Hamish Douglass:
To some extent, Australia's relationship with China is in a worse position than the US's relationship with China at the moment. Some of our own doing from an Australian point of view, but the tensions between, let's call it, the US and China are very fundamental and very different to any foe the United States has had before. It has had ideological foes before, particularly the Soviet Union, and it used to fight proxy wars in various countries around the world. But the Soviet Union had no control over a lot of the world because it was the US dollar that dominated the world and the US economy was by far and away the largest economy in the world. Probably used to account for nearly one third of economic output on a global basis.
Hamish Douglass:
So the US was never too challenged from an economic perspective, it was an ideological battle. If you think about China now, it's inevitable that China is going to become larger, economically, than the United States and economics gives you enormous influence and power in the world. And people then will start choosing between ideological interests and economic interests. And that really challenges the United States' position in the world. And the US is coming to grips with this. Is its rise happening because it's been taking advantage of the United States by stealing its intellectual capital, which is true. Cyber excursions, unfair trading terms. And the US, has it been sponsoring this economic rise of China?
Hamish Douglass:
I would say the genie's out of the bottle, it can't be put back in the bottle. The Chinese economy is so developed now that the US really can't do anything to stop it. But it is now come to terms with, can it slow it down? How does it deal with this situation that is so different? And China is so public with a strategy called its dual circulation strategy that it's really wanting to do what the US did to the world, become an economic power that makes the world so codependent on the Chinese economy and capital that it gets enormous influence even if people aren't happy with what they're doing. A lot of the world wasn't happy with what the US was doing, but the US could do it anyway because it actually had the economic power.
Hamish Douglass:
So this is an ideological-geopolitical battle. It's an economic battle. And it's a technological battle as well. And from time to time there's going to be retaliation of China against US businesses, like China is retaliating against Chinese business. It's going to be the US retaliating against China businesses, like what's happening at the end of the Trump administration. So how do we participate in businesses that benefit from China, yet navigate around the ongoing retaliation that's going to occur from time to time by the United States and China against each other economically? And that's one of the great challenges here.
Josh King:
Trying to address that challenge, Hamish, Magellan recently published an article where the argument centered on the US and China's race to remain, or become the dominant player, in pick one thing, microchip manufacturing. You argue that this serves as a proxy for other technological, political, economic battles between the two countries. Why is the simple microchip so instrumental to this relationship and what's at stake?
Hamish Douglass:
At the end of the day I don't think China and the United States are about to go to war unless there's some terrible accident over Taiwan that the US gets pulled into. But at the end of the day, the battle here for supremacy in the world could be a technological battle of supremacy. If you think about artificial intelligence, quantum computing, 5G networks, augmented reality, virtual reality, driverless cars. And at the center of all this technology and machine learning is computer chips, microchips, or semiconductors, as they're known, and this is an area which the US has reigned supreme and China has really leveraged off the back of the improvements following Moore's Law in computational power. And that's why these become so central at the end of the day, because... Actually whoever wins quantum computing race or wins true artificial intelligence, or what is known as artificial general intelligence, if that ever happens, if one country gets there before the other country, they may have totally won the race of who ends up on top in the world, and microchips are powering the advancements of computational technology here.
Hamish Douglass:
And that's why this is such an important and such a strategic area where China's probably going to invest a trillion dollars trying to get some self-sufficiency in this area. And the fabricators of semiconductors have gone from I think 40 companies producing them a decade ago, or maybe 15 years ago, and we're down to three or four players now in the world who actually manufacture microchips in the world, particularly semiconductors. So it's a very concentrated industry, and it's at the center of geopolitical power in the future.
Josh King:
Coming back to your own content, Hamish, as we wrap up our conversation. The Australian government, Google and Facebook have been in the news a lot recently. Google threatened to leave Australia over a proposed media law that would require the company to pay news publishers. And last week, News Corps and Alphabet, one of the Magellan's long time holdings, struck a deal to create subscription platform and share revenue and Facebook has begun removing news from its platform. And the rest of the world seems to be closely monitoring this clash between Canberra and the technology companies. You said earlier, "Australia doesn't matter," but there it is on the Drudge report, "Rupert versus Zuckerberg." What is the mood on the ground, and what are the implications this might have on other jurisdictions for how people consume the news?
Hamish Douglass:
Well, what's the implication for other jurisdictions? I think it's a very important case study that... And that's why people around the world are focused on it. I think there is a very genuine debate that the traditional media companies' economic models are effectively getting shot, and therefore who's going to fund journalism in the future and journalism's very important to democracies here. And of course the traditional media companies are pressuring the governments to try and get a transfer payment from the technology platforms, and that's exactly what was happening in Australia. I'm not sure that's going to save the traditional media companies, by the way. I think ultimately government's going to have to come through some other solution rather than transfer payments to business models that are dying to solve this issue.
Hamish Douglass:
It does highlight the global regulatory risk that the tech platforms are facing. And this is just an example of part of the technology risk, the sort of regulatory risk that they're facing. But it does also show that how important these services are for society. And there was outrage in Australia of even the thought of Google leaving. Outrage of Facebook shutting people out and just how dependent people are on Facebook. So what it's shown is that this regulatory issue is very real, but also, solutions have to be found because simply allowing these tech companies to walk away isn't acceptable to society either, which shows there is some balance in the negotiating leverage.
Hamish Douglass:
This is going to come at a cost to Facebook and Google, and it's going to be a cost around the world, but I don't think it's a death to their business models. It's going to clip their wings, some of their economic rent is going to be paid back to society for journalism. Whether other countries decide that Rupert Murdock needs to be subsidized, or whoever, the other media proprietors in other Western countries is really a political question. There are other ways of solving this journalism question, and I would say Facebook and Google are very acutely aware... And this is probably [inaudible 00:56:10], that they probably have to be more proactive on a global basis to helping solve this issue of journalism in democracies that it needs to be funded. And that's a very, very important public policy issue. I don't fully agree with how our government has approached that public policy issue, but I agree with the public policy issue that journalism in democracies needs to be funded and supported.
Josh King:
Well, Hamish, we started this conversation talking about Robert Stigwood and the Bee Gees. We touched on Donald Trump and Malcolm Turnbull. We've visited the hundred years of mateship in the Battle of Hamel, and we end up with Rupert Murdoch appropriately seeing very much that, while you might say, Australia can be neutral and removed from world affairs, it's very much on our minds all the time. It's been a wonderful trip around the world with you to talk about some of the major trends affecting the investment marketplace. So, so grateful to have you inside the ICE house with us.
Hamish Douglass:
Ah, Josh, it's been a pleasure and a bit of fun so thank you for having me.
Josh King:
And that's our conversation for this week. Our guest was Hamish Douglass, Chairman and Chief Investment Officer of Magellan Financial Group. If you like, what you heard, please rate us on iTunes so other folks know where to find us. And if you've got a comment or a question you'd like one of our experts to tackle on a future show, email us at [email protected] or tweet at us @ICEhousepodcast. Our show is produced by [Stephan Dupreel 00:57:37] with production assistance from Pete Asch and Ian Wolf. I'm Josh King, your host, signing off from the Library of the New York Stock Exchange. Thanks for listening. And we will talk to you next week.
Speaker 1:
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