Q&A with Will Lam: Philosophy and process
Article | 03 April 2017
William Lam is an Asian equities fund manager at Invesco Perpetual. We recently caught up with him to discuss his investment philosophy and process.
Does having a valuation-driven approach to investing just mean you are a value investor?
The short answer is yes. But the term means different things to different people, so it's worth discussing what it means to me. My approach is underpinned by some fairly uncontroversial beliefs about how the market works. These were well-articulated by Graham and Dodd back in the 1930s, and more recently by Warren Buffett. Firstly, there is the belief that a company's share price will reflect its fair or intrinsic value over the long term. Secondly, in the short term the market will often get it wrong, with share prices deviating meaningfully from fair value.
Given these beliefs, it's almost logical to conclude that the best way to invest is to buy shares that are trading well below fair value, and then wait for the share price to more accurately reflect that value. What it's not about is mechanically buying stocks which trade on low valuation multiples (such as price/earnings or price/book ratios).
In my eyes, a valuation-driven approach is about doing a lot of work to establish what you think fair value is, and then buying a share if it trades well below that value. That is what being a value investor means to me.
So it's a long term approach?
Yes, very much so. It has to be a long-term approach. Share prices may take several years to reflect fair value. While many investors would acknowledge the merits of the approach I've just outlined, many of them feel unable to take it because they are too worried about underperforming in the short-term.
We are lucky at Invesco Perpetual to be part of a larger investment team that includes a number of colleagues who have been with the firm for 20 years or more. You feel more comfortable making an investment with a 3-5 year investment horizon when you have confidence that you will still be managing the fund at the end of that timeframe.
What differentiates your process from other long term value investors?
I am contrarian. I actively seek out new ideas in unloved areas of the market, because I believe that is the best way to find stocks which trade at a big discount to fair value.
Typically it's not easy to find stocks which trade at a big discount to fair value – the market may be inefficient, but it's not that inefficient. If a company is consistently successful, operates in an industry with high barriers to entry, and is broadly acknowledged as being high quality with good management, then the chances are that the share price will be trading at a full valuation.
Stocks which trade below our estimate of fair value usually do so because of bad news putting downward selling pressure on the share price. Sometimes the share price is forced down too far, below what we consider to be fair value, and that's when we'd step in and buy. That contrarianism is what I believe differentiates my style from many other long term value investors.
How do you work out what is fair value?
That is what we spend most our time doing. We will meet management, look closely at historic financial statements, spend time talking to analysts, and build our own financial models for the company. But the simple output of all this work will be two numbers: expected earnings growth for the company over the next 3 years, and a valuation multiple for the shares (such as a price/earnings or price/book ratio) that we believe would reflect fair value for that expected earnings growth.
Those two numbers together can be used to calculate an expected 3-year return for all the companies we analyse. If that expected return is well above what we see as a fair return for the market as a whole, then the stock is trading well below our estimate of fair value.
Can you illustrate this process with an example?
Sure. NetEase was a great example of a contrarian idea at the time of purchase. In our opinion, the company is China's best online game developer and we introduced a holding into the Invesco Perpetual Asian Fund back in 2012, when the shares were deeply unpopular. There had been a lot of news about fraud at US-listed Chinese companies, and all Chinese companies with a US listing got sold down heavily, even good ones like NetEase.
We had been following the company since 2009 and had done a lot of work understanding the industry and the historic financial statements at NetEase. We believed the company could continue to grow earnings at around 15% a year, and that a fair valuation multiple for that growth would be a price/earnings ratio of at least 15 times. At the time, the shares were trading at just 10 times earnings, significantly below what we thought was fair value. Our expected annual return from the shares was well over 20% per annum when we bought them in 2012.
As it turned out, the earnings growth has been much better than we expected, as has the share price performance.
So NetEase is no longer a contrarian idea?
That's a good point. When we introduce a new holding to the fund, it is nearly always a contrarian idea. But that doesn't mean that all the stocks in the fund are contrarian ideas at any given time. Some are new ideas and still relatively out of favour, others are more mature ideas and have largely ridden the transition from contrarian to popular.
Can you give us an example of a more recent idea coming into the fund?
One fairly recent idea is Autohome, a Chinese website and app which focuses on car reviews and other information. We believe that this is a high growth company but its earnings growth seemed to be underappreciated by the market last year because of a lot of management changes at the company. We are also finding new ideas in South Korea, a market we see as undervalued and out of favour.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
The Invesco Perpetual Asian Fund invests in emerging and developing markets, where there is potential for a decrease in market liquidity, which may mean that it is not easy to buy or sell securities. There may also be difficulties in dealing and settlement, and custody problems could arise.
The fund may use derivatives (complex instruments) in an attempt to reduce the overall risk of its investments, reduce the costs of investing and/or generate additional capital or income, although this may not be achieved. The use of such complex instruments may result in greater fluctuations of the value of the funds. The Manager, however, will ensure that the use of derivatives within the funds does not materially alter the overall risk profile of these funds.
Where William Lam has expressed opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco Perpetual investment professionals.
Where securities are mentioned they do not necessarily represent a specific portfolio holding and do not constitute a recommendation to purchase, hold or sell.
For the most up to date information on our funds, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the Annual or Interim Short Reports and the Prospectus which are available in the literature section.