By Scott Ronalds

We posted a blog in late 2007 (Edicts from Edinburgh) that highlighted a few excerpts from an interview that Dr. Sandy Nairn, the CEO and founder of Edinburgh Partners Limited (EPL), did with a U.K. publication, Independent Investor.

At the time, Sandy had a number of concerns about the markets and the prevailing economic climate.  He felt that risk was being dropped from the investment lexicon and he didn’t buy the ‘de-coupling’ theory – which proposed that Asia’s economic prospects no longer rested on the health of the U.S. economy and the emerging markets would be immune from a downturn in the western world.

EPL’s chief executive felt there were still good companies with strong cash flows and relatively secure earnings, telecoms and pharmaceuticals in particular.  He also felt there were small pockets of undervaluation in the financial sector.  It was these areas in which the Global Equity Fund’s assets were concentrated at the time.  Sandy was also happy to hold a relatively high weighting in cash (which rose to 20% by mid 2008).

While EPL’s caution proved to be warranted, the Global Equity Fund didn’t escape the ravages of the market decline.  The large cash reserve and emphasis on defensive companies served the fund well, but was largely offset by significant declines in the financial sector.  And as we’ve reported before, there were virtually no areas of the market left unscathed.

Since the first interview, a number of things have changed and Sandy and the team in Edinburgh are much more positive about the prospects for equities.  In a follow-up interview with Independent Investor, Sandy discusses the global investment environment and explains why his attitude has undergone a radical change. 

You’ve no doubt heard much talk about the current opportunities in the market and may have grown tired of the topic, but we feel that Sandy’s assessment is particularly thoughtful and rests on a well researched foundation.  While a little lengthy, the 8-page interview is worth the read if you’re looking to round out your opinion on the prospects for the markets.

Here are a few key takeaways:

  • My view is that on most historic comparisons, and modeling what happened during previous recessionary periods, it is hard to argue that equities are now in general any worse than fair value.
  • Instead of 18 months ago finding small pockets of undervaluation in a large ocean of overvaluation, I would now describe it more as finding pockets of overvaluation in an ocean of fair value or better.  In some cases, shares are simply, unequivocally cheap once more.
  • There’s no consistently predictive way to know when something peaks or when it troughs. The only predictive capability we have, if you have a long term view, is that when something gets to fair value, you have to start averaging your way in.
  • In our portfolio, which had 20% in healthcare and 20% in telecoms, those proportions have drifted upwards because of their relative performance. We have started reducing them and putting the money into companies whose earnings growth rates are way ahead of what the pharmaceutical industry, for example, could deliver.
  • At current valuations companies with strong growth opportunities look the best risk/reward for the long-run and we are increasing our technology and emerging markets exposure.
  • China is the other major area where we have gone from almost zero exposure to north of 6% in a very short space of time. Having believed the ‘decoupling’ story to a ridiculous extrapolation of the economic importance of China, we have seen a complete turnaround in sentiment to the extent that some share prices are down 70-80%. That is creating an opportunity for us to invest with what we regard as some of the best risk reward propositions.
  • Now you can find companies with excellent earnings potential at cheap valuations. This really is exciting. It is hard to be excited when the world is beset by bad news but that is why such valuations exist. It is absolutely imperative that you take advantage of them which requires you to accept that it may be a while before sentiment changes and prices start to move in the right direction.

And to leave you with Sandy’s answer to the question on everyone’s mind, ‘Is now the right time?’ - You don’t miss the bus by being early, although you might get cold and bored. Being late though is definitely the wrong strategy.