Paul O'Connor:

Welcome and thanks for joining us again for another instalment of the Netwealth Portfolio Construction podcast series. I'm Paul O'Connor and I'm head of investments for Netwealth, which includes responsibility for the funds available on our investment menu and the products we issue as a responsible entity, namely being the Global Specialist Series funds and Managed Accounts.

On today's podcast, we have Jolon Knight from Hyperion Asset Management, and Jolon is an investment specialist and assists articulating Hyperion's investment style, portfolios, and performance to clients. We haven't discussed global equities on the podcast series for a while so I thought today would be a good opportunity to focus a discussion on global equity markets and what opportunities Hyperion believe are available to investors.

Hyperion is based in Brisbane and is a higher conviction growth-focused investment manager. The firm was established in 1996 and remains majority-owned by its execs and is also part of the pinnacle investment management stable boutique investment management businesses. The firm started out managing active Australian equities portfolios and then expanded into global equities in 2014 using the same growth investment philosophy and style.

As of 30th of September 2024, Hyperion managed in excess of 15 billion in funds under management for industry and public funds as well as for many private investors. The fund invested across both the Australian and global equity strategies via large individual mandates or through three publicly available managed funds.

Hyperion is led by their CIO or chief investment officer and managing director Mark Arnold, who has over 33 years experience. Mark's principally supported by the deputy CIO, Jason Orthman, who has over 22 years of experience.

Jolon is a CFA charter holder and has over two decades of experience in investment markets, working in both domestic and international investment banks and brokerage firms as an analyst, institutional sales, and trader. Jolon works closely with Hyperion's CIO, Mark Arnold, and Deputy CIO, Jason Orthman, to provide investment and portfolio insights to researchers, consultants, institutional, and retail investors and listeners of the Netwealth Podcast Portfolio Construction series of course.

We've got three Hyperion funds on the Netwealth super and IDPS investment menus being the Australian Growth Companies Fund, Australian Small Growth Companies Fund, and Global Growth Companies Fund. There's also the Australian Growth Companies managed model on our investment menu. So for those who prefer to access a strategy through a managed account rather than a managed fund, that could be suitable for you.

Global equities have provided really strong returns to investors over the last decade with the main index being the MSCI World Total Return Index returning 13.65% per annum over this period. And positively, Hyperion's global growth strategy has outperformed that index return over the last 12 months, five years and 10 years.

Global equity returns have been strong. They've been driven by an increasingly small number of stocks and namely the Magnificent 7, the US Mega cap stocks we've all heard about being Alphabet, Amazon, Meta platforms or Facebook, Microsoft, Nvidia, and Tesla. All these stocks are trading on historically high price earnings multiples, which makes many investors question whether the returns from global equities can continue. So I'll certainly be interested to discuss this with Jolon and Hyperion's views on what other opportunities they're seeing in the market and are holding in their portfolio.

In addition, the market has seemingly also become complacent with the heightened geopolitical risks, namely the Russian invasion of Ukraine, China's relationship with the West, the recent Trump win in the US presidential election, impending increases to US tariffs on Chinese goods, and a possible global trade war. Despite these concerns, equity markets continue to generate strong returns driven by corporate earnings growth and earnings multiple growth. So really a major question in my mind is how long can this continue?

I guess global growth JDP continues to be strong and positive, albeit less than the Covid years, courtesy of a slight slowdown in the China growth rates. But this all seems to seemingly support equities, company earnings and market return. But will we see a rise in inflation courtesy of the policies the newly elected US Republicans, which the recent rise in US and Australian bond yields over the last week seems to indicate?

I've said a lot there Jolon, but maybe for starters, Hyperion's grown strongly since it was founded, and as I mentioned, now manage over 15 billion in funds under management. And really I guess that's been courtesy of the strong returns generated. So what do you believe is the main reason behind the business success and those strong returns? Hyperion does seem to differ from mine to many of your competitors, and I guess it's based on the average holding period that I know for a stock being about 10 years. And this is really from mine compared to competitors who trade over half the portfolio in 12 months. So I guess I'll summarise this as viewing Hyperion as a long term genuine investor rather than a trader or volatility, but I'll let you elaborate for our listeners.

Jolon Knight:

Well thanks Paul, and thanks for letting me join today. As a Netwealth user and customer, it's good to jump on and talk to some of the broader investor base as well.

To kind of frame your question, who is Hyperion and how do we invest, we're a growth manager, no apologies for that. But very much to your point, Paul, we're a little bit different to a lot of our peer set who clearly return on equity, return on capital, earnings per share growth is very important. But a lot of market participants in our observation and yours as well is they might go looking for those small pockets of growth in years one, years two, or year three and then turn their portfolio over several times to try and trade in and trade out of these smaller bits of growth, trying to predict short term share price moves.

Now that's extraordinarily difficult. I don't think too many people have too many insights on where share prices go on the short term. But for us, what we're really trying to achieve is finding the world's elite businesses that are able to retain that return on equity, return on capital, have that organic sales growth that turns into earnings per share growth not just in years one, two or three, but for multi-decade periods and invest with confidence in these companies for long periods of time. In fact, we see ourselves as business owners, not share traders. If we can identify these businesses and have a structured approach to not only identifying them but also owning them for the long term, you can accrue large amounts of alpha, all things being equal over time. And that's probably one of the key differences between us as our peer set taking a longer term view than what the market does.

Paul O'Connor:

The world, I guess, has really changed materially over the last decade. And I guess what I'm referring to, it's business models and how businesses operate. And I guess there are companies that have embraced the changes and there are others that have lost market share and earnings as a result.

Anyone, I guess, who is familiar with your business and Hyperion would know that you guys talk a lot about investing in new world businesses rather than old world businesses. So can you summarise how you distinguish between new and old business models?

Jolon Knight:

Yeah, absolutely. It's an important topic as well because very much to your point, the world is getting a lot more competitive. If you think back decades gone by, when an industry did well, a group of companies used to do well. But you fast forward to where we're today, it really is a winner's take all environment. You're having effective natural monopolies or duopolies dominating industry sets. And those companies generally tend to be what we describe as new world businesses or structural growth leaders.

The key things that we're looking for in companies are companies have disrupted technologies or strategies, sustainable competitive managers, have high levels of utility for the end user, for the product or service they sell, structural tailwinds. Generally, they have innovative cultures that are customer-centric and operator managers, capitalised business models and truly large addressable markets. These are companies that are coming to market with something new, something innovative, and they're growing by taking market share from the old world incumbents. And if they can continue to grow and take market share from their peer sets and are effectively natural monopolies, they should be able to have positive momentum in any market environment.

Alternatively, the old world businesses that we see, and they're effectively dominating the indexes of the world, in our mind, anywhere from 60 to 80% of the domestic or the global indexes, are what we deem as old world. And these are companies that have low or no growth over the longterm. They're very, very sensitive to the economic growth around them. So if nominal GDP growth is doing well, they'll probably do well. If GDP or economic growth is going down as we've experienced at the moment, their growth will... Their momentum forward will probably slow down in line with GDP. They generally have a product offering or value that is likely to be disrupted from the new world companies that we're looking for and they've got low levels of long-term predictability in their earnings streams, low levels of innovation.

So if we can identify companies that are taking market share from these old world businesses that are out competing, out manoeuvring, have a product that's modern and relevant to the consumers of today and going forward continue to innovate, continue to make their products or services better, that's what we're really trying to identify and trying to invest over the long term as well. There's clearly a high qualitative overlay that you need to identify to invest in businesses like this. That's exactly what we do here at Hyperion.

Paul O'Connor:

And I guess the way I see it, Jolon, old world businesses typically have a significant portion of their revenue in an older style, something that's less cutting edge or disruptive. And that makes it even harder for them to try and structurally change their business to become a new world business. And I remember the example of Fairfax newspapers where their biggest earner used to be their Saturday classifieds that they printed and they couldn't move to online advertising because it was going to destroy the biggest revenue part of their business. But structurally, it's pretty much destroyed the businesses.

So I think what you've said has really made a lot of sense obviously in how you guys look at the world and how you look at your investment universe.

Jolon Knight:

Yeah, absolutely. You made a good point. The old world, effectively your traditional banks and services companies, your commodity companies or your commoditized products where the only mechanism they have is moving their price lower to capture market share, and that only really has a one-off effect effectively racing to zero.

Fairfax is a really interesting example because we, in our domestic portfolios, bought realestate.com in the early 2000 and we still own it today. I think we paid 84 cents for realestate.com back in the day. And you could see that back then, 80% of people were switching online to look for real estate, but only a small amount of the advertising revenue was there. You remember, if you were trying to sell a house 20 years ago, you'd spend 10,000, $15,000 on an ad that was in the paper once, whereas today they can complete dominating and still growing at 20% per annum.

Paul O'Connor:

Well, I guess there's also seek.com that got the employment classifieds and even car sales. They got the motor sales there.

Two of the biggest themes in global equity is that many listeners would have in mind when thinking about the new world, artificial intelligence and digitalization. Are these big parts of the Hyperion Global Growth Companies Fund portfolio? And how do you structure this portfolio construction assuming they are a larger overweight? I guess what I mean by that, a material portfolio overweights in industries and sectors done from firstly a thematic view on that sector and then trying to find companies? Or is it more bottom up and then you end up with an overweight to certain sectors and industries?

Jolon Knight:

We think of the world in effectively 12 structural themes and a number of them are very obvious today, such as the shift from traditional retail to e-commerce, modernization of payments and banking and shift to AI-based platform, software-based platforms and the like. You're effectively going through a transition period at the moment or an infliction point, if you like, where if you think back over the last 20 years, people had exceptionally well in the advent of the internet in the early 2000s and then the adoption of smart devices or smartphones in 2008, 2009, cloud computing in the teens and now AI and machine learning is the next driving force going forward.

How we're thinking about companies is really a bottom-up approach. Generally if a company has something special, something sustainable or competitive about them, they'll fall into one or many of these 12 structural themes that we're investing in. One that we are really excited about, obviously beginning of my response, is AI and machine learning. You don't really have to go looking for that or go hunting because a lot of the companies that we own, that innovation embedded in them, but they have AI and machine learning coming through organically, whether it's the cloud computing side of things with Microsoft, Alphabet, Amazon or the software-based platforms, be it Palantir, ServiceNow, Salesforce.

Well then as we call going to the edge where you get those AI and machine learning products into our hands or devices with Tesla or self-driving or Meta with the metaverse and so on, you have a unique set of companies, we own 22, that have a strong bottom-up fundamental based research element to them, but then will fall into these 12 structural themes.

But to your point, you can't ignore top-down or correlation factors within the portfolio. So we have some soft limits to make sure that we're well diversified across those structural themes. But even with that, we have 22, 23 names in the portfolio now. If we break our portfolio up into business segments by EBITDA for individual businesses within these 23 companies, there are 52 individual business segments across those 23 companies that provide a very diversified product suite over and above the diversification that you get from these 12 structural themes, which is really pleasing to see from a concentrated portfolio.

Paul O'Connor:

Your top two holdings are Tesla and Amazon. We see a growing number of, I guess, competitors for both these companies, and for example, increased regulatory scrutiny on Amazon whilst the number of Chinese EV manufacturers continues to grow, providing strong competition for Tesla. So can you talk about the longer-term growth prospects for both these companies?

Jolon Knight:

Yeah, absolutely. You picked clearly two top weights, and Tesla is always the most topical and amazon's been around for quite a while. And maybe we'll talk to Amazon first and then move to Tesla.

Amazon's a phenomenal business. They've got many businesses within Amazon. It's not just that dominant e-commerce business that we all know and love. Boxes that turn up to my house, I know I love. But they're the greatest e-commerce business in the world, but they're also the largest cloud computing company in the world with Amazon Web Services. They're the third-largest advertiser in the world. Their prime business is phenomenal. They've even got even some smaller businesses that are starting kick into gear, whether it's Amazon Prime Pharmacy that's able to get 95% of first-time pharmacy orders to customers in the US within two days.

And what we've seen with Amazon over time is big reinvestment cycles. It can often hide the underlying economics of the company, whereas over the last few years, Amazon Web Services has been the driving force of returns in Amazon. But what we've seen most recently is that the CapEx investment in the e-commerce business is starting to subside and the profitability of the broader Amazon suite of industry is really starting to accelerate. Even with Amazon being completely dominant in e-commerce and cloud computing, there's still low levels of penetration across the two to the point where they're still able to achieve some really strong amounts of revenue growth. Amazon Web Services, for example, is growing at around 19% per annum, which is just phenomenal for a business of that size.

But we still see a lot of white space for a company like Amazon to step into, whether it's in e-commerce, whether it's in cloud computing, whether it's in advertising and then some of their new ventures as I mentioned, their pharmacy side of their business as well, which is small, but really interesting to see that type of innovation come through for the assets that they have.

Then if we turn our attention to Tesla, we own Tesla in the first half, first quarter of 2020 when they've hit their first infliction point of being cash flow positive, ramping that Model 3 which went on to become one of the most popular cars in the world and to be beaten by their Model Y that came out a few years later, which is one of the most popular cars in the world that's been sold today.

And you may make an interesting point that the Chinese brands are slowly starting to ramp up. You only have to walk around Australia, the amount of BYDs that are in the street, which is really pleasing to see because you can't change industry by yourself. You actually need a peer set there to help carry on this switch to EVs. But when we think about Tesla and the sustainable competitive advantages that they have, their cars are at a different price point to the Chinese. Currently they have fast charging, which a lot of the Chinese manufacturers don't. They have the high software overlay. They have the supercharging network as well. They also have a very strong and growing energy business, whether it's the mega stack factories, batteries that we see down in Adelaide, all the Tesla walls that are in some suburban households, which is growing at a really rapid rate also.

But the real key to Tesla moving forward is their full self-driving and automation, which we're extremely excited about. Either they have a good imagination or have a good understanding of just how powerful this is going to be here in Australia. But the investment team a couple of months ago went over to the US and hired the latest full self-driving car, Tesla car, and it drove around for a whole week.

Jolon Knight:

Yeah, it drove them around for a whole weekend. They did not touch the wheel.

Paul O'Connor:

Wow.

Jolon Knight:

We're very confident that Tesla has a generalised solution to self-driving. And then also once they release that, there's currently 7 million vehicles on the road, Tesla vehicles on the road. I mean, close to 9 million vehicles by the end of next year. You can then monetize either paying that 8,000 to $10,000 upfront to have self-driving on that vehicle or a subscription service, which is currently $100 per month.

Very quickly you'll have a depreciating asset, which is a car turned into something that can appreciate and actually make you money for the lifespan of the vehicle. And then rolling that forward to the Tesla taxi or the cyber cab, which is looking phenomenal, they're testing it in the friendly states in California in the US. So if they can get this car onto market at around $25,000 US that's significantly cheaper than Waymo's that are currently doing self-driving in California. And as best estimates, their vehicles are north of a hundred thousand dollars on the road and they have price parity with taxis or Ubers.

If Tesla can bring this vehicle to market, they can effectively drive anywhere with far superior unit economics and their own Uber or Tesla for Uber product. The future looks extraordinarily exciting for Tesla and we haven't even touched on the Optimus robot, which they expect to be in production in 2026, which is equally as exciting as well. Tesla, in our mind, is still one of the most misunderstood companies in the world. Even with the relative strong short-term performance, there's still significant upside in our mind for the company.

Paul O'Connor:

It sounds to me, Jolon, right at the cuffing edge of a new world business that you articulated earlier in the presentation.

Jolon Knight:

Absolutely.

Paul O'Connor:

In a recent Hyperion presentation, there's some interesting information about two inefficiencies that you guys say to investors you look to exploit, and that's the time arbitrage and the global anomaly. Maybe if you could just provide a few comments about what these efficiencies are and explain how you take advantage of them in your portfolios. I'm guessing the time arbitrage has a link to that long-term average holding of the stock in a portfolio, but I'll ask you to make a few comments on what they actually are how you're using them to your advantage.

Jolon Knight:

Right. The two key efficiencies that we exploit, the main one is time arbitrage. And I guess a derivative of that is the quality anomaly. The time arbitrage is effectively taking a long-term view in a short-term world and we're continually able to exploit that in markets. If we effectively said this at the onset, if we're able to find companies that are able to compound their success not just in years one, two, or three, they have those sustained earnings per share growth at long time periods, the broader market set or the broader sell side, which is your brokers and your investment banks, we're only really placing their guidance or their share price targets in years one or two.

it's very easy to see this on our side where those price targets, you might have a hundred people following your stock in year one, 75 in year two, 30 in year three, and you'd be lucky to have 10 in year four. We're putting as much thought into our 10-year forecast numbers as our seven, as our five, as our three, as our two, as our one.

If you're able to do the work, have a true understanding of the total addressable market that these businesses are operating in, you're able to forecast out and put as much thought into those laddie numbers of the earlier numbers, you can produce what we call a beat the fade, where most market participants expect the growth of these unique businesses to mean revert or to drop off. Generally if they're special, they have something sustainable, it doesn't drop off. If anything, it accelerates and you can take a longer-term view in a short-term world and really agree something special.

The derivative of that is what we call the quality anomaly. It comes back to the core tenement, looking for these new world businesses that are doing something special, something innovative. Maybe the return profile is hidden by the heavy reinvestment or the early event life cycle. If you can identify those companies and hold them for those long time periods, you can accrue very large amounts of alpha.

A good example is we spoke of realestate.com domestically or Xero or Waztech, but in the global products, something like Amazon or Meta or even Tesla today or Spotify as we all know and love, these are really unique businesses, really early in their growth cycle and there's a large return profile in front of them as well.

Paul O'Connor:

We hear a lot about market concentration and I mentioned valuation risk in global equities in my introduction, given that it's been really driven by an increasingly concentrated number of stocks. How can Hyperion reduce portfolio risk in a concentrated strategy like your Global Growth Companies Fund. You mentioned earlier there were what? 22, 23 stocks you hold in that portfolio?

Jolon Knight:

Yeah, there is 23 stocks, but it's probably important point to pull up on. We believe that the commentary in market participants that it's never been this concentrated. As a false narrative, returns don't come at a nice bell curve or as we're taught to believe in school. It really is a power law or the best way to explain that to people is your 80/20 rule. Actually, it's our observation over the last hundred years, it's more of a 95/5 rule. So 95% of all value from equity markets has only really come from the top 5% of stocks. So when we hear that it's never been this concentrated in valuations as stretched, you can kind of smile and say, "Well, good luck."

How do we reduce that concentration risk is really by making sure that we're invested in the most elite businesses of the world, having a look at that correlation risk as I mentioned earlier, and allocating capital to the highest risk adjusted returns at BC within our portfolios. And investing in an effective hour law, so allocating capital to the top end of the portfolio and having a tail for companies that might have some cyclicality in them or aren't quite that long for capital as much as the top end. As I mentioned, those 23 companies that we have, there's over 50 separate business segments within there that further reduce that correlation risk in itself.

Paul O'Connor:

Putting you on the spot a little here and there, Jolon, does Hyperion have a view on the impact a now Republican will have on the US economy and global, I guess, company earnings and equities in general?

Jolon Knight:

It's Trump 2.0. I think. If the last three weeks have been any type of an indicator, that's really good to business-

Paul O'Connor:

A good way to start.

Jolon Knight:

It's been pleasing to say the least. But if you take a step back maybe two months, it was fairly known entities about what was going to occur. Like if Kamala were to have won, you could have argued status quo and Trump 2.0 back on the horse again from eight years ago.

But clearly politics aside, what Trump effectively you could think is trying to achieve is to cut red tape and be good for business. And I think that's probably the biggest takeaway that you can have from a Trump presidency. What that means to, I guess, the broader US economy, I think, I don't know if it's the blunt instrument of tariffs is going to have the horrible effect that everybody is thinking or may have thought. I know it's way too early to comment. Our assumption would be it would be potentially a lot more targeted and be very favourable for US companies, but in saying that we have low levels of sensitivities to manufacturers or anyone that would be in the target of any such tariffs of selling products into the US.

Paul O'Connor:

Any potential thought on inflation? I know the bond markets have sparked a bit post Trump's election then. It's sort of indicating rates will probably go a little higher.

Jolon Knight:

It's hard to see evidence of that currently. Everything that we're looking at is that nominal GDP growth around the world is slowly starting to subside. It looks very much like that, that soft landing is well in place as we speak. Obviously the future's unknown. Inflation rates around the world are, if you annualize, were well within target ranges. Because of those two metrics, you've seen central bank policies, whether it's New Zealand, Canada, the US, Japan, China, it's another kettle of fish, parts of Europe and the UK all starting to step back. Those three metrics; lower growth, lower inflation, and eventually lower interest rates have historically been extraordinarily favourable.

For growth investing, and also funnily enough, including how Hyperion invests currently, there is no evidence to suggest that inflation were to spike. But if it were to occur, we know how our portfolios react in an inflationary environment. We've just gone through four to five years of that. We've been able to accrue really strong returns over the past rolling five years, which incorporates into the Covid period and also stepping out. I think the global product's sitting at around 20 21% per annum over those last five years, which is really healthy returns.

All things being equal, there was a fair bit of volatility in between. And even if for us, we're pretty clear about when we'd outperform and underperform. 2022 showed the whole market underperforms in rapidly rising rate environments. A way that we think about that is it was a one in 250 year event. And it's not the absolute level of where rates are. As you can see currently, rates being at 440 basis points, US 10-year bond yields, earnings per share growth is easily able to catch up and run through that. It's really the rate of change that you need to be worried about. And even if you add 25 or 50 basis points either way from where we are now, it shouldn't have a material impact on high quality structural growth businesses, the likes that Hyperion invests in. So that's a very long way of saying we don't think inflation at this stage looks like it's going to spike, but even if it did, we have very, very near term evidence that our companies are able to work through that quite easily.

Paul O'Connor:

Finally, I think in the interest of time, can you pull your crystal ball out and give us a view I guess on the market environment moving into 2025 and how you think that will be for global equities?

Jolon Knight:

As I've just mentioned, with declining growth rates around the world and inflation within target ranges and interest rate policies starting to step back, throw on top of that Trump 2.0 presidency or the Trump bump we've seen over the last few weeks, by and large, it looks like a very favourable environment to invest in for quality structural growth businesses.

And then thinking more broadly in our portfolio, we have a lot of high quality structural themes that are going to continue to push our portfolio forward, whether it's AI and machine learning or these new world businesses continue to take market share. So even though we've had two years of very strong relative performance over a rolling five-year period, it's well within the bands of normality.

And the forecast internal rate of return for the global product is sitting at approximately 20% per annum forecast out of the next 10 years. Effectively, what that's telling you is that if our companies execute well and do well, that's the return profile that we would expect that portfolio to be able to produce. But more broadly in equity markets, low quality businesses in these type of environments should do well. And so we have a lot of optimism not just for one year rolling forward, but the next five, seven and 10 years should be very fruitful.

Paul O'Connor:

Well, John, thank you very much for joining us the Netwealth Portfolio Construction podcast series. I hope the listeners have enjoyed the conversation as much as I have. It's been really fascinating, I guess, getting the insights about the way Hyperion, I guess, look at markets, look at new world business versus old world business, then also talking about that time arbitrage and the quality anomaly. And I guess for mine, whenever I've dealt over the years and I've spent many years looking at different managers and funds, well for mine it starts with what's really a bit unique and different about the process. And I think you've certainly articulated that well to the listeners today, Jolon. So really appreciative of the time and your input to the Portfolio Construction podcast series.

Jolon Knight:

Thanks a lot and thanks for your time today.

Paul O'Connor:

And for the listener, thanks for joining us again on another instalment of the podcast series. And as I mentioned, I hope you've enjoyed the discussion as much as I have. And hopefully, Jolon is correct that we're going to be in for another good period of returns out of global equity. So thanks for joining us all. Have a great afternoon and I'll look forward to you joining us on the next instalment of the podcast series.