GRTV: Magellan is on the road at the moment across Australia and New Zealand on a seven-city roadshow and it's my pleasure to have with me the founder and chief investment officer Hamish Douglass. Welcome to Auckland.

Douglass: Philip, it is great to be here.

GRTV: It's good to have you here. So, tell me, there's a lot going on out there at the moment.

Douglass: There is a bit going on, yeah.

GRTV: And I'll have to start with coronavirus because that's what everyone's talking about. What's your views on that at the moment and how it's going to impact markets?

Douglass: Yeah. In all likelihood, and it's fluid at the moment, Philip, so you have to understand we don't have all the facts at the moment and the facts may change. If you'd asked me two weeks ago, it looked like it was a localised epidemic around Wuhan in China and it really looked like it wasn't spreading.

So, I was super not that concerned about it. And the markets were saying they weren't concerned and then it spread into Korea, Iran, and Italy and particularly, once it got to Italy, the markets just panicked that it looked like a global pandemic. I would say, if it is a pandemic, it's most likely to be a relatively mild pandemic given the nature of what the flu is. And I think when you really look at the statistics in mortality rates, it's very hard to tell because you don't know how many people are infected.

But if you look at that cruise liner that was out at Tokyo and you look at the mortality rates versus the numbers infected, and it's probably the most pure view we have. It's less than 1% at the moment. So, it's going to have a human toll, but this will pass like a flu season.

And in three to six months it would have passed through many areas of the world. And therefore, I think that in the short term, we could have a lot of volatility in markets, but this isn't 2008. This isn't a financial crisis. And I think if there's a lot of volatility, it's not the time to panic.

GRTV: So, you're not worried at the moment?

Douglass: No, no, no. We're not worried. We have a great portfolio.

GRTV: So, for you, is it an opportunity to top up on stocks as a buying opportunity?

Douglass: Well, we're 95% invested at the moment, and we came out of cash maybe 14 months or so ago. We were at 20% cash and that's been very favourable as interest rates have been coming down.

So, within our portfolio, we're looking ... are there relative trading opportunities? Is there something that has moved down very markedly versus something else in the portfolio that we may switch some things around, or things on our investment list that we don't own would we switch things out on a relative trading opportunity?

We haven't done very much. The markets now they've come back a bit last night ... who knows what happens? But they're currently down 6% at the moment. That's not big moves.

GRTV: It's not big moves. So, the media is talking about coronavirus. In terms of your investment managers and what they're doing, what are they talking about?

Douglass: We tend to be focused on the longer term. In terms of risk in the world, we're very focused on what these super-low interest rates are doing to the world and particularly if it's starting to cause asset bubbles in the world. So, we're very focused on the leveraged loan market at the moment and there's a lot of leveraged loans.

GRTV: So, that's a bubble?

Douglass: Well, it's getting into a territory if you look at the statistics on it, it's kind of looking more worried than 2006 was looking in that area. The problem is they're packaging these leveraged loans up and they're selling them to retail investors because people want income.

GRTV: So, is this like CDOs all over again?

Douglass: To some extent, yes. I wouldn't say it's at the extent of being systemic at the moment, but as people go reaching for yield when they can't get any interest on their term deposits anymore, they go up the risk spectrum and that's happening around the world. We're not saying it's a bubble yet, but we're watching.

GRTV: Yeah. Are there any other bubble areas you're watching at the moment? Or potential?

Douglass: Well, we can start stripping the onion a bit ... in what I call the lowest tier of investment-grade credit in the world, which is triple-B credit. The most worrying thing actually around coronavirus is in triple-B credit in the world because if this caused a recession and that caused those fairly leveraged companies to get downgraded ... if they were downgraded, investment funds wouldn't be able to own them anymore and it could create massive price dislocations in very large parts of the credit market.

GRTV: So, that's something that people should be watching?

Douglass: Yeah. That is something we're watching very, very closely.

GRTV: So, are you worried that investors are going up the risk curve to seek yield in this environment?

Douglass: Yeah, we're super worried about that. It's inevitable. It always happens. The question you have to ask yourself ... a number of questions. Are they moving into areas that are at a great enough scale that when eventually some of those bubbles burst, and you will get bubbles, are they going to be systemic and cause major economic implications there?

A lot of people think that they can get out of the way here. They say, "I know it's happening, but their central banks are all cutting rates. They're likely to cut them further here at the moment."

And to me it's a little bit like people being Cinderella at the ball. All thinking: "Look, I kind of know there's a bit of risk here, but I'm going to leave before this party ends, before you turn into a pumpkin and mice." But the only problem here is the clocks have no hands and who is smart enough to really identify which are the bubbles that are forming? Which ones are systemic? The central banks didn't pick subprime credit.

GRTV: No.

Douglass: And the knowing when they're going to burst. So, what we'd say to people in this low-interest-rate world, is be careful not to be tempted into higher-interest-yielding products. If you are, have very modest exposures. It happened with the finance companies in New Zealand if you remember and it will happen to people again.

It's inevitable we'll have an economic downturn. Coronavirus may or may not cause it. When it happens, people who are investing in this riskier credit are going to have a lot of pain.

GRTV: So, what are you doing in terms of this low-interest-rate environment and the fact that we might go even lower? How are you managing your portfolios?

Douglass: Well, the thing you need to understand is what it means for valuations. Before we got into this let's call it "brave new world" that we're in ...

GRTV: Another brave new world.

Douglass: Another brave new world of very low interest rates. We used to use maybe around 10% discount rates and for a company growing at 4% per annum, it would be worth 17 times its free cashflow. If you're in an interest rate world instead of 5% interest rates, but maybe we're in a 3% interest rate, that very same business would be worth 26 times free cashflow. And if you took it to a 2% risk-free rate, which would be about a 7% discount rate, that 4% growth business and we could think of businesses we own like McDonald's or PepsiCo or Nestlé sitting in that territory. They could be worth 35 times earnings.

So, the real question in this world is where do we think this is headed, these interest rates, and what is fair value at the moment? And we have lowered our discount rate assumption and therefore we've lifted our multiples. We're nowhere near in lifting to the territory we're in, but we could be in this world for six months, it's unlikely. It's going to be longer than that. But we could be in this world for years and years and years.

GRTV: But do you think about how to position things now for when interest rates do turn around and they will at some stage?

Douglass: Yeah. It's prisoner's dilemma. We have been warning people for many, many years the risk of end-of-cycle monetary type.

So, if you look through 2018, we were sitting in 20% cash. Our portfolios relative to markets did very well. We were very defensive against those four interest rate rises that happened in the United States.

But then in January of 2019, the Fed changed its view and then during 2019 the Fed cut three times and the markets rallied 30%.

We were lucky enough or fortuitous enough or whatever it was that we moved out of our cash in March 2019 and we actually did well in that environment, but judging where these interest rates are going is incredibly important and very tricky here. I'm saying, we're in a new world here. If you think interest rates are automatically going to go up, so let's be really defensive [inaudible 00:08:00] at the moment, you can have five years of really bad returns. So, you need to get the balance right.

GRTV: It's a very difficult time. And it's like the issue where people went into cash and deciding when to get back into the market again is a very difficult decision. How do you manage that?

Douglass: I would say, in an 80% probability, we're going to be in a low-interest-rate world for an extended period of time. Coronavirus and other economic shocks caused the central banks probably to be biased towards cutting rates again and once you've cut them to these levels, it's a very high cost to raise them, as we learned in 2018. So, they're going to be very reluctant unless they're really starting to see inflation.

GRTV: And what sort of trends are you following as a manager which might be new or going to give you your out-performance going forward?

Douglass: Philip, this is a really important question. The first thing I'd say is people need to look forward in this world. This is more different, the world looking forward than I think we've seen in 30 or 40 years.

GRTV: So, would that be your whole investment career?

Douglass: Yeah, in our whole investment career. You used to be able to keep going back and doing the same things over and you just move around. You knew their valuation so well. But you think about what social media is doing. If you think about what Amazon's doing. If you think about what artificial intelligence is going to do, there's so many business models that are getting disrupted more rapidly than they have in the past.

So, if I nominated some of the big things we're looking at ... cloud computing, and I'm not just talking about the shifting of computational power, which is really what's happening at the moment from on-premise computers to the big data centres of the world with the big hyper-scale players. We're going to start through 5G and something called the internet of things, IoT, starting digitalising, putting sensors on everything, processing that data.

We're going to turn so many processes effectively into digital processes and software of the world and there's going to be so much opportunity. That is the next 10 to 20 years. I think China and getting the investment view right of China in the next 10 to 20 years is going to be so important for access.

GRTV: But that's getting harder and harder, isn't it?

Douglass: I would say we're still in very early days for investors in terms of the Chinese market and its maturity. I think it's very early days. The consumption side of China ... it's breathtaking what is going on. That has still got, I would say, a few decades to run largely on the urbanisation story in China.

There'll be economic cycles, but it's complex. We're in a completely different country. We're operating in a single-party state. We've got a lot less transparency around accounting and legal protections that we have in our markets, but it's where the majority of the growth in the world is going to be, even though it's slowing down.

GRTV: Yeah. It's going to be interesting times and I'm looking forward to your presentation tonight. Thank you very much for your time, Hamish.

Douglass: Thank you for having me.