It takes a brave man to go against Warren Buffett and Jupiter’s James Clunie has done this not just once recently, but three times.
His most recent challenge came after in-depth analysis unearthed some worrying accounting practices at one of Warren’s Buffett’s holdings.
Clunie (pictured) used Beneish’s mathematical formula – which measures financial ratios and eight variables to determine whether a company has manipulated its earning (M score) – to decide there was something not quite right about US infrastructure construction company Chicago Bridge & Iron (CB&I).
This prompted him to open a short on CB&I through his £260 million Jupiter Absolute Return fund. Buffett’s Berkshire Hathaway owns around 12% of the firm. CB&I’s high M score related to its acquisition of Louisiana-based Shaw Group in 2013. ‘The accounting linked to that acquisition is a major issue,’ Clunie explained.
‘There is some interesting accounting around the purchase, which appears to allow lots of management discretion on outcomes. They can legally alter how things look and I’m not sure why Warren Buffett has a holding in this firm.’
Clunie was vindicated as shares in CB&I crashed in June after a short-seller report from Prescience Point Research Group suggested CB&I had used ‘creative acquisition accounting to conceal losses’ and claimed the firm was overvalued by around 50%. Clunie reduced his short to more ‘modest’ levels in the aftermath.
‘While it’s fair to say I’ve probably got a shorter-term horizon than Buffett, I can’t work out what he sees in IBM. They appear to have aggressive accounting practices and carefully time their share buybacks. These really messy accounts make me suspicious and there are also a lot of headwinds in its core business.’
Clunie continues to short IBM, although this position has been pared recently, and closed his short on Tesco before last month’s negative trading update. There is a chance Clunie could reopen the short though.
‘This won’t be a quick turnaround story. Tesco has a lot of hard work to do and supermarkets don’t like price deflation.’
While these trades have proved to be profitable, Clunie admits going against one of the world’s legendary investors comes with health warnings. ‘I live in constant fear. What does this famous investor know that I don’t know – what have I got wrong?’
Going against the grain
Across the wider portfolio, Clunie’s biggest long conviction is towards oil majors, including BP, Statoil, Total and Exxon. He believes this ‘unfashionable’ area has the potential to surprise significantly on the upside as it gets more disciplined with its cash. His net long exposure stands at 13%.
‘These stocks have invested badly over the years on poor projects and shares are lowly rated. They have now said they will invest less and cherry pick projects,’ Clunie said.
‘In two or three years we could see a better return on capital and the market which once thought these firms were “rubbish” will decide they’re actually “okay”. This is not linked to the oil price or the economy, simply a disciplined approach to good projects and there is potential for 50% upside within three years.’
On the flipside, Clunie is running a 15% short on high quality firms with strong balance sheets. These include Diageo, Intertek and Campbell Soups. ‘A lot of these stocks remain highly rated even though they have suffered from earnings downgrades. They haven’t fallen enough.
‘People tend to love quality firms like Diageo – “this is a long-term idea and I want to own it forever” they think. Diageo is a good company, but at the moment a bad stock.’
Meanwhile the lack of volatility in markets has encouraged Clunie to buy into Deutsche Bourse and spread betting firm IG Group in anticipation of an eventual emergence of turbulence.
He has also bought gold for the first time since he assumed control of the Absolute Return fund last September. He views his 1.5% exposure to the precious metal as a hedge against continued central bank balance sheet expansion.
Overall, he is not particularly excited about the prospects for most asset classes in the medium term and will be happy if he can ‘grind’ out 6% a year for the foreseeable future.
‘Future returns for bonds, equities and some parts of property will be dull for the next eight to 10 years based on starting yields, price-to-earnings ratios and profit margins. The path could be choppy but ultimately the level of return will be dull.’
Clunie has revived performance on the Jupiter Absolute Return fund since he took command, returning 3% in the nine months to the end of May, versus 0.35% in Libor GBP three months. In the 12 months prior his arrival, the fund had lost 1.33% under Philip Gibbs.