The Tesla bet and hedging against a US Democrat presidency

Mark Arnold and Jason Orthman are hedged against a Democrat win in the upcoming US election.

The pair head up the investment team of one of Australia’s top fund managers, Hyperion Asset Management.

Arnold, Hyperion’s chief investment officer, says the firm does not take a view on who’s likely to end up in the White House following the vote in November.

Hyperion’s deputy CIO Jason Orthman, left, and CIO Mark Arnold. Paul Harris

But with a Biden-led administration considered a real possibility, the firm’s “carbon light” portfolios – which include Tesla – are sheltered against a change in climate policy that could follow a Democrat victory.

“If you look at the amount of carbon that’s produced from the companies that we have in the portfolio, it’s a tiny fraction of the [relevant] benchmarks,” Arnold says.

“So we’ve positioned the portfolios to avoid any permanent loss of capital and any shocks to the downside. And that’s deliberately making sure we’ve got a carbon-light product.

“So we’re well positioned if carbon is taxed.”

The policy platform of the left-of-centre Democratic Party has garnered increasing attention as President Donald Trump’s popularity wavers, including its stance on climate change.

Tesla stock has been misunderstood because it’s just been treated as a car company, but it’s much more than that.

— Mark Arnold, Hyperion chief investment officer

Along with plans for a “100 per cent clean energy economy” with net zero emissions by 2050, the party’s policy agenda could also see companies that want to access the world’s largest market forced to pay a tariff if the goods or services originate from a jurisdiction that does not price carbon.

“The Biden administration will impose carbon adjustment fees or quotas on carbon-intensive goods from countries that are failing to meet their climate and environmental
obligations,” policy documents from the presidential nominee say.

The ramifications for asset managers could be significant, rewarding Hyperion’s “carbon light” approach – and punishing those with emissions-intensive exposures.

And this fund manager has form when it comes to long-term structural changes.

Under Arnold and Orthman’s stewardship, Hyperion took out top place in Mercer’s annual survey of fund managers in its long-only, Australian shares category for the year to June 30.

With a 19 per cent return for the year, Hyperion outperformed the median result by a massive 26.7 per cent.

Its Australian growth companies fund has also been named as the top performing, long-only strategy over the two decades to June 30, while its international equities fund, established in 2014, topped Morningstar’s global growth category over the five years to June 30.

Tesla and missing forest for the trees

Hyperion sees Tesla as one of the companies that will drive returns as the carbon intensity of the global economy falls over the long term, irrespective of whether global climate policy shifts with the 2020 US election.

Fundamental to the fund’s conviction in the company – which is a major holding in its global growth fund – is the belief that its value is mistakenly assessed as an automotive business.

“The stock has been misunderstood because it’s just been treated as a car company, but it’s much more than that,” Arnold says. “It’s really an energy or technology company; a software company that just happens to make cars.”

One example that Arnold cites is Tesla positioning for the massive shift that is under way in power generation and energy.

As electricity production and distribution moves from centralised, carbon-intensive sources to renewable generation that is disbursed throughout the suburbs and vast tracts of under- utilised land, new services and products will be created.

Elon Musk has built businesses around it, and Hyperion is betting on it.

“They’ve got very good software using distributed power and moving power from household level to the grid, and then redistributing that power and then storing [it] at different times,” Arnold says.

And while today’s partisan politics and rear-looking policy debates continue, Hyperion is looking over the horizon to create wealth as the economy shifts.

“We think longer term. They’re going to be highly disruptive to some of the biggest industries in the world: the energy industry [and] the transportation industry,” Arnold says.

Hyperion’s Mark Arnold says Tesla is “an energy or technology company; a software company that just happens to make cars”. Bloomberg

Other intellectual property that positions Tesla to capture the growth delivered from long- term structural changes includes computer hardware, a category that saw Apple become the first US company to break above a $US2 trillion market capitalisation last week.

“I think that people underestimate how much innovation there is in a business like Tesla,” says Orthman, who is Hyperion’s deputy CIO.

“Even with their chips for autonomy … Tesla [released their own] 12 to 24 months ago, and I think it was 20 times more powerful [than the existing product].”

That widens the moat Tesla has created in transportation and builds on the software the company developed for driverless vehicles, as well as the data it has collected that underlies the artificial intelligence capability at the heart of the software.

“They’re the leaders in [vehicle] autonomy in terms of the software. They’ve got the data in terms of [having] over 3 million miles of data that they’ve collected,” Arnold says.

The stock is regularly cited as a sign of the retail shareholder and central bank-fuelled excess pushing share prices above their fundamental value.

Boosted by the firm’s and founder’s profile, the stock has surged 8.7 times over the last 12 months, rising from $US211.40 to $US2049.98 at the end of last week.

But Hyperion says this is exactly what it seeks to exploit: market valuations based on a share price relative to its earnings over the next one to three years.

The folly of short-termism

“That’s one of the inefficiencies we exploit where humans tend to be linear thinkers and the world works through exponential growth … And there’s also that recency bias where people overweight the latest results,” Orthman says.

“We bought Amazon five or six years ago, when it was making around $US400 million in net profits after tax. And as you roll for five years now, it makes $US10 billion or $US11 billion in reported profit.

“So it really scaled over the last five years in profits as well as organic sales growth and free cash flows. And we believe that that same thing will happen with Tesla.”

Arnold explains: “I think that’s a mistake that a lot of fund managers have made because they’ve been desperate to try and outperform in every sort of environment over [a] short period of time.”

“And if you’re trying to do that, well you effectively give up the opportunity to really generate long-term returns for clients.

“So that’s why we think it’s day one again, because the opportunities have never been greater, because people don’t understand the scale of the innovation and where they are on the exponential curve of growth.”

This article was originally published in Australian Financial Review.

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