Asymmetric Opportunities Fund March 2019 Quarterly Letter
Dear Investment Partner,
For the quarter ended 31 March 2019 the Asymmetric Opportunities Fund (AOF) returned 5.7% (net of fees and expenses).
By comparison, the fund’s benchmark the S&P/ASX Small Industrials Accumulation Index returned 12.7%.
Portfolio Composition
At March quarter end the portfolio held 16 stocks.
During the quarter 14 stocks (including closed positions) produced gains, while 5 stocks had unrealised losses.
Equities comprised 60% of the portfolio with the balance in cash.
The largest contribution to overall portfolio gains was provided by financial services business Fiducian Group which enjoyed a 19% rise in the wake of the Royal Commission.
The equity portion of the portfolio gained 9.1% for the quarter including dividends versus the benchmark’s 12.7%, highlighting the reasonable returns generated by stock picks and the associated cash drag.
Three stocks were exited during the quarter:
Monash IVF Group was included in the initial January portfolio as we saw a gap between price and our assessment of intrinsic value and importantly, we believed that after the release of the half year results in February the market would gain a better understanding of the improving outlook for the business. Our thesis roughly played out and hence we sold the stock for an 11% gain.
Adelaide Brighton Cement (ABC) was also an initial portfolio position and a business which has a number of appealing attributes. After reflecting on the results of one of ABC’s competitor we reassessed our previous view on cement pricing and decided to watch from the sidelines for the time being. We exited the stock at a marginal profit.
Navitas was sold on market as the share price traded up towards its takeover offer price.
Mistakes
We spend much of our time trying to avoid mistakes of commission; we are also keenly alert to mistakes of omission.
To date, we haven’t had any portfolio holdings that have caused us any real problems and there haven’t (yet) been any occasions of kicking ourselves that we missed an investment opportunity that we should have seen.
We have however been disappointed since the fund’s inception with the weightings we’ve ascribed &/or attained when positioning the fund.
For example, our target weighting for software firm Integrated Research (IRI) was 3% however we had only purchased half of this stake (ie a 1.5% weighting) before the company upgraded earnings on 9 January. The stock is up over 40% from our purchase price.
There are unfortunately two other examples similar to IRI but the fault squarely lies with your Investment Manager for failing to build positions to a weight that reflected our conviction. These two stocks, Johns Lyng Group and IOOF Holdings were up 35% and 21% respectively but only provided around half of the attribution that they should have.
We are disappointed with the results achieved for the quarter and have implemented steps which we hope will reduce the probability of this sub-optimal result occurring again.
As part of this portfolio management strategy review we have also revised up our view on what constitutes a “full” position – previously 5% and now 8% - which we feel was too conservative, below where we have historically positioned our best ideas and to date has restrained our ability to maximise returns from our highest conviction ideas.
A comment on cash holdings
The Investment Manager has assumed that our Investment Partners (i.e. investors in the fund) will make the asset allocation decision as regards their own desired equity and cash exposures.
Put another way, we believe that it is our job to invest the money you entrust to us, not to sit in cash.
Having said that, we do believe that at market extremes a cash level above a “fully invested” level of 10% is warranted. We caution however that we don’t possess any special skill at timing the market, nor do we possess macro-economic forecasting superpowers. So, generally, we expect that a decision to move to higher cash weightings would be driven by a lack of attractive investment opportunities.
As usual, Charlie Munger and Warren Buffett eloquently sum up our thinking:
“We have made very little progress in life by trying to outguess these macroeconomic factors. We basically have abdicated. We’re just swimming all the time, and we let the tide take care of itself….The trouble with making all these economic pronouncements is that people gradually get so they think they know something. It’s much better just to say, ‘I’m ignorant’.” (Munger 2015)
“Charlie and I spend no time thinking or talking about what the stock market is going to do, because we don’t know. We do know, sometimes, that we’re getting very good value for our money when we buy some stocks or some bonds. But we are not operating on the basis of any kind of macro forecast about stocks. And there’s always a list of reasons…why the country will have problems tomorrow. But there’s always a list of opportunities which don’t get mentioned quite as often.” (Buffett 2005)
So, the current cash weighting is a reflection of the recent inception date of the AOF and a desire to buy gradually (a decision which in hindsight has obviously been costly given the rally over the past four months) rather than a strongly held view on market direction.
February Reporting Season
February was a good month for the fund with most companies held by the AOF seeing positive share price movements in response to their financial results release.
Reporting season also provided an opportunity to initiate a couple of new positions. Shares in world-leading sports technology business Catapult Group International were acquired on the day of its results release. The shares are up around 80% since our purchase to 31 March 2019.
Shares in outdoor advertising company QMS Media also look attractively priced to us. Consumer-facing businesses are enduring headwinds and this has a direct flow-on effect for media businesses which are driven by consumer sentiment. However, the outdoor advertising space is enjoying greater share of advertising spend and thereby proving more resilient than some of its advertising industry peers.
Part of the growth story here is the conversion of static billboards to digital but the market dynamics of a more rational market thanks to recent industry consolidation is also an emerging positive.
QMS is a more “pure-play” digital billboard business than its peers and also has its own appealing growth drivers such as its QMS Sport division where it is focusing on sporting stadiums which would appear a great niche to target for eyeballs and advertising reach.
Takeover Arbitrage Opportunities
The market is currently experiencing a buoyant level of takeover action. We aim to assess most takeover offers when they occur but based on our experience in the past, only a small number of these will hold appeal on a risk versus return basis and even less will be available at an attractive entry price.
In January we took a position in Navitas which had received a buy-out offer from a consortium that included the support of Navitas’s founder and substantial shareholder. We considered the arbitrage opportunity appealing on a risk-reward basis and a good use of the fund’s high cash balance.
In late February, fixed wireless telecommunications company Netcomm Wireless announced a takeover offer from US-based Casa Systems. Subsequent to the announcement the AOF quickly initiated a position in Netcomm which we estimate will achieve a low risk return of almost 8% based on the current offer price of $1.10.
Performance for April
April was a very strong month for our benchmark with a gain of 6.3% being recorded. While the AOF is only formally priced quarterly, we are pleased to provide the following internal estimates:
The equity portion of the AOF returned 5.4% in April
The overall portfolio - which continues to hold a high level of cash - returned approximately 3.7% in April
On the stock front, April saw Bravura emerge as a potential acquirer of our holding in capital markets and wealth management software developer GBST Holdings. GBST’s shares rallied over 30% for the month taking it from the fund’s seventh largest position to fourth.
Outlook
The June quarter will undoubtedly see the return of “confession season” when companies update the market on expectations for their financial year results. In the past, this period has often provided over-reactions and opportunities to acquire stocks at attractive prices and position the portfolio for the upcoming August reporting season.
With the portfolio’s elevated level of cash holdings, we stand ready to put the money to work when appealing investment opportunities are identified. On this basis, we expect to move closer to a “fully invested” position.
We take our role as stewards of our investment partners’ capital very seriously and express our sincere appreciation to you for investing alongside us.
Kind regards,
Tim McArthur
Portfolio Manager
Disclaimer: The information contained in this document is general information only and does not constitute investment or other advice. The contents of this document do not constitute an offer or solicitation to subscribe for units in the Asymmetric Opportunities Fund. Asymmetric Asset Management accepts no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information.