Asymmetric Opportunities Fund December 2019 Quarterly Letter
Dear Investment Partner,
For the quarter ended 31 December 2019 the Asymmetric Opportunities Fund (AOF) returned 3.8% (net of fees and expenses and assuming the reinvestment of distributions).
By comparison, the fund’s benchmark the S&P/ASX Small Industrials Accumulation Index returned 0.9%.
More importantly, for the calendar year (CY) 2019, the fund returned 20.4% (net of fees and expenses and assuming the reinvestment of distributions).
By comparison, the fund’s benchmark the S&P/ASX Small Industrials Accumulation Index returned 24.5%.
While it is disappointing to have under-performed our benchmark over the twelve months (the fund under-performed by 4.1%), we do believe the absolute performance was reasonable and that the portfolio is well positioned for both the upcoming February reporting season and CY2020.
Portfolio Composition
At quarter end the portfolio held nineteen stocks.
During the quarter eighteen stocks (including closed positions) produced gains, while four stocks had unrealised losses.
Equities comprised 99.8% of the portfolio.
The largest contribution to overall portfolio gains was QMS Media which received a takeover offer in late October, sending the share price around 47% higher for the quarter.
Three stocks were exited during the quarter:
RuralCo Holdings was in the portfolio as a ‘special situation’ having attracted a takeover offer. The fund held till completion to benefit from the franking credits attached to the proceeds.
Having garnered the attention of multiple bidders during CY2019, financial software business GBST was acquired during the quarter. The fund received valuable franking credits from this transaction too.
We decided to exit (at a small profit) Link Administration for the time being after we lost confidence in the prospects for the Link group of businesses and in turn our valuation on the stock.
Contribution Analysis
Looking back over the inaugural twelve months we are pleased to report that our strike rate was good. Of the thirty positions entered over the course of the year (both open and closed positions), twenty-four of those investments produced a gain with the remaining six recording an unrealised loss. Eleven of those positions have closed, all at a profit.
The largest contributors to the portfolio’s performance during CY2019 were GBST, QMS Media, Bingo, Catapult, Praemium and Fiducian.
A Comment on Portfolio Construction
In conjunction with absolute value, the portfolio is supplemented by relative value opportunities (usually higher quality businesses) and ‘special situations’ (a space which has offered more opportunity and hence weighting in the past year than we would expect to be the case through the cycle.)
Our holdings can be categorised into three groups.
The first group is Compounders.
By and large most of the portfolio is invested in companies that we consider possess above average business models.
These ‘compounders’ will usually possess many of the following traits:
they are run by founders who have most of their net wealth tied to the company
businesses with net cash on the balance sheet
businesses which have some form of identifiable moat (which in turn should bring with it further attractive traits such as sticky customers, recurring revenues, good profit margins and good returns on capital)
businesses which currently produce free cash flow
Certainly not every company in the group will always possess all of these traits but the above outlines what we are seeking.
We aim to purchase ‘compounders’ at discounts to our conservative assessment of intrinsic value and we expect to own them for multiple years.
There are several benefits from longer term ownership including:
Compounders are expected to grow at above average rates and possess numerous positive attributes such as management who think and act like owners. These types of businesses are rare – particularly at an attractive price – so we are not sellers just because the price has gone up. When it makes sense, we want to let our winners run.
Our preference is to pay a reduced capital gains tax rate which requires a one year holding period.
The second group is Value.
These are generally companies with average business models. We certainly don’t get as excited by these companies as we do the ‘compounders’ however when we identify a reasonable business selling at a significant discount to our assessment of fair value then we do take (generally) smaller positions.
To be clear, these companies are not the deep value, structurally challenged, or declining businesses which some may associate with the ‘value’ grouping. Rather, the Asymmetric Opportunities Fund focuses on generally decent businesses, which are likely growing slowly, are more than likely a leader in their field but for some – what we assess to be short term – reason are out of favour with the market.
We are unlikely to hold these companies for the longer term and are inclined to sell when the share price approaches our assessment of fair value.
The third group is Special Situations.
We have provided a reasonable amount of colour in prior letters on this group. To date, a similar percentage of the fund (~10% each) has been allocated to ‘specials’ as has been allocated to ‘value’ which is simply a result of where we have been finding opportunities thus far.
We continue to seek out takeover arbitrage opportunities and other investments with an identifiable corporate action catalyst. In the current environment particularly, we feel that having expected near term completion on a proportion of the fund’s investments is a desirable trait. A recently identified opportunity is the demerger of the global malting business, United Malt from Graincorp.
These three areas offer enough opportunities, in our experience, to construct a portfolio with attractive asymmetric traits. However, in instances where we do have cash waiting to be deployed into investment opportunities we will generally invest this into an index tracker to provide unit holders with full equity exposure.
Disappointments
We have previously outlined an initial mistake made at inception of deciding to average into positions rather than fully positioning the portfolio in week one. We won’t rehash that here but acknowledge that it created an early performance lag which was difficult to close in CY2019. Lesson learned!
We sold Johns Lyng too early. A past employer once told me to “let your winners run”. It is wise counsel and one that we try and adhere to. In the case of John Lyng, while quantitatively the stock had reached our estimation of fair value, it was a couple of niggling qualitative concerns which really drove us to lock in our gains. In hindsight, we could have been slower to sell given the tailwind this business is enjoying.
Outlook
It is natural as we enter a new calendar year for investors to muse over what the next twelve months has in store.
We believe the portfolio is well balanced in terms of asymmetric skew to the upside and near-term opportunities to redeploy cash.
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.