Asymmetric Opportunities Fund June 2019 Quarterly Letter
Dear Investment Partner,
For the quarter ended 30 June 2019 the Asymmetric Opportunities Fund (AOF) returned 2.9% (net of fees and expenses).
By comparison, the fund’s benchmark the S&P/ASX Small Industrials Accumulation Index returned 5.4%.
Portfolio Composition
At June quarter end the portfolio held 16 stocks.
We continued to identify attractive investment opportunities over the quarter with 4 new stock positions initiated, resulting in cash levels reducing to 31% (down from 40% at the end of March). This high weighting to cash came at a cost of approximately 1.9%ⁱ to performance.
The largest contribution to overall portfolio gains was provided by waste management business Bingo Industries which saw its share price rise by ~48% for the quarter. At quarter end, Bingo was the AOF’s third largest position.
The bidding war for financial services software firm GBST was also a significant contributor to fund performance. GBST’s share price rallied 53% over the quarter and closed the quarter as the fund’s seventh largest position.
Four position weightings were increased including our holding in insurance broker PSC Insurance.
We believe PSC has a long runway of steady growth ahead of it and we were pleased during the quarter to see the appointment of Mr Tony Robinson to the position of Managing Director. Tony’s appointment adds to the depth of talent at PSC which includes the founder and board members with significant shareholdings.
We have high regard for Tony who has been involved with several companies that we’ve followed over the years including the OAMPS insurance broking business which was ultimately sold to Wesfarmers.
Four stocks were exited during the quarter:
Whilst the longer-term prospects for Johns Lyng Group are reasonably positive the fund’s holding was sold after the shares traded above our estimate of fair value. We enjoyed a capital gain of approximately 41% over our holding period.
Link Administration was sold for a small loss after we decided to step back and watch from the sidelines after new information came to light which led us to reassess our investment thesis. We continue to monitor the business closely.
We profitably closed out two takeover arbitrage positions: Netcomm Wireless and Villa World.
Year End Distribution
For the year ending 30 June 2019 a distribution of 2.233 cents per unit was paid. (The unit price at 30 June 2019 was $1.0878 cum distribution)
Cash Weighting
As mentioned above, given the rapid rise in the stock market over calendar year (CY) 2019, the fund’s elevated levels of cash have been a drag on performance. As discussed in our March quarterly letter the high cash weighting wasn’t motivated by either a strongly held view on market levels, nor was it due to a lack of identified investment opportunities. Rather it was primarily a decision to spread our entry into the market given the sharp downturn in financial markets during the final quarter of CY2018.
This decision has turned out to be a poor choice given the market’s rally. It has also been a clear reminder of the folly of trying to time the market.
Post end of quarter we initiated a position in an exchange traded fund (ETF) which provides the AOF with a very low-cost exposure to the top 200 ASX stocks.
Going forward we expect (in most instances) to invest any excess cash in this index tracker. We do this for a few reasons:
1) To avoid the said folly of trying to time the market
2) To gain from the long-term benefit of being exposed to equities. Equity markets should rise at roughly the risk-free rate plus the equity risk premium over the long run which (should) provide a better return than interest paid on cash
3) We assume that our investment partners have entrusted capital to us to invest in equities. In other words, we assume that our partners have already made their own asset allocation decisions regarding their desired weightings of cash and equity exposure and are capable of managing their own holdings of cash.
Takeover Arbitrage
CY2019 has proven a fruitful period for arbitraging takeovers. This is a sign of the current market dynamics and in our experience, equity markets don’t always offer this level of attractive arbitrage opportunities.
To give some insight into the different ways that we look to add value, a recent (post June quarter end) investment opportunity provides some insight.
In late February, rural services group Ruralco Holdings announced that it had received an approach from Canadian-based Nutrien which owns the Landmark business in Australia.
At this point we began monitoring events as they unfolded with the key event being how negotiations with the Australian Consumer and Competition Commission (ACCC) would play out.
In June, the spread (or discount) between the traded share price and the implied offer price inclusive of an expected fully franked dividend widened to what we assessed to be an attractive level.
We quickly set about garnering the opinions of industry contacts both in the listed agriculture sector, as well as experts in ACCC process and decision making.
We concluded that there were no “red lights” and that the transaction was likely to be approved by the ACCC. After estimating the probability of success versus the market’s implied probability the fund took a position.
The ACCC and shareholders have both since approved the takeover. And the fund’s position should yield us a return (inclusive of franking credits) of ~14%.
One Disappointing Position
Avid followers of Warren Buffett will know that “The Sage of Omaha” is fond of a few lines from Kenny Rogers’ song The Gambler:
You gotta know when to hold ‘em
Know when to fold ‘em
Know when to walk away
And know when to run
It’s arguably one of the best lessons an investor can learn. When you realise your analysis may be wrong, take the loss and move on (often the first loss can be the best as a small loss can grow to a bigger loss).
We’ve made the decision three times since the inception of the AOF to “move on”. In two case at a small gain (IOOF and Adelaide Brighton Cement), the other at a small loss (Link Administration Group) when new information and insights led us to question our initial investment thesis.
At the date of writing we still own New Century Resources (NCZ) and with the market telling us in no uncertain terms that we are wrong, why do we still hold our shares in this zinc producer readers may fairly ask?
Firstly, some background as to what attracted us to NCZ in the first place.
NCZ has restarted the Century Zinc mine in Queensland. At its peak this mine was the third largest zinc mine in the world and around $2 billion of infrastructure spend was sunk into the operations.
NCZ acquired these assets which include all plant, equipment, pipelines, airfield, ship and port for a nominal price but also took on the rehabilitation liability.
The business model in stage 1 involves recovering the zinc sitting in the tailings dam through a process of hydraulic mining.
Due to the speed of extraction at which the plant was run previously there remains a significant, consistent, high volume zinc tailings resource in the tailings dam.
To date, NCZ has proven during its ramp up that it can successfully reprocess the tailings and cleverly this action also extinguishes a significant portion of the rehabilitation liability.
You can expect the fund’s investment in resource companies to be few and far between but from time to time we will identify what we believe are asymmetric opportunities in a commodity exposed business. [Commodity businesses, particularly single mine assets such as NCZ will always be weighted accordingly given their inherent higher risks].
NCZ has the potential to produce significant cash flows over the next few years as it scales up production. While the market is currently taking a dim view of the longer than planned ramp up and an unforeseen spike in treatment charges for its concentrates, we believe that our patience will be rewarded.
While our base case valuation has focused on the initial cash flows from the tailing operations, there are several “free options” which could provide further upside. These include an in-situ resource in addition to the tailings resource, non-core assets including the 50% share in two cattle stations, and a potentially significant potash resource.
We’ve enjoyed constructive dialogue with management and despite the severe share price fall over the past few months, our re-analysis hasn’t convinced us that our investment thesis is broken.
Our valuation has reduced – time value of money has made sure of that – however we had a large margin of safety when we first entered the position and under what we consider reasonable assumptions we still assess fair value north of our entry price.
Post Quarter End Update
The Asymmetric Opportunities Fund (AOF) is priced quarterly by accounting firm MacKenzie Managed Funds; however we are pleased to provide an unofficial estimate for the past two months.
For the month ended 31 July 2019, the AOF returned 6%. The fund’s benchmark, the S&P/ASX Small Industrials Accumulation Index, returned 2.3%.
For the month of August, the AOF returned -4.3% vs -3% for the fund’s benchmark.
Pleasingly, in the opening days of September the AOF has made up the majority of August’s relative underperformance.
Outlook
While markets are always interesting, they are certainly particularly intriguing at present with historically low interest rates globally and heightened levels of volatility.
The portfolio’s cash position currently stands at 9%; however with imminent cash returns from two companies under takeover, our near-term cash position is closer to 21%. Pleasingly, opportunities identified during the August reporting season have the portfolio well placed to continue to judiciously deploy capital.
We will provide an update on August reporting season and recent purchases in the September Quarterly which we expect to send out in mid-October.
We also hope to be able to provide an update on our progress regarding an Australian Financial Services License and opening the fund to outside investors.
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
i: please note that the cash drag was previously incorrectly stated at 0.5%.
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.