Asymmetric Opportunities Fund March 2020 Quarterly Letter
Dear Investment Partner,
For the quarter ended 31 March 2020 the Asymmetric Opportunities Fund (AOF) fell 42.7% (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 fell 26.9%.
Portfolio Composition
At quarter end the portfolio held 15 stocks.
It was an active quarter for the fund. The decision was made in late February to exit a number of positions where (in most instances) we had both reviewed the latest financial results and were in a position to still crystallise substantial gains.
Among the sales were Bingo Industries, Bravura Solutions, Fiducian and Integrated Research. We also closed out special situations and received our entitlement from the QMS Media takeover.
By the end of February, the fund’s cash levels had been increased to ~22% with a further ~10% of the portfolio turned over and redeployed during March.
As discussed below, the March quarter saw the portfolio become more concentrated as we focused on increasing exposure to our best ideas. During the quarter, four new positions were initiated, while weightings to seven existing holdings were expanded.
At quarter end the six largest positions represented approximately 60% of the portfolio. Salary packaging provider Smartgroup was the fund’s largest position.
Our approach to the Covid-19 induced market decline
We don’t try to pick bottoms. We don’t have an opinion about where the stock market’s going to go tomorrow or next week or next month. So to sit around and not do something that’s sensible because you think there will be something even more attractive, that’s just not our approach to it. Anytime we get a chance to do something that makes sense, we do it. And if it makes even more sense the next day, and if we’ve got money, we may do more. And if we don’t — what can we do about it? So picking bottoms is basically not our game. Pricing is our game." --Warren Buffett (2009)
Despite our economics training, our newfound admiration of epidemiologists and our increased knowledge of corona viruses, in our opinion, this doesn’t give us any sort of edge in forecasting macroeconomic events or pandemic trajectories.
Even so, we believe we are well suited to these current turbulent times.
We have investment experience through other difficult periods including post-Sept 2001 and the Global Financial Crisis. These experiences provide valuable insights into investor behavior. (For a brief and elegant discussion on Behavioral Economics and investor biases I recommend a recent paper by James Montier)
One important lesson we have both observed and learnt the hard way is that acting rationally is incredibly hard when extreme fear is gripping the market. To counter these psychological biases, we remain steadfast in our focus on valuation and identifying asymmetric investment opportunities.
This approach held us in good stead and allowed us to buy when many were selling thereby benefiting from market inefficiencies. Critically, it allowed us to buy companies which appeared to be in free fall without worrying about other factors such as wider market levels of cheap vs expensive. (We agree with our peers that on a bunch of metrics markets didn’t become a screaming bargain on the 23rd of March however we do believe that a subset of individual companies certainly did.)
While we haven’t timed things to perfection and would do some things differently with the benefit of hindsight, we think our approach is a sensible way to manage the portfolio despite the detrimental effect on the 31 March performance print.
Increased portfolio concentration
“One of the ways you know you’re probably getting good value is that there are no other buyers” -- George Soros (Money Masters)
The uncertain outlook resulting from Covid-19 provided the right environment for asymmetric investment opportunities to be found.
Throughout March, markets globally were being driven by fear. This fear was multi-faceted and in some instances, particularly among the smaller and mid-cap stocks which dominate our attention, appeared to result in forced selling or at the very least significant falls due to lower liquidity.
This period led us to focus the buying for the AOF on a small number of outstanding opportunities. We believe the portfolio comprises companies that present limited risk of permanent loss combined with significant upside to our estimate of fair value when looking out over the next 3 to 5 years. In other words, we find the risk-reward skew of the AOF’s portfolio very appealing.
Rather than diversifying to reduce risk, we believe when bargains can be identified not only would it be unwise to not buy meaningful stakes but also that risk of permanent capital loss is reduced when you have high conviction opportunities.
Our five year mindset
“Amidst turmoil, when nearly everyone’s time frame has been compressed to taking it one day at a time, value investors should remain focused on the long run, picking up the bargains — bargains with little downside and plenty of upside — that will work out over a several-year period.” --Seth Klarman (Outstanding Investor Digest, 17 March 2009)
As the saying goes, investing is simple, but it’s not easy!
Our view is that long term investment success is only made more difficult if we constrict the time frame too far. Hence we are not day traders, short term speculators, momentum driven and the like.
By looking out a few years we believe we can gain an edge on the market.
That’s why we give plenty of thought to where we think a company will be in three to five years time. What its revenues will have grown to, how much its margins will have expanded and the required capital invested to get there.
Mistakes
The largest contribution to the overall portfolio decline in the March quarter was the fund’s position in travel agency Helloworld. In hindsight we should have reduced our exposure to both Helloworld (a significant position) and Experience Co (a small position) given both businesses have been directly impacted by travel restrictions. In fact, had we sold out of Helloworld in late February we could have avoided roughly all of the under-performance given its mid-teen attribution to performance.
Having not sold early, we instead endure a painful ride down (56% over the quarter) to the point at which Helloworld’s risk versus reward metrics again looked appealing leading us to top up our holding. As of 1 June, Helloworld’s share price has risen over 300% from its low and the stock is trading near our average entry cost.
Buying when others are afraid
As investment manager of the AOF we believe our job is to identify value and then have the courage of our conviction to buy those attractively priced companies when the odds are in our favour. Over time, in our experience, that should work out well. During a crash like the one we just experienced however, not only is it impossible to know where the bottom is but when you are focused on buying a high conviction portfolio it is also impossible to know just how far the “fear factor”, forced selling and lack of liquidity will influence individual stock prices.
We identified a handful of companies which by early March had already been battered significantly more than the wider market. These companies already looked attractively priced so we started buying. As a result, most of our buying was completed by mid-March and this meant we unfortunately had to endure the agony of only limited buying around the 23rd of March when our portfolio holdings hit “once in a lifetime” type prices.
We are firmly of the view that investors are expecting us to position the portfolio to achieve out-performance against our benchmark while concurrently limiting the risk of permanently damaging capital. Certainly we would have preferred not to have incurred the significant decline in the AOF during the March quarter however we remind investors that we are playing “the long game” and we continue to focus our attention on best positioning the portfolio for long term out-performance.
To use a working example, here’s the path of short term pain, for longer term gain that we choose to take.
As of 1 June 2020 the AOF’s largest position is investment bank Moelis Australia.
On 21 February 2020, Moelis’s share price closed at $6. We made the first purchase for the fund on 11 March 2020 at ~$3.70. A few days later we bought again, this time at ~$3. Our final purchase occurred at ~$1.50 on 25 March 2020.
Moelis’s shares closed the month of March at $1.75.
The AOF’s average entry price is $2.13. Hence we marked to market a paper loss of ~22% at the end of the quarter.
Today, Moelis’s shares are trading at ~$3.70 and the fund has seen a gain of ~ 75% on its average entry price.
In our view, the pain was well worth it!
Performance since March
As readers will no doubt be aware, since hitting a low point on 23 March 2020, the Australian stock market (and global markets too) have rallied strongly.
Pleasingly, the Asymmetric Opportunities Fund has achieved solid gains on the way up which we believe is a direct result of how the portfolio pivoted during the sell-off in February and March.
While the portfolio printed an extremely poor return for the March quarter, April and May have seen strong share price gains for our holdings.
As of close of business 1 June 2020:
The AOF has increased by ~65% since March quarter end. In comparison,our benchmark has rallied approximately ~24% .
For CY2020 the AOF is down ~4%, versus our benchmark index down ~9%.
Since the fund’s inception on 1 January 2019 the AOF has increased ~14%, versus ~13% for the index.
(please note that the AOF is only formally priced quarterly; monthly figures are an estimation)
Outlook
We are cognisant of the difficulties which economies globally face as they attempt to get the cogs turning post lock down. We also acknowledge that a second wave of the pandemic (or a re-spike of the first wave) is an issue which the world needs to contend with.
We are monitoring developments closely and will adjust the portfolio as new facts come to light.
The fund recently took advantage of a takeover offer by Iress Ltd for managed funds administration business OneVue, this sale has helped to boost our current cash levels back towards 10% today.
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.