Asymmetric Opportunities Fund March 2022 Quarterly Letter
Dear Investment Partner,
For the quarter ended 31 March 2022 the Asymmetric Opportunities Fund (AOF) declined 4.8% (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 declined 9.1%.
| Returns to 31 March 2022 | 3 months | 1 year | 3 years (p.a) | Since inception (p.a) | Since inception 1 Jan 2019 (Cumulative) |
|---|---|---|---|---|---|
| Asymmetric Opportunities Fund (Net Return) | -4.8% | 17.8% | 18.1% | 18.6% | 74.1% |
| Benchmark * | -9.1% | 0.0% | 6.5% | 10.0% | 36.3% |
| Value Add (Net) | 4.3% | 17.8% | 11.6% | 8.6% | 37.8% |
*S&P/ASX Small Industrials Accumulation Index (XSIAI).
All performance figures are calculated net of fees & assume reinvestment of income distributions.
Portfolio Update
At quarter end the portfolio held 15 stocks.
Equities comprised 91% of the portfolio with a 9% cash holding.
The top five positions accounted for 42% of the portfolio.
The median market capitalisation was $442 million.
PORTFOLIO HOLDINGS BY MARKET CAPITALISATION
It was a busy quarter in terms of changes within the portfolio as we looked to take advantage of the market volatility by repositioning our holdings.
The fund’s largest position at the start of the quarter, outdoor advertising firm Ooh!Media Ltd, was sold. Ooh!Media is an attractive business with some hard to replicate assets; however, it had the least upside to fair value versus both our other portfolio holdings and new, more appealing investment opportunities that we identified.
Virtus Health was also exited after receiving multiple takeover offers and trading up near the offer price.
Finally, we also sold our small position in invoice financing firm Earlypay Ltd. Earlypay continues to report solid growth; however, the volatility in the market during the quarter just kept on offering up more attractive “asymmetric” opportunities versus some of the then-held portfolio positions.
Driving negative attribution across the portfolio were primarily positions amongst our software names which we added to on price weakness. These are profitable providers of critical enterprise software. Like the rest of the tech sector, they were sold down during the quarter. We are very comfortable that these businesses will continue to grow over the medium term and likewise that their share prices will be significantly higher in the future.
One disappointment from reporting season in February was modular building manufacturer Fleetwood. The company did a poor job of executing its plans, in our view, over the preceding half. We have engaged with management around the cause of this weak result and are comfortable with the steps management has taken to redress the business (Modular Building in particular) and the direction the business is heading.
Two new positions were initiated during the quarter and multiple existing positions were added to. One of the new positions was in communications and detector firm Codan which we discuss in more detail later in this letter.
| Portfolio Characteristics Snapshot | AOF | Small Industrials* | AOF Attributes |
|---|---|---|---|
| Return on Equity | 14.7% | 12.7% | High Quality |
| Net Debt/EBITDA | 0.3 | 1.9 | High Quality |
| Revenue Growth | 20.6% | 15.0% | Solid Growth |
| Earnings Per share (EPS) Growth | 11.8% | 20.4% | Solid Growth |
| Price to Earnings (PE) ratio (x) | 14.5 | 20.8 | Attractively Priced |
| Dividend Yield | 3.7% | 3.3% | Attractively Priced |
Source: Thomson Reuters, Asymmetric Asset Management, 15 April 2022
Median of 1 year forward analyst consensus forecasts
*Small industrials comparison is ASX Small Industrials Index excluding real Estate and Biotechnology companies
Macro.
“Economists have predicted six of the last two recessions.” (source: Unknown)
We know that many of our readers follow financial markets and it is partly for this reason that we don’t summarise or discuss the current market dynamics in our letters.
The other reason we rarely write about macro is that we are ‘bottom up’ investors. That means we begin our investment search at the company level as opposed to beginning with a large picture overlay or ‘top down’ approach. We ply our trade with minimal time devoted to macroeconomics. That said, when it comes to stock selection, we like companies with the economic breeze blowing into their backs rather than their teeth.
Today’s macro challenges are no murkier or scarier (in our view) than at other times. They’re just a different set of challenges.
In short, our investment process rarely pivots dramatically based on the macro picture. However, the portfolio construction does undergo nuanced changes.
For example, interest rates can’t go any lower and, like most market participants, we are aware of what this has done to the pricing of equities via both the discount rate and the influence of ‘TINA’ (there is no alternative).
Given our investment approach is heavily driven by valuation we don’t believe the portfolio has been hostage to a very low discount rate by remaining steadfast in our conservative approach to valuation.
Regular readers of the financial press will no doubt have noted the word recession featuring more and more often. Some of these articles point to research which shows that inverted yield curves have been an accurate leading indicator (around 16 months in advance) of a future recession.
In a similar vein, research points to historical evidence that high inflation and low unemployment heighten the chance of recession in the next couple of years.
At the risk of repeating ourselves, despite the “evidence” about the prospects of a recession, which we acknowledge is a real possibility, we take comfort that we have a portfolio which is skewed defensively.
We continue to find and allocate part of the portfolio (as we write ~13%) to ‘special situations.’ (SS) These holdings have downside protection and attractive risk-adjusted upside.
For example, we continue to hold Cardno. We have enjoyed significant returns from Cardno since we first bought in, reflecting the sale of most of its businesses at very good prices, and a big return of capital.
The company is in wind-down mode and our valuation of its net assets (mainly cash) presents an appealing return/risk ratio in this uncertain market. With the company still controlled by private equity, we believe we have a good chance of realising the excess.
While we don’t own resource stocks which offer a direct “inflation hedge” we do own businesses that will benefit from higher commodity prices. Our exposure here is via Fleetwood which owns significant accommodation facilities in Karratha, WA and Emeco which owns and rents out the largest fleet of yellow kit in Australia.
The portfolio has very little exposure to segments of the market that we would expect to be hardest hit both in an inflationary and a recessionary environment. For example, we don’t own any consumer discretionary businesses. These types of businesses could face significant headwinds in the medium term.
We’d hasten to add that we haven’t tried to create the “perfect” inflation-hedge portfolio or recession-proof portfolio. We simply buy underpriced good businesses that don’t have headwinds. The resultant portfolio offers a mix of offensive and defensive characteristics which is useful given the unknown (or at least very uncertain) path of the economy.
[For those interested in further reading on the current macro outlook we’d highly recommend a White Paper written last year by behavioural economist James Montier. Montier is one of our “must reads” and his viewpoint here is instructive.]
Stock in Focus
"If something looks cheap but you can't figure out why it's cheap, odds are it's you, not the market that is missing something" Seth Klarman
The March quarter provided a wonderful opportunity to acquire select businesses where we could both understand the market’s view but at the same time disagree with the long-term valuation associated with this viewpoint.
Many years ago, we were fortunate enough to get to know Adelaide-based communications business Codan very well. At the time Codan was very much an out-of-the-spotlight business which for many investors, if they happened to look at it, wrote off as an old-world electronics business.
While it took several years, the investment community eventually came to appreciate that Codan wasn’t sleepy or structurally displaced with an old technology offering, but rather owned world leading intellectual property. It became a market darling and we were out.
In recent years the group has made some sensible acquisitions to reduce the lumpiness of its revenues and thanks to a significant decline in its share price (down ~65% from its peak), the fund seized the opportunity to add this high-quality company to the portfolio.
Looking ahead
Despite some of the fund’s portfolio holdings taking a hit over the quarter we are quietly confident about the outlook both for our companies and the identified opportunities “on our desk”.
Our elevated cash level of ~9% is largely due to the timing of transactions. We expect to put that cash to work over the next few weeks.
Whatever the stock market environment happens to be (bullish, bearish, exuberant or fearful) we believe that through hard work we can uncover roughly ten to twenty attractive investment opportunities.
For example, in a roaring bull market we might consider most of the market to be expensive but we back ourselves to find a handful of companies which are the exceptions i.e attractively priced.
Likewise, in a market full of uncertainty such as now, we relish the opportunities we are identifying.
We may be in “uncharted waters” but we don’t react by resorting to market timing expertise which we simply don’t possess. Rather, we will continue to do our best to optimize the portfolio and benefit from volatility by buying a mix of good businesses cheaply.
Our Australian Financial Services Licence (AFSL) application was lodged with ASIC last December. We were aware at the time that there was a backlog of applications and that we could expect to wait months until the review process of our application began. Suffice to say, we are still waiting…..
Kind regards,
Tim McArthur
Pierre Prentice
Portfolio Managers
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.