Asymmetric Opportunities Fund September 2019 Quarterly Letter
Dear Investment Partner,
For the quarter ended 30 September 2019 the Asymmetric Opportunities Fund (AOF) returned 6.6% (net of fees and expenses and with the reinvestment of distributions).
By comparison, the fund’s benchmark the S&P/ASX Small Industrials Accumulation Index returned 3.9%.
Portfolio Composition
At quarter end the portfolio held 18 stocks.
During the quarter 13 stocks (including closed positions) produced gains, while 7 stocks declined.
The cash balance represented ~5% of the portfolio with near-term cash in the form of takeover arbitrage positions a further ~7% of the portfolio.
Eight portfolio holdings achieved gains of over 10%: Praemium, Ruralco, GBST and Catapult were the most significant contributors to overall portfolio gains.
The only significant detractor was New Century Resources which was discussed in detail in the June Quarter report. Our thinking on this position remains unchanged.
The average market capitalization of the fund’s holdings (at the time of writing) is ~$455 million; the weighted average is ~$326 million.
Two stocks were exited during the quarter for immaterial profits:
We decided to move on from our small exposure to accounting software business Reckon after the stock rallied strongly (but only back to levels slightly above the fund’s average entry price).
Whilst the Practice Management software division remains the “jewel in the crown” for Reckon and underpinned our valuation of the company, the potential future capital expenditure required by the software-as-a-service (SAAS) accounting software division led us to reassess our investment thesis and conclude that the fund’s capital could be better deployed elsewhere.
As more facts came to light about the outlook for the financial advice industry and for IOOF specifically, our conviction in the upside for IOOF diminished as our assessment of the range of potential outcomes expanded. We therefore exited IOOF.
Mistakes
Pleasingly, there were no mistakes this quarter which we feel warrant highlighting.
August Reporting Season
By and large we were comfortable with the results reported by our portfolio companies and used the period to increase the fund’s weighting in certain positions. We also added one new name to the portfolio; a business which operates in the information technology/software sector.
There were also two companies where our conviction in their outlooks and potential upside waned, leading us to reduce our exposure post quarter end (again for immaterial profits):
Experience Co (EXP) is an adventure tourism business with operations along the east coast of Australia. When we initially acquired stock in EXP we viewed the company as facing short term headwinds that management could navigate. While we still believe this initial thesis could play out – hence we retain some exposure to the stock – our recent analysis has focused on what we believe could be longer term challenges faced by the company.
EXP’s weighting in the portfolio has been adjusted to reflect our updated assessment of risk vs reward.
Link Group faces certain near-term challenges for which we believe the market has de-rated the stock. We view these near-term challenges as surmountable; however, our analysis of potential longer-term competitive threats has led us to sell.
Special Situations
Previously we have titled this section ‘Takeover Arbitrage Opportunities’ which has been an accurate description of the actions being undertaken. This quarter we have borrowed from value investing legend Benjamin Graham and altered the title to ‘Special Situations’. This is a broader definition and encompasses some of the more recent investment opportunities we have been analysing.
Specifically, these are announced corporate actions, such as demergers and capital restructures. These investment situations are generally more nuanced and the outcomes less certain than takeover arbitrage. While Special Situations will only ever be a minor part of the overall AOF portfolio, they can provide attractive risk-adjusted returns that are uncorrelated with broader market movements.
At the date of writing we have entered one such position.
The takeover for the fund’s GBST holding has now been completed and the fund’s QMS Media shares (discussed below) are trading in line with the recently announced takeover offer price.
Tourism Sector
Our initial schooling in investment philosophy came thanks to Andrew and Chris Davis of the US-based Davis Funds. A key plank of Davis’ investment process is identifying long-term trends.
In a similar vein, at Asymmetric our emphasis is on finding companies with tailwinds and avoiding those with headwinds.
The Australian tourism sector is one that we believe stands to benefit from an attractive long-term tailwind.
Corporate and retail travel agency Helloworld Travel (HLO) is the amalgamation of a number of businesses including Qantas Business Travel, legacy brands Jetset and Harvey World Travel, and AOT.
The merger with AOT in 2016 was a particularly important turning point for HLO as it ushered in AOT founder Andrew Burnes. Burnes is an impressive manager who is the CEO of HLO and the largest shareholder with ~ 31%.
Despite the difficult economic backdrop for travel agencies at present, HLO achieved 19% growth in earnings per share in FY19 and recently upgraded earnings guidance for FY20.
HLO is a company that possesses many of the traits we look for in an asymmetric investment opportunity:
Founder-led management team aligned with shareholders through significant “skin in the game”
A sound balance sheet
A tailwind of both organic and acquired growth opportunities
A smaller, less liquid stock that is not yet on the radar of many brokers or fund managers
A valuation which suggests limited risk of permanent capital loss and the potential for out-sized medium-term returns
On the last point we note that it was pleasing to see Andrew Burns acquiring more shares on-market recently at levels close to our own entry price.
Performance in October
The Asymmetric Opportunities Fund is priced quarterly by the fund’s administrator MacKenzie Managed Funds; however, we are pleased to provide an unofficial estimate for the month of October.
For the month ending 31 October 2019, the AOF returned approximately 2.7%. The fund’s benchmark, returned -0.5%.
On the stock front, two top 5 positions were key positive drivers for the fund.
Platform provider Praemium’s share price rallied around 20% during October after reporting a strong set of numbers for the September quarter. Having purchased a meaningful position in May and then added to that position in June as the shares continued to trade lower, the stock is now trading at levels closer to where we consider fair value.
At the end of October, the fund benefited from a takeover offer for outdoor advertising business QMS Media (QMS) at an ~20% premium to the pre-announced price. QMS is run by its founder and we believe the long-term growth outlook for the group is attractive. So it’s with some disappointment that we expect to be bought out despite having achieved a total return of ~70% from the stock.
Outlook
We continue to find attractive investment opportunities and remain excited about the outlook for our portfolio holdings.
With many companies holding AGM’s during the December quarter we are monitoring AGM announcements for any guidance updates.
We use the lead-up to AGMs as a time to review remuneration reports, proxy statements, the appropriateness of incentive schemes, etc and always cast our votes at meetings.
We are progressing our discussions with a holder of an Australian Financial Services License (AFSL) to operate as a Corporate Authorised Representative (CAR) under their AFSL. We hope to have this finalised before the end of CY2019 with the view to offering investors who meet the definition of “Wholesale Investor” the opportunity to invest in the fund during January 2020.
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.