Asymmetric Opportunities Fund September 2020 Quarterly Letter
Dear Investment Partner,
For the quarter ended 30 September 2020 the Asymmetric Opportunities Fund (AOF) returned 13.2% (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 6.9%.
Portfolio Composition
At quarter end the portfolio held 17 stocks.
Equities comprised ~80% of the portfolio with the balance in cash.
It’s worth noting that roughly 10% of the equity grouping is in companies that have attracted a takeover offer. This provides some downside protection to the portfolio assuming the deals complete and offers near term conversion back to cash for redeployment into our best ideas.
The average market capitalisation of holdings was ~$817 million.
September Quarter Review
During the quarter nine stocks (including closed positions) produced gains, while eight stocks had unrealised losses and a small capital loss was realized in one holding, Gentrack.
Gentrack was a newly established position during the quarter. The company is New Zealand based (but jointly listed on both the NZX and ASX) and has developed a suite of software catering to the management of utility businesses and airports. The stock was exited for an immaterial loss during the quarter when new facts came to light which led us to change our investment view.
Pleasingly other declines experienced were also relatively minor and similarly skewed towards smaller weighted positions.
During the quarter, a net seven new positions were established. In each case, we believe that the price paid offers solid downside protection combined with attractive upside potential.
The largest contribution to overall portfolio gains was Catapult Group. Catapult’s share price appreciated by ~85% over the quarter.
A takeover offer for Citadel Group was also a strong positive driver for the portfolio. As a top 5 position in the fund, the ~44% premium to the pre-offer (undisturbed) trading price provided meaningful positive attribution.
Interestingly, a key detractor from performance over the quarter was Link Administration. This was dramatically reversed in early October when Link received a takeover approach.
Takeover Activity
Portfolio holdings (excluding takeover arbitrage positions) that have received takeover offers:
QMS Media
GBST
Onevue
Citadel
Link Administration (takeover approach which may lead to offer)
Looking back on the past 22 months since inception we are pleased to report that the above five portfolio positions out of a total of thirty-six stocks held (representing 13.9% of all holdings) have attracted buyouts. (note: this excludes any holdings designated as “takeover arbitrage” or 3PL which was not held at the time of offer)
While we don’t acquire shares in a company on the expectation that a buyout will eventuate we believe that Asymmetric’s approach to building a portfolio of positions in companies which exhibit an attractive combination of quality, growth and value lends itself towards acquirers forming a similarly positive view (particularly at the right point in the market cycle).
Indeed, from a valuation perspective, while we do consider relative valuations, our favoured approach for arriving at our estimation of “fair value” is referencing what we believe a knowledgeable owner (i.e a trade buyer) would pay to purchase shares in the company.
We believe this approach has a couple of benefits:
Firstly, it can limit the fund from overpaying for businesses particularly in an expensive market (such as the one we suspect we are in at present)
Secondly, from time to time there will be a buyer out there who agrees with us and makes a takeover offer for our company which can help speed up the time frame to realizing fair value on an investment
Of course, there will always be misses too. Software education developer 3PL had been in the portfolio since June 2019. Our view at the time of purchase being that the business was trading below its intrinsic value.
3PL’s underlying business performance had been disappointing during our holding period and it failed to get a boost one may have expected from the Covid-19 induced school-from-home.
We decided to quit the position and utilize the funds on more promising opportunities in the wake of the virus-induced market sell-off. In August 2020, 3PL received a takeover offer at a ~32% premium to our average entry price from an industry peer!
Repeatable Process
We strongly believe that we have a repeatable process that identifies businesses with attractive attributes.
It is an investment process which we believe can outperform the market over the longer term while protecting investors’ capital from the risk of permanent loss (although often not from near term volatility).
Risk is managed at Asymmetric in multiple ways but the most important four tenets of our process around risk are the following:
Buying at a price that provides a margin of safety should our assessment of fair value prove optimistic or just plain wrong
strong balance sheets (net cash in many instances)
avoiding weak business models and businesses in decline
owning businesses run by founders whom we admire and that have significant “skin in the game”
Certainly not every investment will meet all four of these criteria (and there are plenty more investment criteria as well) but by basing a portfolio on these tenets we believe we build a portfolio of above-average businesses which limits the risk of permanent loss of capital.
To borrow a Buffettism: If you take care of the downside, the upside will take care of itself.
Special Situations
During the quarter we found limited attractive takeover arbitrage opportunities.
We have however identified potentially appealing investment opportunities amongst certain companies that have announced strategic reviews which are likely to lead to corporate restructures such as divestments, spinoffs, etc.
These special situations hold some appeal as in certain instances the announced strategic reviews give us confidence that a catalyst will be realized for unlocking shareholder value in the not-too distant future.
Outlook
The fund has enjoyed a positive start to the quarter, helped along (as mentioned above) by the takeover offer for Link.
This is an interesting development as one of the bidders is private equity manager Pacific Equity Partners (PEP) which owned Link for around a decade before a staged exit which began with an initial public offering (IPO) on the ASX in 2015. Clearly the buyer has a very thorough knowledge of Link’s business!
Pleasingly whatever the outcome it looks as though Link’s shareholders will continue to have the option of continuing exposure to the growing PEXA business as a standalone entity.
Praemium has also experienced solid gains on the back of a well-received quarterly update on fund flows. Meanwhile, Catapult’s share price has seen some recent weakness most likely due to recent market turbulence.
We see a good opportunity set ahead for the fund including selective businesses which should benefit as lockdown measures recede and a vaccine potentially becomes widely available over the next couple of years.
Countering these investment opportunities are what we feel are risks skewed to the downside for the global economy and stock markets which appear to be on the expensive side.
As such the fund remains conservatively positioned with a significant weighting to cash.
This cash has clearly caused a drag on performance. However, under the circumstances outlined above we are comfortable having some cash in reserve.
Update on fund opening
The fund’s administrator since inception has been MacKenzie Managed Funds whose key responsibilities include accurately calculating the Asymmetric Opportunities Fund’s unit price.
MacKenzie’s was recently acquired by accounting firm William Buck. This has led to a change in business name to William Buck Managed Funds Administration.
We are in process of assigning a custodian to the Asymmetric Opportunities Fund, along with attaining the necessary Australian Financial Services License (AFSL) authorisation.
Our aim remains to have everything in place by the time of the fund’s two-year anniversary on 31 December 2020 with a view to accepting investment partners into the fund in the first quarter of calendar year 2021.
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.