Asymmetric Opportunities Fund September 2021 Quarterly Letter
Dear Investment Partner,
For the quarter ended 30 September 2021, the Asymmetric Opportunities Fund (AOF) returned 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 returned 3.8%.
| Returns to 30 September 2021 | 3 months | 1 year | 2 years | Since inception (p.a) | Since inception (cumulative) |
|---|---|---|---|---|---|
| Asymmetric Opportunities Fund (Net Return) | 4.8% | 44.3% | 23.0% | 22.8% | 75.7% |
| Benchmark** | 3.8% | 29.1% | 10.9% | 16.4% | 51.8% |
| Value Add (Net) | 1.0% | 15.2% | 12.1% | 6.4% | 24.0% |
*S&P/ASX Small Industrials Accumulation Index (XSIAI)
**Inception 1 January 2019
All performance figures are calculated net of fees & assume reinvestment of income distributions.
Portfolio Composition
At quarter end the portfolio was composed of twenty stocks with the top ten holdings accounting for ~63% of the fund’s net asset value (NAV).
Special Situations accounted for a further 6.5% of NAV.
Equities comprised 100% of the portfolio and the median market capitalisation was $503 million.
Positive contributors to performance over the quarter included Cardno, Enero and Moelis. Bravura Solutions was a drag on performance.
NUMBER OF PORTFOLIO HOLDINGS BY MARKET CAPITALISATION
During August’s reporting season we were pleased to identify and add a new investment to the fund. It’s an investment opportunity which we view as being very asymmetric.
The company had a market cap of circa $450m, a net cash balance sheet, a leading position within its industry and is set to benefit as the East Coast of Australia comes out of lockdown.
What we find most attractive of all however is the multiple non-core assets housed within the group which we expect will be monetised sooner rather than later.
Our analysis suggests these non-core assets underwrite close to 35% of the current market cap leaving the “core” operating business trading on a single digit multiple.
Our view is that the downside is limited and there are multiple ways to win and achieve significant upside outcomes.
| Portfolio Characteristics Snapshot | AOF | S&P Small Industrials Index |
|---|---|---|
| Return on Eqiuty | 12.6% | 10.9% |
| Net Debt/EBITDA | 0.7 | 0.8 |
| Revenue Growth | 10.7% | 4.9% |
| Earnings Per Share (EPS) Growth | 20.3% | 8.3% |
| Price to Earnings (PE) ratio (x) | 12.3 | 20.9 |
| Dividend Yield | 4.8% | 2.6% |
Source: Thomson Reuters
Median of 1 year forward analyst consensus forecasts
High Conviction Investing
Noting above that we identified one enticing investment from the deluge of August reports may leave some readers wondering if we’re disappointed to have identified “just one” new idea.
While we’d certainly be happy to have identified more great ideas, the reality is that despite turning over lots of rocks we don’t expect great investment opportunities to be plentiful and when you think about the maths we don’t need them to be.
Consider the following:
Our higher conviction (top 10) ideas currently receive an average portfolio weighting of ~6%.
Assuming we hold these positions for five years would imply that, on average, every year we need to be identifying two replacement companies to come into the portfolio and replace the leavers.
So, identifying one very good (high conviction) idea at least every six months is roughly an acceptable pace for investment idea generation.
There is (of course) plenty more action and turnover within the portfolio thanks to necessarily smaller positions for reasons including lower conviction, and higher risk but higher reward dynamics. Relative value investment opportunities also feature in the tail end of the portfolio as do Special Situation opportunities as discussed in more detail below.
Special Situation Investing
Since inception the fund has achieved a high success rate with its Special Situation (SS) investing. Typically, this involves arbitraging takeovers. Of the completed SSs, fifteen have been profitable investments versus one unprofitable.
There are a few points we think are worth noting:
Firstly, the unprofitable SS investment was a realised loss during the March 2020 covid19 induced downturn where we chose to sell the position to redeploy the cash into more attractive opportunities. In this same covid19 period three other SS ideas were profitably closed out with the cash also redeployed.
Point 1: Special Situations can provide protection in down markets.
Secondly, the average net gain from our SS investments is 6%. With an average holding period of 71 days per investment, the annualised return (which is the way we evaluate the attractiveness of a potential opportunity) is ~31% per annum.
Furthermore, when we analyse takeover arbitrage situations, we include the value of franking credits (should there be any) which we expect to receive as part of a transaction. While this doesn’t show up in the performance tables of the fund or in the average returns outlined above, it does have a real value and benefit for AOF unit holders.
Point 2: Special Situation investing can provide attractive risk-adjusted positive attribution to the portfolio while also providing near term liquidity events to release cash for redeployment.
Thirdly, we only invest in SS opportunities that make fundamental sense to us. While we are certainly pleased with our “hit” rate we won’t always get it right. When we don’t, we want to be comfortable with the underlying business we are left holding and the price we have paid – this for us is the ultimate downside protection safety net.
Point 3: Failed Special Situations can create investment opportunities Not overpaying when entering a SS provides comfort and optionality if things don’t turn out as expected.
Playing Defence and Disappointments
As we have tried to stress before, we take the view that our unit holders are investing in the Asymmetric Opportunities Fund expecting us to provide them with equity exposure.
As a result, our approach assumes that our co-investors don’t expect us to make market timing calls or to hold significant levels of cash for extended periods.
So, within that context, how does the fund’s strategy deal with what may be the later stage of a bull market?
At Asymmetric we try to build a robust portfolio which can sustain itself through all market environments – an “all-weather” approach to investing.
We avoid fads and hot stocks. Not owning these types of stocks makes managing a portfolio much simpler when the music inevitably stops by allowing us to act more rationally during times of heightened uncertainty.
Our wariness of current market exuberance while not alarming (in our minds) nor particularly new, did lead us to adopt a slightly more defensive tone with the portfolio during the last quarter.
The market being the great humbler that it is, indeed humbled us once again this quarter. In hindsight, leaving the portfolio as it was would have led to higher portfolio returns for the quarter.
While it was disappointing to not capture all of the alpha that in hindsight we could have, it is important that we stick to our investment process which aims to identify strong businesses trading at meaningful discounts to our assessment of fair value. Over the medium term we expect this to deliver good returns for unitholders.
Within that framework we don’t think it’s worth playing a game we’re not good at – namely, timing the market – but we remain alert to the market’s value and open to adjusting our defensive vs offensive positioning.
What we’re thinking about
We think society is supremely fortunate in having so many great minds who freely share their research.
Certainly, we count ourselves lucky that this includes great investing minds who share their insights.
Below are a few recent observations that we’ve found particularly interesting.
GMO released an insight recently which caught our eye. As they say, “A picture tells a thousand words…”
With a similar train of thought, in a recent podcast Chris Davis (Davis Funds) noted that:
“As a percentage of the S&P500, Financials are earning more now than they were ten years ago - despite record low interest rates which is a headwind- yet collectively Financials are worth less [by market capitalization]”
There are many supporters of the argument that the world economy is entering a risky inflation environment and there are plenty of “talking heads” (as always) who are eager to give you their view on the subject. Many of these views and the commentary are simplistic; and if there is one thing we consider certain about macroeconomics it’s that things are anything but certain!
We find the thoughtful research from GMO useful here. For a deep dive into a complex economic question we’d recommend part 1 and part 2 from James Montier’s White Paper as a good place to start.
Here’s an excerpt from part 2 and, for all the thousands (maybe millions) of words being devoted to this topic, we love the concise strategy GMO suggests for moving forward:
We have a relatively sanguine view on the likelihood of inflation becoming ingrained in the system (much as it pains us to agree with the Fed). However, the dark arts of macroeconomics are notoriously tricky, and we have often talked of the need to build robust (as opposed to optimal) portfolios – effectively, portfolios that can withstand multiple outcomes. As such, it behooves us to consider how to deal with inflation in the context of your portfolio. The first choice you must make is to determine whether you are interested in an inflation hedge (something that closely tracks inflation) or a store of value (something that will preserve purchasing power). For long-term investors, the latter is probably of more interest. A focus on the store of value naturally leads to a search for real assets. Despite conventional wisdom, commodities in general haven’t been a good store of value. The ‘best’ real asset we have found is equities. They make a terrible inflation hedge but over the long term they are the businesses that charge prices and pay wages, so their cash flows should be real if these two elements are roughly matched, and thus they act as a store of value in the longer term. Of course, you can do better than simply buying equities, you can buy cheap equities. This is like being offered inflation insurance at a discount.
Fund Update
We’re pleased to report that based on internal estimates (the fund is only formally priced quarterly) the AOF returned ~ 5.9% in October. In comparison, the fund’s benchmark declined 0.6%.
Positive news flow from AGMs has continued for portfolio holdings into November with some key holdings benefitting from management commentary relating to the earnings outlook.
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.