How the new-look Monash fund is positioned for more “cracking” returns
These traits go some way to explaining why he moved heaven and earth to try closing the persistent discount of the Monash Absolute Investment Company. When the buybacks, options and other capital management measures tried over the years failed to fix the problem, he and his team took the “nuclear” option.
Last May, the Monash LIC became the first ASX-listed vehicle to convert into an exchange-traded managed fund.
“We now have no discount. And of course, the unitholders are now all there because they want to be invested – they can leave any time they want,” Shields says.
“In the LIC, because of the discount, we attracted some investors who were not aligned with the investment strategy and that caused problems for the other investors, as these guys essentially just wanted the whole thing wound up so they could get their hands on the discount.”
In the eight months to 31 December, the Monash Absolute Active Trust (ASX: MAAT) has returned more than 14% after fees – about 5% ahead of the small ords and even further in front of the ASX 200.
With a high conviction investment strategy that tops out at 30 stocks, the fund is currently butting up against this upper limit. Its hedge fund structure also means MAAT holds short positions.
And importantly – because spotting sell signals is incredibly tough – Shields and his team also use a “two strikes” approach to decide when to drop stocks.
“Last year, we actually had eight stocks kicked out and it sounds like, "God, that was a bad year. You must have had bad performance." But actually, we had very good performance and the key is getting onto these things early,” Shields says.
This approach saw the fund clear out a few tech stocks before the big correction started last November. In the following interview, Shields reveals how the fund is currently positioned and discusses one of the stocks that was dropped last year. He also gives insights into MAAT’s short book including an explanation of why it currently sits at a record high of 10% short.
It’s now around nine months since switching the Monash Absolute Investment Company into an ETMF structure, the Monash Absolute Active Trust. How’s it going so far?
We're extremely pleased with the investment product that we've created, in that the problem we had with the LIC trading at a discount – and everything else we tried, whether it was the buybacks or the options or the increasing communications – despite the excellent performance, none of those things closed up the discount. With the exchange-traded managed fund, we have no discount. It's just terrific.
The other thing, of course, is that the unitholders are there because they want to be invested. They can leave any time they want. Whereas in the LIC, because of the discount, we'd attracted some investors who were not aligned with the investment strategy and that caused problems basically for the other investors as these guys essentially just wanted the whole thing wound up so they could get their hands on the discount.
We eliminated both those problems. And since that time, we've just had cracking returns. For the year to December, we were up 14% after fees. And that was about 5% ahead of the small ords. And more ahead of the ASX 200. January had a bit of a pullback, but we're still running about 5% ahead of both the small ords and the ASX 200 after fees. It's been a good outcome for everybody.
And we're also at quarterly distributions of 1.5%. It's quite an attractive product, an attractive experience for people who have been invested in it.
Can you talk me through the high-conviction approach of the fund?
We're focused on making money for our clients every time we make an investment, whether it's a long investment or a short, that creates a portfolio that really has no regard at all for the index. It also sometimes holds more cash and sometimes holds less cash. The amount of cash we're holding really is an outcome of the investment opportunities we find and what we closeout.
Typically, since we've started, we've been holding about 20% cash on average, and it varies anywhere from about zero cash to about 40% cash. Now, we've got pretty much no cash in the portfolio, which sounds a little bit paradoxical because the market was quite weak in January. But in fact, that's when you start to find some great opportunities. We've got more stocks in the portfolio than usual.
We also have more shorts in the portfolio than usual. We're running about a 10% short position, about 110% long. We've got virtually no cash in the portfolio. What's been causing that? Well, a few things.
First, we've been building our positions into reporting season where we can identify companies that we think will have positive earnings surprises. But also with shorts, where we think they'll have negative earnings or outlook statements, which will drive the share price down.
But we're also finding stock-specific opportunities, companies that we just think are cracking businesses that we're able to get into at valuations where we think we've got very big payoffs. That's why we've got more positions in the portfolio than usual.
What are some of the themes that you are looking at for the next year or two?
We’re always looking for recurring business situations that will drive medium to long term step changes in earnings – whether those step changes are up or down. Typically, these are around product rollouts or it could be just a company that has organic growth, but can add a bit to that with growth by acquisition.
Often you can also find, whether it's because of technological disruption or some other disruption into an industry – for good or for ill – you're able to find beneficiaries or people that are going to do badly because of it. And these can lead to quite large step changes in earnings that the market doesn't really price.
More recently, in addition to those standard situations, we've been seeing some businesses that tend to have more long term challenges arising from COVID's impact, because the effect has extended for a lot longer than we would've expected two years ago when we first saw it.
Generally, those disruptions are around travel and around supply chain issues. Companies that have substantial capital requirements, but have very poor cash flow, they're just going to have to keep raising more capital and perhaps also see their footprint shrink as well. We've been focusing on those businesses, I suppose, from a negative point of view.
Another interesting theme that's playing out globally is around what's happening in the oil industry. There's been such underinvestment now for a period, and such a mindset against investing any more in the oil industry, that's having ramifications for the ability to bring on new or expanding oil facilities.
Over time, you usually see a price signal for oil go up and you get a supply response and it takes years, but if there hasn't been an investment for years and there's a mindset against wanting to invest, then, in fact, we're probably going to see the price of oil go higher than it has previously. And that's going to be very good for oil companies, but it's also going to feed into the cost of business for mining companies, for agricultural companies and for anything to do with transport. That's something else we've been thinking about.
Are there any other sectors you’re explicitly avoiding or shorting?
Transport and travel are examples. And oil is one aspect of it, but it's also about COVID to a large extent as well. But I wouldn't focus on sectors we're explicitly avoiding. All our shorts are very stock specific. Even if they've got an industry headwind, which can be great, they're really about the business itself and its position in its industry, and what it's up against.
In terms of avoiding a sector, one sector we just continue to avoid is the banks. And it's not that they're terrible businesses. It's just that we can't see big enough payoffs there. That's one very large section of the market that we've just got an “avoid” on. It's not enough to want to short it, but it's not good enough to be interested in, either.
Our average, since we started has been about 6% short, so shorting has been a very small part of our portfolio over time. And that makes sense because just can't make as much money in shorts as you can longs. In longs, you can get multi-baggers.
In shorts, the most you can lose is 100%, but that's very, very rare. Typically, in a cracking short, you might make 30% or 40% absolute tops.
On the other hand, you can have your face ripped off with a short as well. It doesn't make sense to put the same size position in the portfolio at an individual level for a short as you would for a long, because the payoff is lower and the risk is higher.
Likewise, it doesn't make sense to have an overall position greater in the shorts or even as much for the shorts as you have in the longs. We make money from the shorts because we're looking out for the shorts in the same way we're looking for the longs. It's just that the opportunities aren't as great and there aren't as many, and therefore we have a lower weight to those shorts, but we've actually done very well out of the shorts. If you look back over the last five years, we've made about two and half per cent per annum out of our shorts, which is a pretty good return for something that's only averaged about 6% of the portfolio for it to be contributing about 2.5% a year. But that also goes to our selectivity in the shorts as well.
One company you’ve been very enthusiastic about in the past is PeopleIN. Do you still own it, and if so, why?
We certainly do. It’s one of these businesses that have good organic growth. Obviously, sometimes the organic growth is stronger than other times. It's quite good now because we've got a tight labour market and that's very good for labour-hire companies. But apart from that, it's got growth by acquisition. The growth outlook now is very strong for the medium term. In addition to that, it's trading on a relatively low PE multiple. It's not a well-covered stock, and because analysts tend to be quite conservative in their forecast, we feel that there are still significant upgrades to come in the earnings numbers from the analysts. There’s a triple whammy coming for this company in terms of upside. It's still one of our largest holdings.
It hasn't reported yet for the first half, though it held an AGM around the backend of November, where management was very optimistic. It was a great market for them.
And though I say it’s one of our top holdings, there are many companies that are our top holdings. We like to have relatively even weights across our businesses because we take the view that we're probably going to get eight out of 10 right, and if we do, you've got to have relatively equal weights to ensure the portfolio benefits.
If one company dominates and goes bad or if you've got some that go really well but the weights are too small, then they can't offset those that don't work. We've got about a dozen companies that are our “favourite” companies in a sense.
Can you tell me about the “two strikes” approach you use in deciding when to exit specific stocks?
Of course, we have some stocks that aren’t our favourites and that, of course, are not our larger holdings. They're quite small immature businesses, which we call product launch stocks. And we have half a dozen to a dozen of these companies at quite early stages. They are often multi-baggers and sometimes they've gone on to become quite large businesses for us, but we've got to be ruthless in kicking these companies out if they're not thriving because we're not in there to muck around with them for years.
Last year we had three companies that we got rid of because they were failing to thrive, as very small companies.
Last year was quite a big year for us in terms of kicking out stocks in the portfolio that had two strikes. We actually had eight stocks kicked out and it sounds like, "God, that was a bad year. You must have had bad performance”. But we had very good performance last year and the key is getting onto these things early.
We're now left with a couple of companies still in the portfolio that have got a single strike against them each. We'll see how they go this reporting season.
What are some examples of things that prompted some of the strikes you mentioned earlier?
One of the things that got us out of tech stocks was we saw that in August, for example, when they were reporting last time, a lot of the stocks had marketing spends that were higher than expected. And even when their earnings were in line, they struggled a little bit because they had to push it on the volumes to get there. And that was a signpost for a strike, for us. We had markers as to what marketing spend should have been, as a percentage of sales and so forth. And they were missing it, and so that was a strike for us, and that was fantastic because that got us out of stocks before they had another three or four months of very significant falls.
But I don't think anybody really had any idea what the real-world cost of that change in privacy was going to be in terms of the decreased inefficiency of the marketing spend and the company's response in having to increase their spend on marketing to try and make up for that. And so we used that information throughout the year, as we noticed it to our benefit and we avoided losing some money, but we didn't make any huge amounts of money from that insight. If we'd been short all those tech stocks, we would've made a lot of money.
Did the confession season that comes ahead of reporting season see any of those one strike companies graduate to two or three?
January was an interesting month for us because, given that we are looking for step changes in earnings, quite often we have stocks in the portfolio that are quite high growth stocks and they tend to attract high valuation multiples.
In a month like January, when it wasn't just the tech stocks that were underperforming very badly, it was generally growth that was underperforming very badly. We had removed some tech stocks from the portfolio because they'd been hitting our price targets. And, naturally, we just de-weight them or exit the stocks. But there was a real headwind for us because of the bias against growth.
But we still outperformed the small ords. We underperformed the ASX 200. And the great thing that happened for us in January was that we had three or four of our companies come out with quite positive pre-announcements, whether it was sales or whether it was just comfort around their earnings and they were quite conservative statements.
Two of our companies rallied on conservative statements of earnings because it was so transparent, it was obvious the directors were underplaying the outlook. In fact, we got a lot of comfort from the fact that even with the growth bias in our portfolio, we performed in line with the market. That’s generally a very good sign as you're going into reporting season.
If you've got no companies that have come out with bad news and you've got companies that are already giving you positive reports that you're going to have a good reporting season. We typically do have a good reporting season, and fingers crossed we're about to have another good reporting season.
What’s the story behind one of your most recent portfolio inclusions, BHP Group (ASX: BHP)?
Typically, we don't have much in the resources space because we don't like to bank on a particular commodity price to run. And let's face it, for the resource companies, usually, the main driver of any stock is its underlying commodity exposure. But there are some situations, typically if there's a mine expansion going on that we don't think is being priced by the market.
We've got that in the case of Strandline Resources and for some of the large resource companies like BHP and Rio Tinto, where the analyst forecasts are very, very much lagging what's happened with the commodity prices. The commodity prices have really kicked up since towards the end of last year and the analyst forecasts haven't.
In the case of BHP, it needs a 100% EPS forecast increase for the FY '22 and FY '23 for the analysts to catch up to where commodity prices are at spot at the moment. That's not to say that the spot price won’t either fall back or kick up, but it's more that we are going to see some pretty decent increases in EPS forecasts with BHP and Rio, if those commodity prices don't start falling back soon. And our view is that they’re going to be okay. It’s such a degree of upgrade that's needed, it hits our recurring situation. We want to be in these companies now during this upgrade cycle.
We hold these companies in a group trade, where we've got four companies that collectively total 10% of our portfolio weight.
And finally, as a bit of fun: What would you be doing if you weren't a portfolio manager?
It's pathetic, really. There's nothing else I want to do. It's nothing else I can think of being enthusiastic about doing as a full time job apart from doing this. And it's just such an interesting job because I'm paid to stay across the news, stay across all sorts of industries and businesses. I get to go and speak to the management and I don't get to be bored because I'm always moving from one thing to the other. Then to top it all off I've got to use evaluation discipline to work out where to put our money and invest long and short. And then you see the payoff, you see the results every month.
Benefit at every stage of a cycle
Monash Investors Limited invest in a small number of compelling stocks that offer considerable upside and short expensive stocks that are at risk of falling. Want to learn more? Hit the 'contact' button to get in touch or visit their fund profile below for further information.
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Glenn Freeman is a content editor at Livewire Markets. He has around 10 years’ experience in financial services writing and editing, most recently with Morningstar Australia. Glenn’s journalistic experience also spans broader areas of business...