Heading into the pandemic, Romano Sala Tenna and the team at Katana Asset Management were already carrying higher cash levels. This put them in a prime position to snap up bargains as prices fell, and led to a nearly 10% total return for the Katana Australian Equity Fund in financial year 2020. But the decision to hold so much cash prior to the COVID crash wasn’t a mere stroke of luck. It was the result of deep research into the virus intersecting with the five-pronged process that – much like the namesake blade – Katana refined over 17 years to minimise the afflictions that arise from emotional investing.
“Through team decision-making, we are able to mitigate these emotions and individual biases – not perfectly, but at least partially. This requires confidence but also humility. Confidence to back a view against the herd, but the humility to recognise that view could nonetheless be wrong.”
In this wire, Romano shares some of the secrets from that process – and why humility is a critical part of it. We also hear about why Katana is excited about ‘COVID recovery plays’, and his latest update on banks.
Romano Sala Tenna - Katana Asset Management
Your fund delivered +9.7% in the 2020 financial year versus -7.9% for the index. How did you navigate the market volatility?
People don’t plan to fail, they fail to plan. A lesson we learnt from previous cycles, is that unless you have a documented investment framework that definitively identifies the criteria that are to be applied in buying and selling stocks, 2 things are likely to happen:
Firstly, you are likely to lack consistency and discipline, which over time makes it difficult to learn and improve.
Secondly, you are likely to allow your emotions to take over during severe market dislocations - instead of trusting in the facts and fundamentals.
We have been refining our investment template for 17 years. During the most recent crisis, this framework enabled us to reduce (not eliminate) some of the noise and emotion. An investment framework is something that every investor should develop and constantly refine to fit their own EQ.
Some of our success was also due to our extensive research and reading. We quickly realised that we needed to understand as much as we could about COVID-19 in the shortest possible time. As the crisis unfolded, we were averaging 4-6 hours per day just researching the background to the virus, its virulence, transmissibility, morbidity and more. As a professional investor, we had the luxury of being able to dedicate this time, and it provided a competitive advantage over retail and other investors.
However perhaps the largest driver of our performance, was our ability to be flexible and combine the best precepts of the different investment styles to navigate the different phases of the crisis.
As a truly style agnostic manager, we were able to utilise the different aspects of value investing, growth, quality, mean reversion and yes momentum.
For example, when the market began recovering, we were able to stay focused on key technical/momentum indicators, despite every fundamental data point screaming ‘sell’.
What are the key principles of your investment approach?
As Warren Buffet famously wrote all those years ago: “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1”.
At Katana, we are not about getting the best return possible, we are about getting the best risk-adjusted return. At the centre of everything we do is capital preservation. More than 30% of the funds we manage are owned by the investment team. Our long-term wealth rests alongside that of our unit holders, and will be decided by how we compound our returns year after year. Remember, if a stock drops by 50%, you need to make 100% on the remaining capital just to break even.
Secondly, decisions are based on an investment framework that has been refined continuously over the past 17 years. This framework encompasses more than 60 individual criteria across 4 categories: Quality, Value, Growth and Timing. This has enabled us to not only have a consistent framework to assess companies, but more importantly it has provided a platform through which we can continually assess and improve based on investment outcomes.
Thirdly, we have worked hard to remove ‘artificial constraints’ that hinder instead of assist our investment process. For example, whilst we appreciate the need for our performance to be ranked against a benchmark, it should not dictate how we invest. If we are negative on the banking sector (which comprises ~20% of the market), then we won’t just move to 15% or even 10% - we will and have in the past - move to 0%. Other artificial constraints include limiting the investment style, market capitalisation, sector, stage of development, index etc. We absolutely respect what all these attributes mean, but in and of themselves, they are artificial barriers that can limit investment performance.
Fourth, we hold on to an old fashioned concept known as ‘diversification’! Peter Lynch from Fidelity fame was arguably one of the greatest investors of the modern era. He repeatedly said that if you can get 6 out of 10 investments right, then you are a ‘rock star’. The very best of managers make mistakes. Better that mistake be one of 60 stocks rather than one of 15. Our goal is to hold on average 50-60 high conviction positions. There are no space fillers- if it is in the portfolio then we believe it has above average prospects on a risk-weighted basis.
Our fifth and final principle is centred on teamwork. Fund managers are still prone to the same emotions that afflict all investors. Through team decision-making, we are able to mitigate these emotions and individual biases – not perfectly, but at least partially. This requires confidence but humility. Confidence to back a view against the herd, but humility to recognise that view could nonetheless be wrong. It is written that “pride cometh before the fall”; in our experience pride guarantees the fall! As we have seen firsthand over the past 15 years, we can be the Pidgeon one year and statue the next!
A lot of fundamental investors are sceptical about technical analysis. What value do you get from it, and how do you incorporate it into your strategy?
Given that the #1 driver of share prices at this time is momentum, technical analysis (TA) has never been more important. The key from our perspective is to always remain focused on what a price chart is telling us about the underlying SENTIMENT. If we approach TA as some black box that arbitrarily spits out buy and sell signals, then we are on a collision course with failure. However, if we remind ourselves that a chart represents the interaction of thousands of buyers and sellers, then how the price moves gives us insights into the prevailing sentiment.
Given we have over 60 investment criteria at Katana, we are unlikely to ever base an investment decision on a single criterion, especially one that is based on sentiment. However TA enables us to fine tune entry and exit points, remain patient and act in unison.
Was there anything that didn’t pan out for you last financial year? What were the key lessons?
As in every year, there were many mistakes and hopefully lots of learning. Most relevant over FY2020, was the reminder that markets can stay irrational longer than investors can remain patient. Accordingly, with momentum being the number one performing investment style for the year, we were reminded –brutally at times – to ‘read the tape’ not just the balance sheet. Sentiment is the number one driver of short-term prices. Whilst our investment process is founded on a host of factors such business model, valuation, financial strength, management, culture and sector dynamics, ultimately we must move in synch with the market in so much as that is possible. In practical terms, this means doing the enormous amount of research and analysis required to know what to buy, but then waiting for the inflection point before taking action.
Banks have put on an impressive performance since you called the bull case on Livewire. Can you update us on your view heading into reporting season?
Our bull case was based on a 30 year perspective which highlighted that the market had become asymmetrical – i.e. only focused on the risk and completely overlooked ‘what could go right’. Today, some symmetry has returned, however the course of action moving forward is really dictated by one’s timeframe.
Over the short to medium-term, we see that the banks are likely to stumble along with the overall market and oscillate in a volatile trading range. Our intention is to keep a core holding but actively trade a sleeve as prices vacillate. Over the medium-term and beyond, we see above average upside from the current levels. Remember, when COVID-19 inevitably sails off into anonymity, investors will be left with negative real interest rates, and hence be ‘forced’ to seek a sustainable yield that beats inflation. Under this scenario, the banks are likely to once again return to favour.
Which stocks, outside the banks, are you most excited about this financial year?
There is a danger that gold has become a crowded trade, and that is something that does occupy our thinking. However, with negative real interest rates in the US in the vicinity of minus 1.25%, the probability is weighted towards ongoing appreciation. In this sector we have recently realised profits in Northern Star (NST) and Evolution (EVN), but built positions in Saracen (SAR), Regis (RRL), Resolute (RSG) and some small ‘place markers’ including Dacian (DCN) and others.
Beyond that we are most excited about some COVID-recovery plays. This is quite a diverse label and includes travel stocks such as Qantas (QAN), Webjet (WEB) and Hello World (HLO) right through to retail and retail REITs such as Scentre Group (SCG), Vicinity (VCX) and Unibail Rodamco Westfield (URW). We would however urge caution, and emphasise that the time to invest in these stocks is when the sentiment towards the old world economy begins to recover. This is not likely to happen until infections stabilise.
We note that you’re at 18% cash which is at the lower end of your historical range. Does this imply you’re bullish on Australian equities?
COVID-19 was an excellent example of why we do hold above average cash reserves over the journey. It was a true ‘black swan’ event.
The significant fall in prices throughout March meant that funds such as ours were able to deploy capital into companies that were trading at 50c in the dollar or better. Our cash weighting dropped to well under 10%, and would have fallen further except for our decision to maintain funds to enable us to participate in capital raisings (which in the fullness of time did not materialise at the anticipated level). With the easy part of the recovery now behind us, we see the outlook as being more balanced with a slight bias to the upside.
What are some of your the best investing 'secrets' that you’ve learned over your career?
The first advice I read in my first investment book were words to the effect of “cut your losses short and let your profits run”. Over the past 25 years, pretty much every seriously successful investor has repeated that very same mantra: be disciplined with your losses and be patient with your winners. It’s really not rocket science – but it’s as obvious as it is hard to do!
There are a myriad of reasons why in practice this can be such a challenging discipline; for example how many times have you been whipsawed out of an investment only to then see it double!? What this does to your preparedness to take a stop on the next trade is clear.
Some ways we attempt to encourage this discipline at Katana, are through:
- firstly recognising and acknowledging how we are wired
- putting in place a process and structure to remove the emotion and
- ultimately utilising team decision making and accountability.
There are literally hundreds of other lessons that we have learnt along the journey, continue to learn and unfortunately re-learn. A wonderful example of this last category is the need to ‘read the tape’. This expression will be lost on most of the current generation of investors, but it refers to the old practice of reading the ticker tape that came over the telegraph line, which contained price and volume data. The skilled traders of yesteryear would use this data to form a view of how the market was behaving and hence where prices were likely to go. Of course things have evolved a long way since that time, but what remains essential is to understand the basics around price and market sentiment.
In short, don’t fight the Fed and don’t fight the tape.
Flexibility with accountability
Katana's approach and philosophy was setup to challenge the artificially imposed constraints of managing money. Find out more.