Lifting the hood on one of Australia’s best performing funds

What sets a top performer apart from the funds that consistently fail to outperform an index? According to Michael Goldberg, Managing Director and Portfolio Manager at Collins Street Asset Management, there are several important ingredients.

Alignment of interest between the manager and investors, an unconstrained approach that’s differentiated from the broader market, and perhaps surprisingly, a focus on capital preservation. And of course, buying stocks at a discount. 

But above all else, it’s about conviction. There aren’t that many great investing opportunities out there, so it’s critical to do to the research, back yourself, and size your positions accordingly.

In this Fund In Focus, Michael explains why it’s important to get comfortable being uncomfortable, why they eschew the idea of a broadly diversified portfolio, and he shares an undervalued company from their portfolio with significant upside potential. 

Edited Transcript

Michael Goldberg: Hello, and thanks for joining us. I'm Michael Goldberg. I am the Managing Director and Portfolio Manager at Collins Street Asset Management. And I thought today we'd have a bit of a chat about our flagship fund, the Collins Street Value Fund, and a little bit about our process, our philosophy, what makes us different, and what's really driven our returns over the journey so far.

With respect to the disclaimer on the screen at the moment, I think it's probably worth pointing out two key points: 

1. We are a wholesale-only fund. So investors do need to qualify as sophisticated. If you don't know what that means, or if you'd like a little bit more advice, we're happy to take your call. Our contact details will be available at the end of the presentation. 
2. This is not a conclusive or complete coverage of our fund. Again, if what we discuss today is of interest, please feel free to reach out to me or Rob, our head of investor relations. We'd be happy to walk you through our information memorandum and have a conversation.

The Collins Street approach to managing money

Now, before we get into the nuts and bolts of our philosophy and process, I think it is worth calling out our view on, or our approach to, investing other people's money. And also, to briefly talk about the sorts of investors that might find value in investing in the Collins Street Value Fund.

So to start off with, I think it's important to call out that we are not a "get rich quick" scheme. The vast majority of our investors are already financially comfortable. They've spent a lifetime building businesses. They've spent a lifetime building property portfolios or just generally building up their wealth. And they're coming to us for a considered approach to investing in shares to provide diversification, certainly for themselves, but also for the next generation, for their children and children in the future.

That is their core consideration. And because so many of our investors are looking to maintain and build wealth gradually over a long period of time, capital preservation tends to be first and foremost in their minds. And so it also needs to be first and foremost in our minds. Now, how that manifests throughout our philosophy and process, we will certainly cover in this presentation. But it also manifests through our portfolio construction.

With respect to how we view ourselves and the importance of aligning our interests with our investors, we think one of the very first steps that any manager of money or anyone who's been entrusted with money is to ensure that our interests are aligned with our investor's interests. 

From our perspective, when we're investing in ASX listed companies, we repeatedly see directors and managers who have come up with some wonderful scheme to incentivise investors; some arbitrary assessment of what adds value.

So where we as investors are concerned about return investments, or we're concerned about the strength of the balance sheet, or we're concerned about an improving share price, oftentimes directors will be remunerated for a product roll-out, or for growth in revenue. Too often we've seen managers sacrifice our best interests for their best interests, and unaligned interests are almost a guarantee of unfortunate outcomes. That's not to say, per se, that aligned interests are a guarantee of good outcomes, but you can be sure that if you've aligned your interest with the people who are looking after you, you'll get better outcomes, on average, over the long term.

Track record

With respect to our track record, I don't want to spend too much time on this particular slide. None the least because past performance is no guarantee of future outcomes, but I think it is worth pointing out that our process, our approach, has generated some of the best returns over the journey, both over one year, three years, and five years. We've been recognised by both Morningstar and Mercer for our good returns. 

I think what's especially interesting is that some of our best performance, certainly some of our best out-performance, has actually occurred during periods of market volatility and weakness from the general markets.

Just as an example, most recently in January 2022, when the market was down 6.5% or thereabouts, we actually managed to generate a positive outcome. Now, I'm not quite sure what that suggests, but I suspect that it speaks to the approach we take to picking the companies that go into our portfolio. I suspect it speaks to our portfolio not being representative of the broader market. And I think it speaks to our approach and consideration for capital preservation in general.

Point of difference 

I think it's probably also worth noting how we differentiate ourselves. Obviously, if we're achieving the is different sorts of outcomes. It can probably be accounted back to the different approaches that we take to our investment journey.

First and foremost, I think it's worth calling out that we only invest in companies we want to own. We're not driven by some mandate to own 100 different companies or have specific sectoral exposure. 

For us, if we are not absolutely enamoured, if we don't absolutely love a stock, we simply won't invest in it. Secondly, I think it's worth calling out that we view ourselves as investors, not speculators. Now, that's certainly not to say that there's anything inherently wrong with speculating. Certainly, people have made money out of speculating. Certainly, it can be fun to speculate. But I think for us, it's very important to: 

1. Distinguish when we are looking at a company, whether we're investing or speculating. 
2. Recognise that our mandate is to invest and not to speculate. 

So while there might be a place for speculating, it's certainly not within the Collin Street Value Fund.

I think as well, as we've discussed, the alignment of interests sets us apart from many of our peers. For instance, one way we align our interests is by having a zero fixed management fee. If our investors don't profit, we simply don't get paid. And the other way we align our interest is by investing alongside investors in the fund. So positive outcomes for our investors are positive outcomes for us and vice versa.

Finally, the key point of how we might differentiate ourselves from others is that we're unconstrained in where we find value. 

Oftentimes, we'll get questions like, what box do you fit in? What sectors will you invest in? How big does the company have to be? Or how small does the company have to be before you invest in it? 

I think pigeonholing one's self into a specific sector or a specific market cap bracket really just does a disservice to that portfolio manager and any investors that are investing within a fund. 

So from our perspective, we're happy to invest in industrials. Obviously, that is the natural stomping ground for value investors, but we're equally happy to invest in technology stocks and commodity stocks. Wherever we can find value, we are happy to invest there, almost irrespective of the market cap size of those businesses.

The Collins Street investment philosophy for finding value

With respect to our philosophy, we do like to keep things simple. Essentially what we are looking to do is buy a dollar worth of assets, or a dollar worth of earnings, for 50 cents. 

To be able to find these ideas where you can buy a dollar for 50 cents, the key is getting comfortable with being uncomfortable. 

Now, whether that means getting comfortable with being uncomfortable with our process, or perhaps getting out from behind our computer screens, and asking the tough questions of management, going and doing some due diligence in areas that perhaps other people feel uncomfortable doing. Or if it means investing in sectors or businesses or companies where people are generally uncomfortable with those sectors and businesses. In either event, if we can get comfortable being uncomfortable, we certainly can find significant opportunities.

I think when push comes to shove, all we're really trying to achieve is to do just that little bit more than the next guy, in search of what we call an information advantage. Because if you can achieve an information advantage, you can very easily translate that into a performance advantage.

Now, it doesn't just stop there. Once you've gone through that process, and you've identified a good quality business, I think the key, perhaps even the linchpin, to our philosophy is that we invest with conviction. As I previously said, we're not looking to own a diversified portfolio. We're looking to buy our favourite, most high conviction ideas. And I think if we've identified these businesses, we want to make sure that once we buy our position, it can have a meaningful impact on our broader portfolio. 

As a rule within the Collins Street Value Fund, once we've identified one of these businesses, we tend to put between five and 10% of our investible capital into that idea so that when it does inevitably pan out, we're able to benefit in a meaningful way.

The research process

I think similarly, with respect to our process, we try to keep it pretty simple. We're not looking to reinvent the wheel. 

Essentially we try and look at an investment opportunity as if we're looking to buy the whole business. So much like you would look at the financials and visit operations and test products if you were looking to buy a whole company, when it comes to buying a share of that company, on the equity market, we look to do the same thing. 

Now, certainly, every company is going to be different. And so the process that you go through for each of those companies is going to look different, but we look to put in the best effort we can to get that information advantage.

And I recall a few years ago, we were looking at a business that offered a hair product that promised to thicken and regrow your hair. And as part of our process, even though they had studies indicating that it did work, we went and bought 10 cases of the product, distributed it to my follically-challenged family members, and for the next couple of months, every fortnight, the members of my family would provide me with a report on how they were going with that product. As it turned out, the product was actually pretty good. But for other reasons, we didn't invest in that business.

A little bit different, companies like The Reject Shop (ASX: TRS), Metcash (ASX: MTS), or Retail Food Group (ASX: RFG), which is one that we currently hold, our process will again be different. For those companies, we visited operations. We talked to managers. We talked to customers. We tasted their delicious food. 

We do whatever we could to get a sense of how things were going at the coalface so that we can get an advantage over what the market appreciates or recognises. Because oftentimes what you'll find is, if you're able to find out what's happening on the ground, you're actually six months ahead of what the market actually knows.

With companies that are larger, with better coverage, companies like ANZ (ASX: ANZ), one of our first investments in the Collins Street Value Fund, the process will be different. Again, there's not a lot of value in turning up to the local Collins Street or Bourke Street branch and asking some pointed questions to the teller. Certainly, if I started asking about their customer flow or how much cash they've got in the till - I'm probably not going to get the sorts of outcomes or responses that are going to be beneficial to myself or the fund.

Portfolio positioning 

We're not really concerned with having the same sorts of weightings as the market does. Instead, as we've said, if we find a good idea, we're happy to invest in it, almost irrespective of what sector it's in. I think the one point perhaps worth making on this graph, I think most of it is self-explanatory, except for special situations, which currently represents about 8% of our portfolio. And at the moment, that's represented by a couple of convertible notes that we've been able to negotiate directly with the management of these companies. 

We really like convertible notes because they give us the ability to have equity upside while having debt-like downside protection. 

Similarly, our current holdings indicate that we're not really bothered by which sector we invest in. We're not even really concerned about how large the companies are that we invest in, or how small the companies are that we invest in. We've really only got two considerations: 

1. Can we find value within that business? 
2. Given that we are a liquid fund, can we find the liquidity in this business to both get in and to get out?

Now, oftentimes, you'll have to find enough liquidity to get out within the market. But sometimes, companies themselves will create these liquidity events, which will allow us to buy businesses that we otherwise wouldn't if we then had to go and sell them within the market.

An example of a high-conviction position

And that brings us to an example, which I hope will add some colour and elucidate some of the discussions that we've had up until this point, and the company is Beach Energy (ASX: BPT). Beach Energy and the oil and gas sector is a space that we've been interested in for quite some time. But back in 2021, we found Beach Energy falling from about $1.80 down to $1.20. And then in August, falling down to about $1, we got really excited. Essentially our view was that the market had wiped off almost 50% of the market cap of this business for a production downgrade of just 5%.

Now, our view was that that was an emotional overreaction to what was going on. And so over the next couple of months, in August and September of 2021, we were able to build up a significant position in Beach Energy at around $1.05 at the time where we thought it really was worth, its intrinsic value really was worth, about $1.80.

We looked at it from a high level. This is a quality business with good management, a strong balance sheet, trading on a price to earnings ratio of about five times, at the time that we were doing our purchasing. 

This is a company with some significant growth potential out of LNG in their joint venture with Mitsui, which will pay dividends in 2023. And a company that was trading at about half the valuation of its major peers on an earnings and production basis. But it wasn't just that Beach looked interesting as a standalone because it was a cheap company, but it also had a second tailwind.

The second tailwind for Beach is really a sectorial tailwind. There seems to be a growing dislocation between demand, supply, and fossil fuels in general, but specifically in oil and gas as well. 

Now, this is not the reason we bought Beach Energy, but it's certainly something that could make things very interesting for the sector and Beach over the next five to 10 years. You see, oil and gas demand is actually expected to increase well into the 2030s, even as supply comes off now in anticipation of an eventual decrease in demand.

So you've got this really interesting confluence of factors at the moment where, due to political and social considerations, banks are making it almost impossible to get funding for new projects. 

Within the sector, you're seeing a consolidation with the likes of Oil Search and Santos (ASX: STO), having just recently announced that they were merging. And at the peripheral of the sector, you've got the likes of BHP (ASX: BHP), who traditionally have had energy-type projects, now selling those energy type projects to the likes of Woodside Petroleum (ASX: WPL). 

So you've got the situation where you've got weakening competition. You've got an increase in demand, and you've got funding problems for new projects. Now, I don't know where this is all going to land. And certainly, the situation is far more complicated than my brief explanation allows for. But if we are taking out the natural breaking mechanism of new competition for the cycle of prices, it's certainly going to be very interesting over the next five or 10 years to see what happens with fossil fuels in general and oil specifically.

So with everything that we've seen from Beach Energy, and the industry, since we first invested in it, we're quite happy with our position. 

We tend to think that based on current situations, Beach Energy really should be worth north of $2. And we think that once the market recognises that the price is where it is based on emotion and shortsightedness, and recognises that the economics of the project are more important than how investing in the project makes you feel, that investors in Beach will do quite well.

Michael Goldberg's advice to investors 

I think if I could leave our investors with one message for their personal investment journeys, it would be to have a process. It doesn't need to be complicated. It just needs to be thought through, and it needs to be repeatable. Because at the end of the day, having a process really is the first, and perhaps the best, defence we can have against emotional decision making and investing in companies based on emotions. 

Long-term success in investing doesn't come from big swings or from lucky breaks. It comes from making smart, considered decisions, again and again, time after time.

That really is, as far as I'm concerned, one of the keys to long-term investing success.

Want to know more about the Collins St Value Fund? 

The #1 ranked Collins St Value Fund, with an 18.7% p.a. net track record since 2016 is a high conviction, unconstrained, deep value Australian equities strategy available to sophisticated/wholesale investors only. To find out more click here.