Making smart investments in a tough market

Patrick Poke

Livewire Markets

With the ASX 300 down more than 5% in the first half of August, many investors are seeing red across their portfolio. But one long/short hedge fund that’s been bucking the trend has been Totus Capital. In the first half of August, the fund returned +2%, resulting in about 7% of outperformance in just over two weeks. This is not unusual for the fund either, which has typically made gains in months that the market is down.

To get an idea of what’s behind this performance and hear a bit about what they’re investing in currently, I spoke with founder and Portfolio Manager, Ben McGarry.

The long and short of it

Like many long/short managers, the last 12 months has been a challenging period. On the short side, low quality businesses have been bid to new heights, while the opportunities on the long side have been limited due to high prices among potential long candidates.

Recently though, there’s been a big reversal in these trends. And it’s not just limited to Australia. One of the fund’s key short positions is down over 30% this year. McGarry believes the stock’s equity could ultimately be worth nothing though. He'll reveal the stock and discuss his short thesis in just two weeks time at Livewire Live.

Meanwhile, some of the fund’s key long positions appear set for better times. McGarry was particularly bullish on the prospects for Google’s parent company, Alphabet, which he says has been “treading water” for a couple of years. Closer to home, he also likes the outlook for salary packing company, SmartGroup, which has recently been through a major de-risking event – more on that below.

Despite the recent correction and worries about trade wars and yield curves, McGarry wasn’t prepared to call the current equity party over just yet. He does caution investors however, that the hour is late.

And for the value investors out there, there’s no good news just yet. He still says it’s tough to find value in the market today as many high quality companies are trading at very high prices.

A ‘Smart’ investment

Given the well-publicised downturn in the new car market, it may come as a surprise that one the best performers in recent months, and currently the largest holding in the Totus Alpha Fund, is SmartGroup. SmartGroup provides salary packaging and novated leasing, to health, defence, and not-for-profit sectors, allowing employees to take advantage of tax incentives to purchase new cars.

SmartGroup traded below $8 as recently as April, but after reporting strong results on Monday, is now above $11. Despite a massive 9% fall in new car sales in the first half, the company managed to increase profits by 5%.

“This shows the business is far more defensive and less cyclical than the market had realised.”

He said the recent result was a major de-risking event. The market believed the major risks to the stock were policy changes by the Federal Government, which now looks unlikely, and the difficult macro environment, which the company appears to have weathered.

“With both of these risks now in the rear-view mirror, the air should be clear for the stock for the next year or two, at least until the next Federal Election.”

He adds, however, that even come the next election, Labor is unlikely to want to take another controversial policy to the ballot box. Given any changes to tax treatment would affect essential workers who can least afford it, such changes would certainly seem to be controversial.

McGarry identified a list of reasons that they like the stock, including:

  • Management has plenty of ‘skin in game’, with the CEO owning $36m of stock,
  • A capital-light business model,
  • Conservative accounting,
  • A duopoly market structure, with McMillan Shakespeare (MMS) being the only major competitor,
  • Solid organic growth prospects, and
  • A sticky customer base, with just three clients lost in the last 15 years.

All this, and it trades on a PE of just 16x 2020 earnings with a 5% fully franked dividend yield.

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1 stock mentioned

Patrick Poke
Patrick Poke
Managing Editor
Livewire Markets

Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.


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