In the midst of a bear market, investors can't help but ask 'have we reached the bottom?' Will the economy face a W, U, V or even L shaped recovery? And how can investors gear their portfolio to accommodate for these ambiguous times?

According to NAOS Asset Management CIO Sebastian Evans, predicting the future is pointless. Not only this, but he is ignoring the index completely. 

I reached out to Sebastian following their recent webinar to ask how he is structuring his portfolio. He shares how he's deploying cash, and some stock that will hold up, regardless of what the future brings. 

Sebastian Evans

If you weren’t the CIO at NAOS, what would you be doing right now?

Most likely something where finance and long-term investment could be used to make long term meaningful positive change to people, society, or the environment as opposed to a pure financial return. 

What is the most useful insight into the economy that you’ve picked up from the weekly NAOS CEO insights?

The sheer number of Australians who have previously travelled overseas for business or leisure. In 2018 the figure was over 11 million, of which >60% was for leisure. For the next 1-2 years at least, COVID-19 will have a profound effect on how people do business overseas and travel domestically for leisure.

How do you predict the market will recover and how have you managed your portfolio to suit the ambiguity?

Predictions such as these, in my view, are pointless and are likely nothing more than a PR exercise to grab people’s attention. The most helpful thing investors can do is to focus on industries that will have genuine clear-cut tailwinds over the next 3+ years, and look for quality exposures to such sectors. In our view, such tailwinds include an ageing population, domestic tourism, cloud-based communications and infrastructure spending.

How does your belief in 'ignoring the index' fit into your investment process?

Ignoring the index allows us to focus on an investment, purely based on its fundamentals and the long-term earnings growth prospects of the business. We do not need to worry about the noise associated with tracking an index, where investment decisions can be heavily influenced by a stock’s liquidity and therefore its potential to be included in the index. When the next index inclusions are announced for the ASX-200 investors should ask themselves, would they own any of these companies for more than 6 months?

Why is your cash weighting so low (1.2%) and how have you been deploying cash throughout the crisis?

We run highly concentrated funds (Listed Investment Companies with approximately 10 stocks in each on average) and over the years our investment philosophy regarding risk management has been firmly focused on the balance sheet flexibility within our investments. The best form of defence in a crisis such as the one we are currently in, is to ensure your investment has the financial flexibility to trade through without needing further equity, and then potentially have the flexibility to acquire businesses that don’t have the same luxury but may have high quality assets. We have been adding to several investments which we believe will show excellent earnings growth over the next 24 months; Experience Co. (EXP), MNF Group (MNF) and BTC Health (BTC) are examples of these.

What are some sectors you’re avoiding at the moment?

Any sector where there is potential for significant structural change i.e. REIT’s with heavy office and retail exposures, anything associated with inbound travel, and financials where we believe bad debt exposures will take a long time to play out.

When do you expect a turnaround in fortunes for Enero Group? 

I think the more important question is: Does the business need to recover if it did not fall into a hole in the first place? Yes, PR can be cyclical, but if you look under the hood at Enero Group’s (EGG) client exposure you will see the likes of Aldi, Facebook, Adobe, Government and healthcare businesses, all of which we do not believe will be changing their PR spend profiles significantly.

Importantly, EGG has also recently won a number of new clients including Zoom in Europe and Atlassian in certain geographies.

EGG also has a significant cash balance which could be used to acquire complementary businesses to expand their Hotwire PR offering.

What are the implications of the easing of government restrictions for MNF Group? Do you think its performance will slow? 

We are a firm believer (though conflicted due to our large holding in MNF) that COVID-19 has accelerated a change in how people will communicate with each other; whether it’s for business, education or communication between friends and family. From our own experience we have found using services such as Zoom, GoToWebinar and Slack to be very effective, low cost and flexible. As an example, during April we held a webinar event for our own shareholders which had circa 800 investor views which compares similarly to the numbers we receive for face to face investor roadshow events held in capital cities around Australia.

We also firmly believe that some of the new services that are yet to be launched by Google, Zoom and the like to assist in the way people communicate, will further entrench this trend for many years to come.

With MNF having the networks, software and people to support these service offerings in Australia, New Zealand and Singapore we think they can comfortably grow EBITDA at >15% p.a. for the next 3 years with the potential to organically fund a $75 million acquisition if a suitable candidate was discovered.

Could you share a stock that you think can survive the crisis and ease into normality?

A boring business but one of our largest holdings is BSA Limited (BSA). They provide contracting services to the likes of the NBN Co. BSA is well capitalised with a solid net cash balance sheet, is now led by CEO Tim Harris (previously CFO of Leighton Contractors) and over 80% of the EBITDA is recurring in nature. BSA is one of the few maintenance contracting providers with a national network, which we believe gives them a significant competitive advantage compared to their peers. Having spent the last 3 or so years right-sizing the business and focusing on its core competencies, we believe BSA can grow revenue from circa $500 million to over $700 million in 3-years, especially with the tailwinds associated with the NBN, 5G mobile rollout and the sheer scale of infrastructure networks which will need to be maintained.

Think long-term

NAOS Asset Management is a specialist fund manager providing genuine long-term, concentrated exposure to Australian Listed Industrial Companies outside of the ASX-50. For more of Sebastian's insights, please follow him here.