The low cost ASX100 fund thriving by keeping it simple
Throughout the history of financial markets, there has been a tendency to overcomplicate things. Adding alpha is difficult, so therefore we must need ever more elaborate, complicated strategies to beat the market. Things are changing so fast, we need to change faster in order to stay ahead.
It is easy to get caught up in these ideas. They’re not called 'market darlings' and 'crowded trades' for nothing. Happy to let those crowded and often unsustainable opportunities go by, however, are the team at Elston Asset Management. Instead, their focus is purely on the ASX 100.
I recently spoke with Bruce Williams and Leon de Wet who oversee the Elston Australian Large Companies A Fund to learn more about their approach to managing money, how they are viewing the current environment and some of the stocks that pass their filters.
Elston’s laser focus on the top 100, robust analytical process, and strict adherence to risk parameters mean that they don’t have to chase the latest fads and trends. What they do have to do is know the top 100 inside and out. And that is precisely what they do.
The other thing that sets Elston apart is that the fund is style neutral. In the team's view, both growth and value matter and are important at various points in the cycle, so they don't want to be constrained from pursuing the best opportunities at any given time.
The fund is index unaware but has strict limits on the minimum and maximum position sizes – no smaller than 2.5% and no more than 6.5%. The typical number of holdings is 20-25 stocks but the Elston team knows the 75 they don’t hold just as well as the ones that they do.
“I think as a portfolio manager, the biggest mistake you can make is really focusing on what it is you own. A lot of our work goes into securities that we don't own. If something screens really well across the board, and we don't own it, it prompts us to go back and have a look at that security and question why, and vice versa," says Williams.
The team employs a rigorous screening process, looking for stocks that have strong ratings across traditional factors such as price to earnings (PE) versus history, earnings growth, margin expectations, etc, to narrow the universe.
Once ideas are generated, the team conducts thorough fundamental research, talks to management, updates their financial models, and then rounds it out with a qualitative assessment of each business. Ultimately, they are bottom-up, active stockpickers and their approach focuses on proper diversification, active management, and reasonable concentration. It was Warren Buffett who famously said that wide diversification is only required when investors do not understand what they are doing.
This is not something you could accuse the Elston team of, and the proof is in the pudding. Whilst the Elston Australian Large Companies A fund is relatively young, having launched in December 2018, it is backed by a strategy that has been in operation since 2012, via a Separately Managed Account (SMA). Since 2012, the strategy has delivered total returns of 11.2% per annum after fees, handily outpacing the S&P ASX 100 Accumulation Index (the benchmark) return of 9.4% pa. That performance sees the strategy ranked in the peer group first quartile across 1, 3, 5, and 7-year time horizons.
The performance for the past 12 months is 6.86% after fees, which is a credible result given the difficult backdrop for most equities, with the ASX200 down ~5% over the same period. At the same time, Elston is one of the lowest costs funds in our database, with a management fee of just 33 basis points.
“You don’t get too many purely large cap funds. It is a market that has been left to beta. And we think because it’s been left to beta, active returns are still available to you, and we’ve proved over time that it is possible,” says Williams.
WHERE ARE WE IN THE CYCLE?
Williams and de Wet are very mindful of earnings expectations moving forward and these expectations are shaping their portfolio construction and stock selection.
"Our view is that expectations probably are a touch optimistic," says de Wet.
Coming out of reporting season, Williams notes that companies have done a fantastic job given input cost pressures and supply constraints, by passing higher costs onto customers. The problem, however, is that is not a bottomless well that companies can keep going back to.
“What concerns us is that we think there is a limit to that until it becomes demand destructive. So whilst the expectations looking forward on earnings are still reasonably positive, if you see companies continue to crank through cost increases, at some stage it is going to bite.”
If that’s the case, then the question becomes whether earnings expectations are too high and will companies be able to keep passing on costs, or will they have to start really looking at their own P&Ls and become more efficient?
MOVEMENT AT THE STATION
The considerations above have seen some movement in the Elston portfolio recently, with an increased focus on quality, sustainable earnings, and pricing power. The fund has bought The Lottery Corporation (ASX: TLC), noting that it is a monopoly-like business.
“It’s the only licenced lottery and Keno operator. They have a loyal customer base and a very strong brand. So we believe recurring revenue is very strong, and that's likely to be resilient even if we do go through a slower economic cycle”, says de Wet.
In terms of what the team have been selling, de Wet highlights Beach Energy (ASX: BPT). This divestment was somewhat circumstantial, with the merger between Santos and Oil Search providing such a compelling proposition that the team preferred to have their exposure there. Contributing to the decision has been the team’s overall reduction in energy exposure. Having enjoyed the benefit of surging oil prices, the fund has reduced energy exposure from approximately 13%, to less than 10% of the portfolio.
FAVOURITE LARGE CAP
de Wet cites CSL Limited (ASX: CSL) as his favourite stock, pointing to the blood plasma business as the growth engine over the next three years – which is Elston’s investment horizon.
“It's very possible that CSL can deliver low to mid-teen earnings growth over that timeframe” says de Wet, citing a recovery in blood plasma collections post the pandemic
de Wet also cites the 30% growth in the number of collection centres and CSL’s new Rika platform, which provides a better experience for donors and collects more blood in a shorter space of time, as drivers moving forward.
As for Williams, his pick of the bunch is Endeavour Group (ASX: EDV) and he notes that now it is out on its own, and no longer an afterthought in the Woolworths stable, capital allocation and management should be vastly improved. As well as that Williams really likes both the retail division and the pubs business. On retail, Williams says “Dan Murphy's and BWS are very strong brands. Endeavour is investing very heavily into those, not only in terms of store roll-outs, but in terms of customer experience… which should provide a lot of benefit over time.” When it comes to the pubs business, Williams says that as well as attracting customers back post-pandemic, ”there's a lot of development they can do on their existing sites in terms of renovations, in terms of expanding their offering on site.”
ON THE HORIZON
If it wasn’t already clear, the Elston team are keenly focused on quality names with pricing power at the moment. And that is due to the expectations around earnings already discussed, as well as inflation expectations.
The team notes that a lot of the inflation has come from the supply side, whilst management policy is with the demand side, creating a fundamental mismatch.
"We are concerned that [central banks] will, depending on how high rates go, really put a clamp on demand. And so we've just gradually been moving from more cyclical growth to structural growth securities, or those where the underlying customers will be quite defensive," says Williams.
Williams goes on to highlight Amcor (ASX: AMC) and Brambles (ASX: BXB) as stocks that are quite defensive. Both have customers from the defensive consumer staples segment, and both have been quite capable in terms of passing on cost increases to this point in the cycle.
Whilst Williams and de Wet have strong and well-informed views about earnings and inflation expectations, they also have what every good investor has… and that’s humility.
“None of us really know what the future's going to turn out like, right? We obviously have to make educated guesses but it would be silly of us to think we have a crystal ball and we know exactly how things are going to pan out.
Our portfolios attempt to cater to different thematics, and we'll get some of those right, and invariably, we'll get some of those wrong, but hopefully that diversified approach will provide good outcomes for clients and outperform the benchmark”.
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My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them...