The thesis behind L1's new 10-stock portfolio
When it comes to equity market investing, L1 Capital Founders Mark Landau and Raphael Lamm have many bases covered. L1's suite of strategies ranges from their flagship long-short strategy, which is available as a unit trust and LIC, to long-only Aussie large caps, international equities, a global multi-strategy hedge fund, UK residential property and now the Catalyst Fund.
So, what's the thesis behind their latest strategy, which is capped at holding just ten stocks? The Melbourne-based duo has teamed up with ex-investment banker and board adviser James Hawkins, who brings a new lens to the firm's established stock-picking process.
Hawkins says the L1 Capital Catalyst Fund looks to invest in companies where a proactive approach to engaging with company management and boards can help to release value for investors.
"When people think of activism, they typically think of a merger or other whizz-bang type of activity, not the lower-case 'a' activism such as increasing the quantum of a share buyback or lobbying for capital deployment measures," Hawkins says.
In this video, Hawkins provides more detail on the thesis behind L1 Capital's newest investment offering and why the firm is taking a concentrated approach.
Why did you choose to join L1 Capital and launch a new fund?
I've known Raphael Lamm since our university days and Mark Landau for 15 years, so I had great respect for both, in terms of not just the quality of the people, but also their skill sets. And importantly, I could see a very significant market opportunity in Australia, a $4.3 trillion market, where there's less than $1.5 billion of capital focused on activist investing. Between the three of us – Rafi, Mark, and myself – we thought the combination of their stock-picking combined with my experiences of two decades as an investment banker and originally an M&A lawyer, we thought that was a unique combination of skills to really focus on unlocking latent value in Australian companies.
What is the thesis behind the L1 Capital Catalyst Fund?
The Catalyst Fund is very much a “best ideas”, high conviction fund with an activist overlay. The way we operate, in practice, is the Australian equities team of L1 already does their deep-dive analysis and assesses companies on a value and a quality basis. Then the Catalyst team will assess the Catalyst overlay, and the ability to influence an outcome by virtue of our activist approach. It's very much about enacting and accelerating the catalyst, which will bring forward returns for our investors.
How concentrated will the portfolio be?
In terms of broad parameters, the fund can hold up to 10 stocks. They can be Australian listed companies or overseas listed companies, the latter provides us with some optionality. We're very clear on where our competitive edge is and that is in the Australian marketplace, so we're very focused on this market, so when we go offshore, it'll be the exception rather than the rule.
In terms of diversification, we carefully select the type of stocks we have within our 10-stock portfolio – for example, different companies, different sectors, different leverage and growth characteristics. We have adopted a high-conviction concentrated strategy. If you have more than 10 stocks in the portfolio, you're starting to dilute the whole basis and thesis upon which you're investing, if you have a really high conviction in a number of stocks.
What does an “activist approach” mean and how does it add value?
The way we think about the activist approach is first and foremost as a “best ideas” high conviction fund, with an activist overlay. The term “activism” is very broad. I'd describe it as running from capital “A” Activism at one end of the spectrum, all the way down to lower case “a” Activism at the other end. And when investors think of activism, they typically think of capital "A" Activism – such as a big de-merger, a big sale of a part of the business, the “whizzbang” type of activism. But they don't think about the lower case "a" activism, which might be increasing the quantum of a share buyback from 5% to 10% because of the earnings accretion of that enhanced buyback size and scale; they don't think about the deployment of capital into a higher returning part of a company’s business and encouraging companies to go down that route.
There is a big spectrum of activism, and of course, there's also public and private activism, and we fully expect that in an eight or so out of 10 of our investments in our activist approach, it will never be heard of publicly, because we'll be working very constructively with the board. It's only in those rare cases where they become public that the people who actually hear about the activism, and that's typically why people only think of the capitol "A" public initiatives as what constitutes activism.
How is ESG used in the process?
We’re also very ESG-aware. We consider the E, the S, and the G whenever we consider any investment for the L1 Capital Catalyst Fund. We think where we all have a particular focus and add value is in respected the G, the governance. I think it's fair to say that when a lot of other ESG focused funds focus on the ESG, it's on the E or the S, we actually think the G is something that can materially enhance shareholder returns over the medium to long-term, and having a real focus on that. That being said, there's also clearly a heightened focus on ESG from particularly younger investors,
There are many examples offshore of activist funds that are purely ESG focused, and the recent example of Engine No. 1 investing in ExxonMobil, and actually getting three directors appointed to the board, was very illustrative of the impact that a very small investor on the register can have if they can really corral the opinions and votes of other large institutional shareholders.
How much of an activist can you really be in an equity market the size of Australia's?
The Australian market is very conducive to being an activist investor because it's a small market, through Rafi, Mark, myself, and the team members relationships, we have connectivity to most Australian corporates. We know the regulatory framework, we know the key players, we know the media, so actually having that knowledge and connectivity we think is advantageous. That said, we of course need to be very respectful of the fact that Australia is a small marketplace, and we need to have regard to the fact that there's a lot of overlap of directors, and that will very much influence the way we go about our engagement with companies.
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