It’s a fairly obvious truth in the funds management world, but not everybody wants to try it: to beat the index, you have to have a portfolio that differs from the index.
That was the philosophy behind Monash Investors, an experienced absolute-return specialist Australian equity investment manager established in 2012. The founders, Simon Shields – a former head of equities at both UBS and Colonial First State – and Shane Fitzgerald, a former senior equity analyst from UBS and JPMorgan, had no interest in comparing their investment performance to a market index, which they felt consigned an investment manager to riding the share market up and down.
Instead, Shields and Fitzgerald decided to use their stock-picking skills to simply try to produce a positive return, no matter what the market did, while trying to avoid loss in any one financial year. They set a target return of between 12–15 per cent a year after fees, over a full market cycle, which they define as five to seven years.
For that, they charge a “classic hedge fund structure,” a 1.5 per cent + GST base fee and a 20 per cent + GST performance fee, which kicks in above the Reserve Bank of Australia (RBA) cash rate. With the RBA cash rate at 175 basis points (1.75 per cent) at the moment, to the extent that on a before-fee basis First Monash Investors does better than that, it gets 20 per cent of that difference as a performance fee.
Monash Investors manages a registered managed investment scheme which was established in July 2012. The total return (capital gain plus dividends reinvested) of the S&P/ASX 300 was 10.8 per cent a year over that same time period. For the financial year ended June 30 2016, the scheme returned 13.6 per cent (after fees). The S&P/ASX300 managed a total return of only 0.9 per cent.
In April 2016 Monash Investors launched a listed investment company (LIC), the Monash Absolute Investment Company Limited (ASX code: MA1). The performance of the LIC – which holds about $50 million – in its first few months shows that pre-tax NTA (net tangible assets) value at 30 June was 96.05 cents, down 0.26 per cent since inception.
How you beat the index, in the view of Shields and Fitzgerald, is to be benchmark-unaware – as in you don’t care what the index is doing – unconcerned about how large a stock is or whether other consider it a “value” or “growth” stock, able to go long (buy) or short (sell) a stock, and only invest in what you think is a compelling opportunity. And if you can’t find anything to buy that looks compelling, you can hold up to about 40 per cent of the portfolio in cash – all things that normal Australian share funds can’t do.
“We’re looking for stocks that have very big payoffs from the current share price to our price target, or that are going to fall a lot to get to our price targets,” says Shields.
“Our return targets are absolute-focused targets, and they’re targets over the course of a year, at a minimum. We’re trying to achieve that 12–15 per cent a year after fees, over the cycle, while trying to preserve capital. We’re not worried about monthly returns, which is something that other fund managers are concerned about, because they are measured that way.
“What we’ve gone out in the market to do, requires a very different approach to most managers. It means that we look at each stock on its absolute merits, we set high absolute hurdles for each stock, because one of the ways we’re able to protect is by setting the bar high and only investing in something, long or short, if it’s a very compelling case. We also diversify, not with respect to what the benchmark looks like, but on an absolute basis. And we also run very tight stop-losses.”
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"We’re looking for stocks that have very big payoffs from the current
share price to our price target, or that are going to fall a lot to get to
our price targets,” Monash Investors, Founder and Portfolio
Manager, Simon Shields.
Shields says the portfolios they manage do not stipulate a concentrated portfolio, but it tends to work out that way. “We look at the stocks and work out what our pay-off targets are, whether there’s an event in the offing that’s going to affect the price, and depending on those two factors will determine how we treat the stocks.
“In stocks that have very high payoffs according to our targets, we tend to have weightings of around 5 per cent. So it tends to be a relatively concentrated portfolio, but we don’t target a number of stocks. If we can find the opportunities, we’ll put them in,” he says.
At the end of June Monash Investors had 20 companies in what it calls its “outlook” stocks, stocks with the most upside (or most downside, in the case of short positions) and these represented about 70 per cent of the portfolio. At the moment about 12 per cent of the portfolio is short, some around large payoffs, one in a pairs trade, one around anticipating a particular event.
Going into June 2016 the fund had a net cash weight of 36 per cent, so it was well positioned given the volatility in the markets that occurred during that month. With the fall in stocks prices as a result of Brexit, Monash Investors took the opportunity to buy stocks and ended the month with a net cash weight of 24 per cent.
“It’s nice that we could top up our holdings, but we would have had fairly significant positions anyway in our stocks – we weren’t waiting for 5 per cent–10 per cent falls,” says Shields. “But we’re looking for stocks that will do well regardless of what the stock market does. In a sense it’s less relevant to us, whether the market moves 5 per cent–10 per cent either way doesn’t really affect us in the sense of the stocks we’re looking to own, where we’re looking at payoffs that we think are 60 per cent–80 per cent. But where we’re watching something and it is suddenly 10 per cent cheaper, that’s an opportunity,” says Shields.
“We’re implementing the same investment strategy with the two investment portfolios we manage, they’re just two different ways to access it. There are slight differences to do with the fact that the LIC is a company, therefore it pays tax, and as a result when it pays distributions there is franking on those, because it has already paid tax. Likewise the LIC isn’t getting inflows and outflows every day in the same way that the unit trust is, and so those inflows and outflows into the unit trust will change the weights marginally relative to the LIC.
“We can also invest in pre-IPO (initial public offering) stocks, which can take anywhere from three months to two years to get to their liquidity event, the listing. As a result, when we were putting the LIC in place there were some unlisted stocks in the unit trust that we weren’t able to put in the LIC. They will become closer over time. That is the only significant portfolio difference.”
A good example of this ability is sports technology company Catapult, in which the unlisted fund invested nine months before the IPO, at 38 cents. Catapult listed in December 2014 at 55 cents a share: it now trades at $3.72, within a few cents of becoming a “ten-bagger” for Monash Investors.
“We like Catapult – it’s doing a capital raise at the moment. It produces wearable technology for sport teams, and it’s acquiring a video technology company. Catapult is the dominant player in its space and has extremely strong sales growth, but it is only about 8 per cent penetrated into that market, so it has a very strong outlook,” says Shields.
Other main holdings include financial services company Challenger, childcare company G8 and transaction cards specialist Emerchants.
“We’ve liked Challenger for quite some time, for us it’s a combination of the demographic pressures that are on society and government, which are encouraging people to look after their own retirement funding, and favour annuities as a result. In any case, the retirement savings market is growing very quickly and Challenger is at the forefront of annuities, where it doesn’t have much competition, and it’s actually rolling-out its products into more distribution channels. We see there are good bottom-up operational reasons why their earnings should be going well, and there are more industry reasons giving them a tailwind,” says Shields.
“G8 has been sold down quite a bit, but stable and growing earnings, quite cheap. There is risk of government funding changes, but there seems to be bipartisan support at the moment, so right now at this price, this environment, the stock appears to us to have a good outlook and a lot of upside.”
He says the company has also done well in Emerchants. “It’s got an interesting niche providing specialised transaction cards. For example, it’s made a lot of money in corporate bookmaking cards, a way that the bookmakers’ customers can get their winnings.
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1 Please refer to http://www.monashinvestors.com/maif/ for more information
