Written by Portfolio Managers
Australasian Growth Fund
The Australasian Growth Fund returned -2.7% for the month, bringing it to a 12-month return of 3.5%.
The fund underperformed in December. The principal reason for the decline related to our weight in technology stocks which came under pressure during the month as global bond yields increased. While our technology weighting has led to short-term underperformance, it also presents an opportunity to add to several core and new positions at more attractive valuations, as we seek out businesses with growth prospects that can drive material long term outperformance and strong balance sheets that can withstand short term market turbulence. The Growth portfolio continues to sell lower conviction positions and is deploying the funds into higher conviction opportunities that have arisen from the market sell-off.
Palla Pharma (ASX: PAL) was a notable and company specific detractor during the month. This has been a legacy holding which we have been selling down for several months following a number of operational disappointments. Unfortunately given poor market liquidity we were unable to fully sell our position and held a small weight in the fund when the company entered voluntary administration this month. We have subsequently marked down our holding to a likely cash liquidation value which we hope to realise in coming months. A key lesson from our experience with PAL is to sell early when operational and company related issues first arise, as more often than not the issues and investment losses compound.
Written by Mike Ross, Portfolio Manager
Australasian Dividend Growth Fund
The Dividend Growth Fund returned 4.0% for the month, bringing it to a 12-month return of 36.3%. Contributors to performance in December included Australian Clinical Labs, Macquarie Telecom and Johns Lyng Group. City Chic detracted from performance.
Johns Lyng acquired Reconstruction Experts, a leading provider of insurance focused repair services in the US. On pro forma FY21 numbers, the deal was 64% accretive to earnings-per-share (EPS). The acquisition provides a beachhead for the company’s expansion abroad and founder and CEO Scott Didier will relocate to Denver to manage the expansion. We participated in a capital raising to fund the acquisition. Post-transaction the company retains balance sheet capacity for further acquisitions.
MA Financial acquired mortgage broking group Finsure, expanding distribution capability for its lending division. We participated in a capital raising to fund the acquisition. The company also upgraded its earnings guidance for the 2021 year, with EPS now expected to exceed the upper end of its 30-40% range. Original guidance in February 2020 was for 10-20% EPS growth. MA Financial also issued 2022 guidance of 15-25% EPS growth.
Australian Clinical Labs (ASX: ACL) is the third largest provider of pathology services in Australia that listed on the ASX mid-year. We did not participate in the IPO. The company had an underwhelming start to life as a listed entity, trading below and around the issue price for some time despite significant profit upgrades, largely driven by Covid-testing volumes. Understandably, the market treated these upgrades with scepticism given a) Covid-testing volumes are temporary, b) the company had been listed by private equity which still own 35% and were perceived as sellers and c) the company had a very limited history trading profitably. We built conviction to establish a position in the company after multiple meetings with management and broader industry research that highlighted real opportunities to consolidate the market and management had culled unprofitable contracts, won new profitable contracts and invested ahead of the curve. We valued ACL significantly above the share price at the time, even with conservative Covid-testing forecasts. Since establishing the position, the share price has gained more than 40% after three recent catalysts: 1) ACL completed a highly synergistic and accretive acquisition that expands its footprint in New South Wales and Queensland, two states where it is underweight; 2) the Omicron variant has led to increased Covid-testing volumes driving upgrades to ACL’s net profit guidance to $128m, 65% above prospectus guidance; 3) private equity shareholder Crescent Capital announced it would not sell shares when released from escrow after the 1H22 results in February. Crescent noted the company was well placed to benefit from future Covid variants and a backlog of testing for other medical conditions due to the pandemic.
The half-yearly distribution of 5 cents per unit was processed on 31 December and should now show in your investor portal.
Thank you for your support in 2021.
Written by Chris Bainbridge, Head of Australasian Equities and Portfolio Manager
Australasian Emerging Companies Fund
The Australasian Emerging Companies Fund returned -0.4% for the month, bringing it to a 12-month return of 5.7%. December didn’t leave us feeling joyous this year. The prospect of tapering and tightening by the Fed combined with uncertainty around Omicron to deliver a ‘holiday cocktail’ which wasn’t what we ordered. Below we touch on 2021: what worked, what didn’t and how we’ve adapted.
Positive performers included RPMGlobal Holdings, Aussie Broadband, Cettire, and Calix. These were textbook ECF investments: off the radar companies, founder led, growing quickly in large markets and beating expectations. Pleasingly, from a process perspective, we added to a number of these names on the way up as they proved out our investment hypothesis and the risk reward improved.
Unfortunately, positives were outweighed by three factors: (1) a sharp drop in growth companies; (2) large positions which underperformed; and (3) liquidity.
Growth: Companies in technology, telco and payments exhibit the characteristics we look for (structural growth, durability, high levels of recurring revenue) and produced the bulk of winners for ECF in 2021. Unfortunately, there was no escaping the sell-off in growth stocks, even at the small end of town, with the impact being sharply felt in unprofitable companies. Unprofitable microcaps skew to the downside as they lack the valuation support, optionality and pool of investors of larger companies. We have lowered our exposure to these types of companies. At the same time, we’re selectively increasing our exposure to larger, high-quality earners caught up in the sector wide sell-off.
Position sizing: Large positions in Frontier Digital Ventures and Kip McGrath Education Centres dragged on performance. We will adjust our caps around position sizing for future investments to give ourselves more shots on goal.
Liquidity: Small, less liquid positions, proved a poor risk reward. Small companies often have dependent business models (dependent on a single product, market, or sector). Any stumble with the business combined with low levels of liquidity makes it difficult to exit these positions. Accordingly, we will adjust our market size and liquidity caps.
Looking ahead, we enter 2022 optimistic and enthusiastic. Optimistic because the positioning, sentiment and valuation of growth companies is ultra bearish. The reward for investing during such periods is significant. We’re enthusiastic because investing’s a game of cumulative knowledge and compounding advantage. You never compound faster than when you’re challenged. We’ve used the challenges of 2021 to adapt our process and believe our focus on earners, quality and execution will drive strength in 2022.
Written by Chris Bainbridge, Head of Australasian Equities and Portfolio Manager
Australasian Growth 2 Fund
The Australasian Growth 2 Fund returned -4.3% for the month, bringing it to a 12-month return of 3.6%.
Growth 2’s a concentrated growth strategy which invests in the leaders of tomorrow. We concentrate because backing our best ideas has driven strong returns. When concentration works, it works well, which is what we saw in 2019 and 2020. When it doesn’t work, performance can be challenged, which is what we experienced in 2021.
Below we touch on 2021: what worked, what didn’t and how we’ve adapted.
Positive performers included IDP Education (ASX: IEL), Uniti Group (ASX: UWL) and Imdex (ASX: IMD). These were straight out of the Pie playbook. They were emerging leaders beating expectations, turbocharged, in the case of IEL and UWL, by market catalysts such as Index inclusions. The combination of fundamental and market factors produced the twin engines of growth: earnings and multiple re-ratings.
From a process perspective, we turned the challenges of 2020 into strengths in 2021.
- We let winners run (IEL, UWL, IMD);
- We cut immediately after reducing expectations (Doctor Care Anywhere Gr (ASX: DOC), Afterpay (ASX: APT), and Nuix (ASX: NXL)); and
- We recycled capital from losers not winners (Keypath Education International (ASX: KED)).
Unfortunately, positives were outweighed by three factors in 2021: (1) a sharp drop in growth stocks; (2) quality; and (3) execution.
Growth: Companies in technology, telco and payments exhibit the characteristics we look for (structural growth, durability, high levels of recurring revenue). Unfortunately, growth companies in the technology and payment space came under pressure in 2021 with a sharp bifurcation between profitable and unprofitable stocks. Sentiment to high growth companies has flipped to ultra bearish, depressing multiples to levels last seen in March 2020. The reward for investing during such periods is significant. Rotations require resilience but they’re generally short and sharp. We’re selectively increasing our exposure to high-quality earners in the space and we’re confident our resilience will be rewarded.
Quality: Our quality filter worked like a WhatsApp call, dropping out intermittently. This resulted in us: (1) overpaying (Whispir); and (2) participating in IPOs we shouldn’t have (DOC, KED, NXL). Expectations of the durability of revenue and earnings drives multiples. We’ve honed our quality filter with a stringent focus on durability and the productivity ratio. (continued over page)
Execution: In 2021 we made the mistake of adding to positions which weren’t working (EML Payments and Nearmap). We did so for two reasons: (1) we considered the events to be ‘external’ (regulatory review/litigation by a competitor); and (2) valuation. Unfortunately, external events quickly have internal impacts (higher compliance costs/class actions) and doubling down on valuation doesn’t work. Value is like gunpowder, you need a catalyst to set it off. Large positions which aren’t working over-index on capital and mindshare. They create a negative feedback loop as the capital and energy aren’t allocated to finding the next winner. Moving forward, doubling down will only occur on the basis of a pre-identified catalyst. Our goal is to maximise IRR (returns) not TSR (being ‘right’).
Intense persistence is the price of excellence and we’re constantly pressing to get better. We’ve adapted our process to turn the challenges of 2021 into strengths of 2022 and remain focused on doubling down on our playbook for what works. Looking into 2022, we’re optimistic for two reasons: 1) fundamentally our companies are firing; and (2) time is the friend of growth companies. When they’re not going up, they’re just getting cheaper.
Information is current as at 31 December 2021. Pie Funds Management Limited is the manager of the funds in the Pie Funds Management Scheme. Any advice is given by Pie Funds Management Limited and is general only. Our advice relates only to the specific financial products mentioned and does not account for personal circumstances or financial goals. Please see a financial adviser for tailored advice. You may have to pay product or other fees, like brokerage, if you act on any advice. As manager of the Pie Funds Management Scheme investment funds, we receive fees determined by your balance and we benefit financially if you invest in our products. We manage this conflict of interest via an internal compliance framework designed to help us meet our duties to you. For information about how we can help you, our duties and complaint process and how disputes can be resolved, or to see our product disclosure statement, please visit www.piefunds.co.nz. Please let us know if you would like a hard copy of this disclosure information. Past performance is not a guarantee of future returns. Returns can be negative as well as positive and returns over different periods may vary.