Neuberger Berman Global Corporate Income Trust

We have highlighted on many previous occasions, the extraordinarily low interest rates around the world are forcing investors to take on more risk just to sustain (rather than grow) their income each year. Now, this is all well and good if these investors have undertaken due  diligence  and understand what it is they are investing in. Unfortunately, this isn’t always the case.

As independent financial advisers, we are regularly approached by any number of fund managers seeking to distribute their latest  product  to as many people as possible. Listed investment companies have been increasing popular in recent months, with the sector doubling since 2014 due primarily to the fat commissions they offer financial advisers for recommending their products. The obvious  risk  in  this instance is that it is not unlike what occurred with the likes of Timbercorp and Great Southern, that many revenue driven advisers shirk the need for due diligence and focus simply on the commission they will receive. Interestingly, with the move to discretionary managed accounts, the investor may not even know they hold the product until well after the fact.

Of course, we aren’t saying that all listed investment companies are justified solely by their commissions, but that it’s important to understand what it is your investing in.

With this mind, we wanted  to  take a closer look at the very popular Neuberger  Berman Global Corporate Income Trust. Incredibly, despite the fund manager and strategy having no previous exposure to the Australian sharemarket, they were able to raise close to $1bn from investors. The fund was distributed by an extensive list of brokers, joint leader managers and ‘co-managers’ including Evans Dixon, Morgan’s, National Australia Bank, Ord Minnett, Bell Potter, Paterson’s, Shaw and Partners and Wilson’s. The fund was also marketed heavily by Peter Switzer’s media business and conference program.

We have broken our analysis down into a few simple sections:

Who is Neuberger?

Neuberger is a New York based fund manager with expertise  across most sectors of the market including equities, fixed income and alternatives. They were established in 1939 and have over $455bn under management globally with closer to $7bn under management in Australia, primarily with institutions. It’s important that investors do not confuse size with security, as whilst the manager itself is extremely successful and  huge by Australian standards, they do not control the performance of the underlying investments.

What is the fund?

The Corporate  Income  Fund  is  a specialist income focused fund that invests solely into senior bonds issued by global listed companies. This includes secured and unsecured senior debt which are both positioned at the top of the capital structure and first in line in the event that an issuer defaults on their obligations or moved into bankruptcy. The fund targets an annual income of 5.25% delivered monthly through regularly distributions and to complement this through active management and  investment  selection  with   an absolute positive return the secondary aim. The fund is run by one of the largest non-investment grade fixed income teams in the world, with over 50 dedicated staff.

What does it invest in?

The fund is managed according to a number of overriding allocation restrictions with the primary one being an asset allocation of 60% to the US, 20% to Europe and 20% to emerging markets. Management aim to hold between 250 to 350 individual bonds with an external rating by one of the majors of BB or B. The underlying portfolio is heavily diversified, which in some instances would be considered as   a way to reduce the risk of yourThe Corporate Income Fund invests into what is commonly referred to as ‘junk bonds’, ‘high yield’ bonds or unrated credit. At present, the portfolio holds less than 1% in what are considered investment grade bonds, with a rating above BBB with the remainder allocated as follows:

The fund is managed according to a number of overriding allocation restrictions with the primary one being an asset allocation of 60% to the US, 20% to Europe and 20% to emerging markets. Management aim to hold between 250 to 350 individual bonds with an external rating by one of the majors of BB or B. The underlying portfolio is heavily diversified, which in some instances would be considered as   a way to reduce the risk of your investment. The geographic and sector allocations are as follows:

Thus far, the fund has delivered on its objectives, delivering a  return of 6.63% since inception including an income of 4.74%. The fund  has, however, only been operating since   September   2018, which is an extremely short period of performance to review.

What are the risks?

In our view, the risks of this investment are substantially higher than many of both its investors and the financial planners who recommended it truly understand. The fund invests into fixed rate, senior bonds, issued by institutions that fall many rungs below the likes of the Commonwealth Bank on the credit ratings scale. For instance, the largest current holding is Petrobras bond, lending money to the Government-backed Brazilian gas and oil producer. Being fixed rate securities, the entire portfolio is subject to the risk that prevailing interest rates, primarily in the US, begin to rise once again, whether due to inflation or a stronger economy, resulting in a reducing value of these bonds and potentially a capital loss on the investment.

More importantly, however, investors are exposed to an immensely higher risk of default on the loans made through this fund than through  the likes of a Bond  Fund  issued  by PIMCO or Schroder’s. Yet the managers are extremely clear with this fact in all their publications reporting that essentially none of the underlying investments would pass the investment grade requirement. This represents a substantial  risk  to investors for many reasons, but primarily, the risk of default is substantially higher. The bottom right table shows the probability of default for various bonds rated by market-leader Standard and Poor’s (S&P) over many decades. As you can see, the CCC rated bonds, with makeup  11% of fund today,  have  a 26% probability of defaulting in the first year of their issue, which increased to 50% (yes 50%) after just 8 more years. The trend improves as you move into B rated  bonds that make up 45% of the portfolio, but at 13% after three years, this is substantially higher than the .08% probability of one of Australia’s banks going bankrupt.

Of course, this is all well and good if the investor is aware of the risk and secondly, comfortable with the level of volatility that may be ahead. The managers rely on a substantial amount of diversification to reduce the impact of any one issuer defaulting, however, in many cases this sector of  the  bond  markets  is already highly leveraged. For instance, the largest exposures are to cyclical or struggling sectors including energy, basic industry and media all of which are being disrupted on a daily basis and potentially entering a structural decline. The threat of higher interest rates isn’t limited to the value of the fixed rate bonds, but the viability of the companies issuing them in an increasing competitive environment.

Our View

Be careful what you wish for. To  be honest, we don’t believe an investment of this risk level is suited to the majority of superannuants, pensions and mum and dad investors that make up its share register. The fund was opportunistically listed at a time when Australian investors were seeking alternatives to fully franked dividends under the threat of a Labor Government; to this we say well done. The managers were able to leverage off  this  concern to raise close to $1bn in ‘forever capital’. If you were not aware, the benefit of an LIC or LIT (listed investment trust) for managers is that the capital raised will remain forever, there are no redemptions or purchases, the units are simply traded on the stock exchange. So Neuberger have effectively locked in 0.85% of management fees on $1bn in perpetuity.

We believe this type of strategy may be appropriate for large institutions seeking to complement high quality Government bonds or cash balances with a small allocation to unrated bonds and who have sufficient capital to offset any losses as they occur. We do not, however, believe the strategy is particularly suited to the conditions in which the global economy currently finds itself. An investment in junk bonds is generally best made when interest rates are high and falling, as this provides both earnings and valuation tailwinds. With the launch of this fund in Australia coming towards the obvious end of a 10 year bull market and with US rates increasing, the timing in our view is questionable. The largest issuers in this sector have and will remain companies under pressure, as few others are willing to lend to them. Whilst these may be large companies by Australian terms, the pitch presentation relied upon a comparison of the ‘median’ revenue of these companies being $7.67bn versus the ASX 200  of just $1.41bn, this comparison is irrelevant given Australia represents just 2% of global sharemarkets and it’s the quality of the underlying businesses that matter most.

One of the less considered risks of this LIT is that many of the underlying bonds that form this portfolio, whether in smaller US companies, or emerging markets, are substantially less liquid than traditional bond markets and in many cases are traded over the counter rather than on a listed exchange. We have always been wary of investment strategies offering investors exposure to less liquid investments via highly liquid structures like listed shares.

In conclusion, we believe this strategy has no merit and the 5.25% promised monthly income is not sufficient to offset the substantially higher risks of default.

The Wattle Watch

In any given month, Wattle Partners meets with many different professionals offering a new investment product, idea or scheme. Most are a pass from us, but now and again some pique our interest. 

It was a busy few weeks for the Investment Committee with a number of interesting managers presenting in the Wattle Partners office. We will cover these in future issues but one particular highlight came from Sanaka Capital.

Sanaka Capital is a specialist Indian private equity player run by Shankar Narayanan, who spent many years at global private equity giant Carlyle. He has extensive experience on the ground in India and has acted as CEO of many investee companies over several decades.

The fund is seeking to raise USD$500m for a 10 year investment period with most companies falling in the small and mid-cap size range. They plan to invest a minimum of $10m in each company and are targeting the highest growth but somewhat defensive themes including consumer staples, financial services, healthcare, manufacturing and chemicals.

The strategy will focus on investing into companies with a track record of profitability, rather than loss makers, and which are servicing niche sectors of the economy where 75-100% of the fund will be invested. They will be encouraged to use the capital and expertise of the manager to expand into under serviced areas of India that offer both community and investment benefits.

India remains one of the highest growth economies in the world, expected to grow at 7.8% in 2019, after increasing 7.4% in 2018 and is quickly undergoing a huge transformation under a re-elected Modi Government. India is the youngest large economy in the world, the number two population online internet users at 462m and the number two producer of fruit’s and vegetables.

Management noted the major reasons behind each sector as follows:

  • Consumer – favourable demographics, rising income levels, growing awareness, improving access and a shift to branded goods.
  • Healthcare – increasing life expectancy, rise in chronic diseases, increasing insurance penetration and medical tourism.
  • Financial services – economic growth, high savings rate and increasing need for credit and savings account;
  • Technology – skilled english speaking workforce, highly qualified talent pool with signficant scale potential;
  • Manufacturing – huge semi-skilled labour force, Made in India initiative, and a quality engineering and technical talent pool.

The fund typically targets investment opportunities that have the ability to deliver annualised returns exceeding 30% per year over the 3 to 5 year investment periods. The managers charge a standard private equity fee of 2% for annual managemet and 20% of outperformance over 8%. This fund typically requires a minimum investment of $1m but is accessible exclusively through Wattle Partners at substantially lower levels.

Antipodes Global Fund

What’s the fund?

This month we are taking a closer look at the Antipodes Global Fund. The fund is an unconstrained, long-short global share fund that seeks to generate positive returns above it’s benchmark in all market conditions. The management team define themselves as being pragmatic value in that they seek both traditional deep value companies as well as growth companies being mis-priced by the market.

Antipodes was founded in 1 July 2015 by the Portfolio Manager and CIO, Jacob Mitchell. Jacob was previously the deputy to Kerr Neilson at Platinum Asset Management, where he spent 14 of his 22 years of experience. Jacob is supported by Graham Hay (23 years’ experience) and Andrew Baud (15 years). Staff own 76% of Antipodes with the remainder held by Pinnacle Investments, their administration and marketing partner.

They implement a fundamental value focus to analyzing companies and operate in a niche within global markets; being the identification of underappreciated companies in the midst of structural change. Their view is that markets have a tendency for ‘irrational extrapolation’, or pricing in the current circumstances in perpetuity, which presents opportunities on both the long and short side through patient, fundamental research.

Where does it fit in your portfolio?

The Antipodes Fund fits the requirements of the Thematic Bucket as its underlying investment philosophy is to identify investments based on broad ‘cluster’ or global ‘themes’. These can be societal, sectoral or country specific, but all are focused on purchasing an undervalued company that will benefit from substantial earnings growth.

At present, they believe that US domestic companies and global developed market defensives (like infrastructure and utilities) are expensive compared to their trend and therefore ripe for a correction. They believe that European, Japanese and Korean domestic sectors are comparatively more attractive and offer a greater margin of safety. Further, they have an increasing exposure to Chinese technology and related businesses that have been sold off due to the trade war as well as industrial conglomerates throughout the world undergoing much needed transformation.

Why invest?

During Jacob’s previous tenure, he was able to achieve excess returns of 5.7% per annum over the benchmark in the Platinum Unhedged Fund and 9.9% in the Platinum Japan Fund, over the last 7 years. It is this time spent focusing on the Japanese and Asian markets that we believe warrants investing into Antipodes over the alternatives, as we believe Asia will be the growth driver for the global economy in the years ahead but is generally underrepresented in managed fund portfolios. The fund has grown from inception to around $6.5bn under management in 2019 reflecting the strength of their investment process.

We prefer the Antipodes Fund because we believe the opportunities available offshore are more attractive than those in Australia and the value-oriented approach implemented by the managers will complement well with the growth focus of the other international managers. The Antipodes team have a great deal of experience investing throughout Asia, including China, India, Hong Kong, Japan and Korea, which results in a natural bias of this fund towards the East. The importance of Asia is continuing to grow as the centre of financial markets gravitates towards China. We believe Antipodes is the Australian manager best placed to provide outsized returns from this transition and that this will provide substantial diversification.

What does it invest in?

The fund is high conviction, expected to hold between 30 and 60 individual companies, has a focus on capital preservation and the requirement for a ’margin of safety’ in all investments. They also take an active approach to managing currency, understanding that obvious under and overvaluations can be used to boost returns over the long-term.

The fund has a highly diversified portfolio and varies substantially from the MSCI Index which holds around 60% in US equities. The current geographic exposure is as follows:

Importantly, the funds net exposure, which is the combination of their long positions less their short positions, is just 63%.

The largest current holdings are similarly spread across the globe with five highlights being:

  • Facebook: They were attracted to Facebook’s underwhelming valuation following the anti-trust and privacy issues that arose in 2018 and remain focused on the huge usage growth that continues to deliver on each of Facebook’s platforms. Most importantly, they highlight that Facebook has stopped thinking about ‘safety’ and is once again embarking on major innovation projects including e-commerce, digital currency which should lead to further monetization.
  • Siemens: Antipodes see value in Siemens recent change in strategy. The company spent many years dragging down European indices as management sought to acquire every business possible but struggled to combine disparate units in a profitable way. Due to investor pressure the company is now simplifying and releasing substantial value to investors, with the sale of its European power assets a particularly positive decision. The company continues to hold strong positions in important sectors like automation hardware and software which they believe are undervalued.
  • Samsung: Samsung fits into the computing/connectivity bucket in the portfolio due to its substantial operations in manufacturing semi-conductors, batteries and flash memory for the likes of Apple, Sony and Nokia. Antipodes believe the company was oversold due to macro issues like the trade war and the complex generational ownership transfer occurring in Korea. They see substantial value in the operating business, supported by strong demand from key customers whilst the modernization of Korea will see increasing dividends and shareholder returns via buyback.
  • Alibaba: Alibaba is an incredible business, being the dominant business to business and business to consumer e-commerce provider in China. The company operates the successful T-Mall and Tao Bao sites among many other businesses. Alibaba was established as an online version of the wholesale markets that occur all over China and has successfully evolved numerous times in the face of increasing competition from outside and within China. The company’s investment in Ant Financial which dominates the online payment landscape in China, offers further upside as it continues to expand into investment, insurance, credit and other financial products.
  • Tesla: Tesla is a high profile short of Antipodes selected on the basis that the company has been over hyped as a ‘disruptor’ and will have little chance of delivering on inflated expectations. This position has been profitable and is expected to generate further returns as the likes of BMW and Mercedes-Benz launch much anticipated electric models in the coming months.

How has it performed?

The short-term performance has been weak adding just 2.6% over the 12 months to 30  June but long-term returns are solid at 10.5% per annum since inception, slightly above the benchmark. The fund’s weak short-term performance has been due to an overweighting to Chinese and other Asian technology companies which fall within the Connectivity / Compute and Online services clusters, but which have been hit by the US-China trade escalations. The Software investment, including Microsoft, and simplifying Industrial Conglomerates like Siemens added to returns. Importantly, this is a long-short fund which has carried substantially less exposure to the market, at just 60%, meaning the returns have been delivered at lower volatility and risk.

What income does it provide?

As with all managed funds, the Antipodes Global Fund must distribute all income and realised capital gains each year. Therefore, distributions are dependent on both the performance of the underlying investments and whether any investments are actually sold. As an actively managed strategy the fund receives minimal dividends and the majority of returns come in the form of capital growth and realised gains. The distributions since inception in 2015 are as follows and have averaged around 4% per annum with the intention to be paid semi-annually:

  • 2015-16 – 3.16 cents per unit (2.33%)
  • 2016-17 – 2.18 cent per unit (1.35%)
  • 2017-18 – 9.24 cents per unit (5.37%)
  • 2018-19 – 9.04 cents per unit (5.42%)

A golden era for active managers is coming

By Russel Pillemer, Pengana Capital

“It is not a stretch to imagine the next 10 years will be a golden age for Australian active managers”.

The constant barrage of reports about the demise of the active fund manager is relentless. The average investor might conclude the age of active is over and it’s time to switch to low cost index-type solutions. However, more informed investors understand nothing could be further from the truth.

The coming years are likely to be a golden era for active managers. It is highly improbable the next decade will be a repeat of the last decade’s smooth sailing. Over the past 10 years, markets have experienced an incredible run with indices soaring. Momentum has been a key driver, and in times like these, fundamentals hardly matter, leading active managers to struggle to outperform.

There were many active managers who were, in reality, closet index managers. As the cost of index funds has decreased significantly, many of these managers have lost clients and been forced to close – and rightfully so.

Meanwhile, there has been a proliferation of active, with many raising too much money. It’s a well understood phenomena that if a fund manager manages too much money (relative to the size of their market) they will be unable to perform well.

Asset gatherers are insufficiently incentivised to outperform.

Many of the large Australian institutional investors withdrew from active managers and moved to index funds. Either they consider low fees to be their primary objective (with returns being a distant second), or alternatively they have defined risk as the divergence of returns from the index, rather than the risk of losing capital. This reasoning makes sense in a bull market, where index products have outperformed high-cost active strategies. However, it is patently obvious this is nonsensical in a sideways or downwards market.

It is not a stretch to imagine the next 10 years will be a golden age for Australian active managers.

Due to the large number of closures and losses of mandates, there is far less competition for fundamental trades. This is particularly significant for small and mid-cap companies, which includes almost all of the Australian market.

And passive index-style strategies are ideal counterparties for active managers who can identify mis-pricing opportunities that index strategies create by virtue of their “dumb” trading rules.

Survive and thrive

The index trade is overcrowded. We know this as so many investors have capitulated and moved to index-type solutions. But history teaches us that overcrowded trades will inevitably unwind. Finally, active managers tend to thrive in volatile markets – and while it would be foolish to attempt to predict the direction of the markets over the next decade, it is reasonable to assume that volatility will be higher.

Investors need to identify active managers that are well-positioned to survive and thrive.

Look for highly skilled teams or individuals with substantial experience and proven track records. Ensure they have stuck to their guns and not surrendered their investment style to pressures emanating from the extended bull market. A credible manager will construct their strategies with an interest in downside protection and limit the amount of money they are willing to accept. I would add that such a manager defines risk as in “the risk of losing money” not “the risk of divergence from the market return”.

Good fund managers should be backed by appropriately resourced businesses so they are not faced with existential risks or operational complexity. Critically, they should not be hostage to large institutional investors who pose undue concentration risks. While the investing masses are piling into low-cost index-type solutions, the smart money is seeking alternative managers with the above attributes.

These intelligent investors are predicting a very different decade ahead and focused on securing allocations in expert managers. Investors who are doing this are likely to be handsomely rewarded over the coming years. Investors who are opting for low-cost solutions will inevitably realise the cheap lunch is likely to cost them dearly.

Pinebridge Global Dynamic Asset Allocation Fund

What’s the fund?

This month we are taking a closer look at the Pinebridge Global Dynamic Asset Allocation Fund. The fund is a multi-asset strategy that was originally established to manage the assets of the AIG insurance statutory fund. Statutory funds are similar to a typical pension fund in that they are required to generate consistent returns to meet the regular drawdowns that result from insurance claims. The fund targets a return of CPI + 5.00% per annum regardless of market returns and achieves this by focusing on asset allocation rather than investment selection.

The strategy is quite straightforward in that the 20-strong multi-asset team of $50bn work constantly to determine the risk and return outlook for every asset class in the world. The multi-asset team understand that economic trends in the short (within 12 months) and long-term (over 5 years) are incredibly difficult to predict. In their experience, the greatest level of certainty and actionable trends falls in the medium term, 2-3 years; as a result, they focus their analysis on building a model of economic inputs and review this quarterly. These expectations form the basis of forecast returns for all major asset classes (in the form of a Capital Markets Line) and underlying sectors of the economy. The results are plotting against each other at which point the management team allocate capital to the most attractive sectors on a risk to reward basis.

Where does it fit in your portfolio?

The Pinebridge Global Dynamic Asset Allocation Fund (GDAAF) targets a return of CPI + 5.00% over rolling three-year periods. This meets the return requirement of the Targeted Return Bucket. Importantly, the funds mandate is to deliver this whilst exposing the portfolio to two thirds the volatility of equity markets and through a highly diversified selection of assets. The fund reduces risks by investing into a series of exchange traded funds (ETFs), external and internal managed funds in order to gain its exposure to the various sectors of global markets. The strategy has outperformed its benchmark over the very long-term and most importantly been able to restrict losses during all major market events. Given the fund has a target of 2/3rds the volatility of sharemarkets, this is one of the more growth oriented Targeted Return strategies, meaning it complements well with the lower risk Smarter Money and Invesco funds.

Why invest?

Extensive research has shown that asset allocation drives a large portion of long-term returns and importantly, that simply maintaining the same asset allocation over time is not sufficient to deliver on the typical CPI + 4.0% objective of most investors and pension funds. In fact, research by Dalbar Inc. found that in order to generate this return over extended period and in different conditions, an investor would need to hold 100% equities at some times and 100% bonds at others. Obviously, this is extremely difficult to implement.

We are more concerned that the 30 year compression in bond rates will come to an end soon and that the historic levels of Quantitative Easing may have brought forward sharemarket returns for the next decade. We have undertaken substantial research in order to identify the asset classes that are able to protect your portfolio in what we believe will be either sustained low bond rates or a rising bond rate environment; both scenarios are not great for equity investors. We came to the conclusion that applying a more dynamic approach to asset allocation; that seeks to benefit from medium term opportunities offers the best potential to achieve this.

What does it invest in?

As detailed above, the fund invests into a combination of ETF’s and managed funds both internally managed by different parts of the Pinebridge team or those offered by external managers; the key being the team has more time to focus on value adding asset allocation decisions. The largest holdings at the current time are as follows:

  • Productivity Basket: The Productivity Basket was established by Pinebridge to capture the huge increase in investment that was expected and continues to occur around the world. Their research highlighted substantial underinvestment by business and sought to build an active portfolio of exposures to this important growth sector of the global economy. The underlying allocations are as follows:

 

  • US Small Cap Equity: Pinebridge have a generally positive view for the US economy believing that fiscal and monetary conditions facilitate a further extension of the cycle and that the current slowdown in economic data will be short-lived. The result is that their Capital Markets Line suggests US smaller companies offer greater risk adjusted returns due to the higher exposure to the true US economy and substantially cheaper valuations than the mega cap S&P 500 constituents.

 

  • US Government Bonds: The fund has increased its exposure to US Government Bonds from 5.5% to 8.6% during the quarter as they grew more confident in the prospect of rate cuts to stimulate the economy and believe that the large amount of Government debt necessitates lower rates for longer. This has added protection for investors in periods of volatility.

 

  • Japan Equity: Management have a long-held view of two things in Japan; 1) Abenomics will continue for the foreseeable future and eventually be successful in stimulating growth; 2) Japanese companies would become more shareholder focused. The combination has performed well for investors, with many Japanese indices now focused on the Return on Equity and cash returned to shareholders rather than on reinvestment of profits.

 

  • Indian Equity: Pinebridge’s global network means they have in-country analysis teams in most important markets, with India a case in point. The team in India have delivered one of the best performing domestic equity funds in the world and were able to successfully foresee the implications of Modi’s run to Government and subsequent reform agenda to the benefit of investors. This offers a differentiating point and an exposure that is very difficult for investors to access.

How has it performed?

Pinebridge has successfully navigated the worst market events over the last 20 years via its conviction to its asset allocation approach. This affords management the ability to increase cash, bond and other fixed interest weightings when the Capital Markets Line suggests they offer better risk-adjusted returns. Importantly, their models suggested this was the case prior to both the Dot Com Bubble and the Global Financial Crisis, triggering a substantial move into low risk assets at just the right time.  

The fund has only been available to retail investors in Australia since 2015, but the wholesale class has returned 6.94% since inception with $1.43bn under management here. This is in line with the CPI + 5% benchmark but delivered with substantially lower volatility. Shorter term performance has been weaker, due to the higher growth allocation to the Productivity Basket with a 3.07% return for the 12 months to 30 June.

What income does it provide?

As with all managed funds, the Pinebridge Global Dynamic Asset Allocation Fund must distribute all income and realised capital gains each year. Therefore, distributions are dependent on both the performance of the underlying investments and whether any investments are actually sold. As an actively managed strategy the fund receives minimal dividends and the majority of returns come in the form of capital growth and realised gains. The distributions since inception in 2015 are as follows and have averaged around 5% per annum with the intention to be paid semi-annually:

  • 2014-15 – 4.93 cent per unit
  • 2015-16 – .03 cents per unit
  • 2016-17 – 5.84 cents per unit
  • 2017-18 – 5.04 cents per unit

Importantly for investors, the fund provides daily liquidity and charges a management expense ratio of 1.00%.

Fallen Angels iSentia

We may be wired differently to the rest, but when we see companies fall by 20% or more in a day out interest is automatically piqued. Whether it is the need to search for a discount, or something contrarian in our blood, we tend to see value in these ‘fallen angels’. And with interest rates at an all-time low, markets and most importantly individual companies trading at stretched valuations, there seem to be more and more of these every month. This month we take a look at media monitoring battler, iSentia, whose share price has fallen 70% in the last 12 months and closer to 90% over the last few years.

Who is iSentia?

iSentia operates in an extremely competitive sector, being media-monitoring, advertising and brand management. The sector is that cut throat that iSentia instigating legal proceedings against one of their main competitors in 2018 after learning they were piggy packing off their own site without paying for the service.

iSentia was established in 1982 and is the original ‘newspaper clipping’ business in Australia. In its beginnings the company would physically collate important information about various companies from a variety of sources and deliver this to them on a regular basis to guide marketing, advertising and business decisions. To this day, the business is essentially the same, with the main difference being that the content must be delivered in real-time.

In 2019, iSentia offers a software-as-a-service (SaaS) platform that is easily scaleable and able to collate content from 5,500 mainstream media outlets, 55,500 online news sources and 3.4m user generated sources from around the world. The business is capital-lite in that new clients can easily be added to the platform without additional expenditure, adding quickly to cash flow and boosting profits. The company has a strong competitive position, with the most extensive database of sources and years preparing value added services that it hopes to upsell to clients.

What happened?

After listing in 2014 valued at some $700m, iSentia is today worth just $50m; hence the recent talk of the business being taken private once again. It has been a swift fall from grace that boils down to a few things, but primarily the disastrous acquisition of King Content for $48m and an inability of management to change the direction of their business as the needs of their customers and the markets changed.

iSentia was a willing acquirer of many business before and after its eventual listing with the purchase of King Content, a content marketing agency, meant to be the one that took it to another level. The company was focused on producing content of questionable quality for businesses in Australia and helping them market this in order to attract new customers. By all reports the company was a leader in its industry but relied upon a heavy sales culture to build revenue and find new customers.

It seems the greater issue with iSentia was its inability to adjust to the entrance of a key competitor in Meltwater and change the way it did business. The industry was quickly moving to a more templated subscription approach to media monitoring and not one of custom, tailored reports that had for so long driven iSentia’s dominant market position. It appears to have simply taken too long for management to adjust to the new normal and combined with King Content resulted in four successive profit downgrades in 2018. The company was recently removed from the All Ordinaries such has been the level of poor performance.

Financials

The companies financials aren’t in bad shape given the share price movement. Most importantly the group only carries $41.1m in debt, which it has extended and continues to repay with positive cash flow. The covenants remain well out of sight, at 3x leverage and interest cover, with the company well ahead at 1.5x and 12.3x respectively. Recent guidance for revenue of $120m in FY 19 appears on track after the company delivered $62.2m in revenue for the first half, a fall of 7.2% on the previous year. The issue, however, was the NPAT loss of $22.1m resulting from the $22.3m writedown of goodwill on the King Content and other acquisitions. The company remains heavily reliant on the Australian market ($44.7m revenue) with the Asian market the new focus of management ($17.5m).

Our View

What if we told you there was a company with 90% market share in its core domestic market, had the most extensive data base of news sources, serviced 5,000 clients and operated in a sector that is now considered by most business as non-discretionary spending. Sounds good right?

We think it may have some value but is not for the faint hearted. Media monitoring is incredibly important for businesses both small and large, as it is one of the only ways to collate an extensive amount of data and news without employing a dedicated staff member to do so. iSentia allows companies to manager their brand, understand what people are thinking about them and to deploy specifically targeted advertising campaigns that increase the return on their marketing investment. Yet the business has moved from bad to worse.

After announcing a new CEO in August 2018 the company appears to be on the improve, however, the full year results will tell us the real story. According to recent reports, the group is more sales and quality focused than before and better prepared for the continued cost cutting within the industry. At 90% market share of a $100m market in Australia, the company is obviously good at what they do, however, there real opportunity is in Asia, where they are still struggling to break in to the $400m revenue market. The new CEO has doubled down on their Asian expansion as well as refocusing and simplifying their business and re-engineering legacy systems that had been costing clients and staff time and money.

They continue to move into the modern age with the graphic below showing where iSentia have been stuck and where they need to be. Advertising and brand management now needs to be proactive, not reactive, and social media is as if not more important than traditional media sources.

The opportunities for iSentia appear to be in two areas, the aforementioned expansion and investment in Asia, as well as the cost cutting and innovation within their platform. They have been focused on automating key parts of their service delivery including daily updates and other templated reports but need to justify the spend in comparison to lower cost tools like Google.

At this point, just 25% of their clients utilise Value Added Services, something that needs to be improved. Management are focused on tripling the number of products they offer and servicing clients better to ensure their 79% recurring revenue continues. The company is a high risk one, but an interesting deep value opportunity in the small cap space. They are five times larger than their main competitor, have an excellent system and 28% of revenue in their growing Asian market. One for the watchlist.

Munro Global Growth Fund

What’s the fund?

This month we decided to review the Munro Global Growth Fund, which was established in August 2016 by Nick Griffin. Nick was formerly of K2 Asset Management where he had been running a similar strategy and delivered an average return of 16.5% for the international share portfolio he managed.

Munro is a global equity long-short fund that is focused on identifying secular trends occurring across the global and investing into a portfolio of 30-50 exposed companies. The fund targets double digit returns in all markets, which it believes is possible by investing into those sectors growing faster than the economy in general. Most importantly, Munro has a focus on capital protection which it delivers through its shorting and stop loss policies.

Many clients of Wattle Partners were early investors in this fund, receiving a substantial management fee discount at the time (from 1.35% to 1.00%), and it has since grown to around $1bn as Nick’s skill and competitive advantage becomes obvious.

Where does it fit in your portfolio?

The Munro fund sits within the Thematic Bucket of portfolios due to its sole focus on identifying companies that are capable of growing earnings in an increasingly uncertain global economy. Munro aim to achieve this by applying a thematic or secular approach to analyzing investments whereby they break down their entire universe of global companies into ‘Areas of Interest’ or sub-sectors which offer the greatest leverage to their identified themes. These themes change regularly but have recently been focused around the following:

  • The Digital Enterprise (e.g. Microsoft);
  • E-Commerce (Amazon);
  • Emerging Consumer;
  • Internet Disruption (Google) ;
  • Digital Payments (Pay Pal);
  • Innovative Health (Danaher);
  • Connectivity (Keysight Technologies);
  • Food Revolution (IFF);
  • Infrastructure (United Rentals); and
  • Security (Cisco).

The entire premise of the Thematic Bucket is to expose your portfolio to the themes and sectors that will generate the greatest risk-adjusted returns in the decades rather than months ahead. Munro fits the objectives of the bucket due to Nick Griffin’s proven skill in identifying trends occurring around the world, that saw the fund hold Amazon, Netflix and Alphabet sometime before they became common in Australian share portfolios.

The fund’s exposure and Nick’s competitive advantage is generally within the technology sector, as evidenced by the areas of interest, and therefore complements well with the other investments within the Bucket that are more consumer focused. Importantly, the fund can take both long and short positions, meaning investment ideas that do not pass the due diligence process and are identified as being expensive can be short sold to profit investors.

What does it invest in?

The fund is well diversified, with the largest holding typically between 5% and 7% of the portfolio and a minimum of 30 positions at any given time. The technology and disruption focus of the fund means it is tilted towards the US, with the current geographic allocation as follows:

Of particular interest to investors concerned about the prospects of volatility, is the fact that the fund currently has around 40% in cash following the sale of a number of positions in the lead up to the end of financial year. The managers note that the cash holdings isn’t based on a macroeconomic view but a result of a lack of appropriate opportunities. Sector wise, the fund is overweight technology as you would appreciate, with consumer related businesses and financial services the next largest holdings.

As the Australian currency moves towards long-term lows, it’s worth pointing out that the fund is actively hedged and reports the movement in currency separately to its investment performance for full transparency.

What are the major holdings?

The major holdings of the fund are well spread, including many well-known and popular names. We discuss five of the top holdings below.

Alphabet (Formerly Google): The fund has a long-standing position in Alphabet on the basis that online advertising and in particular advertising on mobile platforms is growing at a substantially faster rate than traditional forms of media. Within this market Google and Facebook along with it are attracting a substantially higher proportion of advertising spend. Munro noted that they found the recent sell off on the back of revenue growth of only 17%, compared to 20% in recent years, bemusing and see substantial value if the company is eventually broken up. They believe the 17x forward price earnings multiple does not reflect the value of Waymo, Google Cloud or YouTube.

Alibaba: Alibaba is an incredible business, being the dominant business to business and business to consumer e-commerce provider in China. The company operates the successful T-Mall and Tao Bao sites among many other businesses. Alibaba was established as an online version of the wholesale markets that occur all over China and has successfully evolved numerous times in the face of increasing competition from outside and within China. The company’s investment in Ant Financial which dominates the online payment landscape in China, offers further upside as it continues to expand into investment, insurance, credit and other financial products.

Amazon: The company speaks for itself in creating one of the richest men in the world in Jeff Bezos. What started as an online bookstore has become an e-commerce behemoth spanning every aspect of the vertical business. Amazon continues to expand its core product overseas and is attracting a larger and larger portion of online sales due to its extensive selection, low prices and extremely efficient procurement technology. The company has expanded into many different business lines, including Audible the audiobook subscription service, Whole Food Markets, where it is seeking to disrupt the traditional grocery store through automation and most importantly, Amazon Web Services which offers cloud support for businesses.

Beyond Meat: Whilst not a large holding, the investment in Beyond Meat was worth mentioning given the success of this company on listing. The company which retails plant based burgers and meat substitutes is exposed to the fast growing vegetarian and vegan food markets and after listing at just $25 is now valued at $140 per share.

Other large holdings include Microsoft, Adobe, United Rentals and ITV.

How has it performed?

The fund performed extremely well in its first 18 months of operation, delivering returns exceeding the benchmark by in excess of 4-5% consistently. In recent months performance has lagged the benchmark, but remains slightly ahead. This has been due to the large increase in the funds cash holdings, to 40%, as they were stopped out of a number of positions and are awaiting opportunities to deploy this capital. Given Munro’s track record of delivering outperformance, we are not concerned about the short-term weakness particularly given it is due to a more conservative allocation to inflated markets.

What income does it provide?

As with all managed funds, the Munro Global Growth Fund must distribute all income and realised capital gains each year. Therefore, distributions are dependent on both the performance of the underlying investments and whether any investments are actually sold. Munro has two traits we value in investment managers, being reasonably low turnover and low active share, indicating it is not replicating the underlying index. This may mean that distributions are not particularly large each year. For instance, the distributions for the 2018 financial year were 3.84 cents per unit and 3.48 cents per unit in 2017.