The interview with Morningstar’s Graham Hand was recorded on the 25th August 2023 and the transcript has been edited for brevity. Please find links to the recording  on Spotify, Apple, Google, Buzzsprout (starting at the 31 minute mark, interview is for 28 minutes duration):

Graham Hand: Andrew, welcome to the Wealth of Experience.

Andrew Mitchell: Thanks very much for having me, Graham.

Hand: Look, you recently went through your first full 10 financial years of the Ophir Opportunities Fund, and obviously, you were managing money before that as well. So, what are some of the biggest lessons of the last 10 years?

Mitchell: I think the lesson you get constantly reminded is that the market doesn’t go up in a straight line, and you, as a fund manager don’t have your performance go up in a straight line either and it moves around with the market. From my perspective, I invest all my personal money in the Ophir funds, and I’ve learned over time not to try and time the market to just be a consistent investor. And that original fund that you spoke about then, the Ophir Opportunities Fund, it’s done 21% per annum for 10, 11 years or 10 financial years. And it hasn’t been all beer and skittles along the way, but the trend line has actually stayed remarkably similar. But you’ve had a lot of volatility as we’ve obviously gone through in the last 12, 18 months. And it’s really just staying the course as an investor, sticking to your process, and not getting worried out of positions that you believe in. Likewise, I guess investors listening here, not getting worried out of the market because capitalism works.

Hand: Do you feel you’ve been able to convince your investors to understand that, to stay the journey with you?

Mitchell: Yeah, I think we’ve been successful in doing that, because we do have a track record from our previous employer that was five years, and that included the GFC. And it’s very handy to point to how we performed during the GFC. As I said, the last 10 years, we haven’t gone up in a straight line, and we can show how we’ve had these volatile times. And we have lost a few people along the way, but once you’ve got that track record and people say, hey, you know, you do have these 20% pullbacks, we fell – the strategy we were running at our previous employer fell 50% or so during the GFC.

Hand: As the market did.

Mitchell: Yeah. We did a bit worse than the market. But then, when I started there running this strategy, it was in, I think, September of 2007, so it was a complete baptism of fire, went straight into the…

Hand: Welcome to the market.

Mitchell: Yeah, exactly. And investing in small caps, we fell a bit more than the market. But then by the time we left, the strategy was up 80% after five years. So, if you went to sleep or in a coma for five years, you’d woke up, you’d be very happy with your return. From the bottom, that was the darkest time in the market, March 2009. The fund was up massively to get to that 80%+ return. I think it’s like 160% or 200%, or whatever it is. So, when you can point people to that period of time and show that this is all the part of a normal market, I think it helps people. And when investors come into our fund, they tend to hear about us in good times, when you’ve done a 70%, 80% sort of year, the phone’s ringing off the hook.

Hand: That you’re featured on some league table or something like that?

Mitchell: Exactly. You need to anchor people’s expectations and make them realistic. And I know I’ve had a few conversations with people who were coming in and they have unrealistic expectations. And you say, hey, just know that every seven or eight years, there’s a recession, we’re in small caps. The price of admission is volatility to the downside in a recession. Just remember we had this conversation because you will need to be strong enough to hold on if there’s a 50% fall, because if you don’t, you’re going to miss the bigger game is, sort of, riding the share market over a long period of time.

Hand: So, in that time, let’s say, at Ophir the last 10 years, is there a stock that stands out in your mind that you think you identified before the market did and did well, but also another one that you’ve perhaps been disappointed in?

Mitchell: Oh, there’s plenty on both sides. The one that obviously people would remember very well is Afterpay. We got into that when it was something like two or three dollars. And the thing about Afterpay when we speak about it, we invested very shortly after the IPO. And to give background, the work we did was we were speaking to retailers, and they were telling us, unlisted retailers, that it was really driving their online sales and the customers loved it and it was changing the behaviour. And we said, right, we’re onto something. Did we think that this was going to be a 30, 40 bagger or as people think, how did you spot this 50-bagger? We didn’t. We thought we were going to make 2, 3 times our money and this was going to be very good. Along the journey, the key thing with Afterpay was actually not selling it. We sold it all the way. So, it was like a 5% position all the way, but not selling it to zero because there were many times to be worried out of it. So, you had to actually believe in your central thesis to the company and not be worried out because there were people who hate stocks that are going up because they don’t own them, so they want to fling mud. So, I think that was a good one to get early on, and obviously everyone knows that.

And there’s been plenty that haven’t gone well. One that’s happening right at the moment, it’s a smaller weight in our portfolio, but it’s a company called Omni Bridgeway. So, it’s a litigation funder, which means that, let’s say, a class action costs a lot of money for lawyers. They need to fund it, and this is sort of a team of lawyers that go and say, okay, we’ll give you some funding so you can fund this class action. But the quid pro quo is we get some return on the other side. The problem with this business is the duration. The way the court system works, things get pushed out, judges take a long time to make judgments, and then there’s appeals. And we’ve been waiting for the cash flow to come, and I think the market just absolutely has lost all confidence, and we’ve seen the company fall significantly. It hurts when you’re watching a company down 3%, 4% a day. So, we certainly don’t get them all right, and they seem to hurt a lot more than the ones that are going well feel good for you.

Hand: You mentioned earlier with Afterpay, but have you got a stock that you think is not only one that you’re keen on, but you think it’s got characteristics that are particularly resilient for a difficult market? There’s all this feeling about, is a recession coming. And one that you might think it’s not going to shoot the lights out, but it’s got such a great business that you think the resilience is there?

Mitchell: Yeah. Well, we hope we’ve got quite a few of those businesses because we’re generally not investing in cyclical companies. Most companies have an element of cyclicality to them. Omni Bridgeway is obviously a classic one, a litigation funder. It’s almost counter to the market. People want to sue people in times of a recession and the court system works in its usual way.

One that hasn’t gone well for us very recently, but since we’ve owned it has done tremendously well is a company called TransMedics. So, this is a business listed in the U.S. It’s a $3 billion, $4 billion Aussie market cap company that’s involved in organ transplants, specifically, removal, storage and transportation of hearts, lungs and livers used for organs. What their technology enables them to do is to keep the heart beating outside of a human body rather than competing against an Esky, a Yeti Esky for storage and transportation. There are some small competitors that don’t have much market share. But this business as we show with data is actually growing the number of organ transplants that occur in the U.S. So, I think from 2005 to 2020, the amount of heart, lung, liver transplants went from 10,000 to 15,000. So, you had 5,000 organs extra grow in the U.S. In the last three years, it’s gone from 15,000 to we think it will probably be about 19,000 this year, so 4,000 extra. That’s really accounted for by TransMedics, and they’re a service. So, they make doctors’ lives easier. It’s similar to Afterpay in a sense that when you speak to everyone in the value chain, everyone wants it to succeed because doctors aren’t waking up at 3 am to transplant an organ as it’s kept alive longer on a Transmedics device. And the hospitals like it because they make a lot of money and insurers like it because they save money. So, this business is marching to its own beat. It’s growing market share in a growing industry and in fact, it’s growing the industry and that’s why we think it’s similar to Afterpay.

So, in some senses, to your question, what’s a resilient business? Well, you want one that’s in a resilient industry that’s growing market share and that has those elements and the added element which is rarer, you see it in like a ResMed and an Afterpay but it’s quite rare, it’s actually growing an industry itself that’s been around for a long time.

Hand: Yeah. So, Andrew, I want to ask you a specific question about your listed investment company. But before I do that can you just explain to our readers what your range of funds are and what’s open at the moment?

Mitchell: Yeah. So, we have the Ophir Opportunities Fund. That is our original fund that’s been going for since August of 2012, and as I said before, it’s done 21% after fees per annum. It’s the number one ranked fund out of all Australian equity funds since its inception. So, it’s done very well. That’s our original fund, an Aussie small cap fund, long only. Then we have OPH, which is the Aussie High Conviction Fund. There’s about a 50% overlap with that small cap fund. That’s listed, trades under ticker OPH on the ASX. It has less stocks, so you think 30 stocks versus the 40 in the Ophir Opportunities Fund. Then we have two global funds. So, the Global Opportunities Fund, it’s done circa 14% per annum for almost five years after fees and has beaten the benchmark, I think – these aren’t exact numbers – by about 7% per annum since it started, maybe a bit more. That fund is closed, but the Global High Conviction Fund is open. Now, that fund has an 80% overlap with the Global Opportunities Fund. So, this is a global small and mid cap fund. The average size of a company is about $5 billion Aussie market cap, and it invests in the Western world. So, the U.S. is about two-thirds of the index and so two-thirds of the fund is the U.S. It’s also got English stocks, European, Scandinavian stocks and every now and again a Canadian stock in it as well. And it’s got about 30 companies where the Global Opportunities Fund has 40 companies. So, they’re the four funds.

Hand: So, just looking at OPH, because obviously, we’ve got a lot of people who like to buy listed investment companies, easy to execute on the exchange. It was launched in 2015. If I look at its full history, most of that time it’s had a premium to NTA. It’s currently at a discount. Last time I looked about 12%. Why do you think that changed from premium to discount and what can you do to remove it?

Mitchell: The premium versus discount is very interesting because I just see opportunity. I see many are fearful of the fact it can go on a premium and discount. Steven and myself have been investing again since January. It’s simple. Fear and greed. When the market is greedy, asset prices are inflated. So, you go back to 2021. We’re trading at a 20% premium. Asset prices…

Hand: The most extraordinary premiums, isn’t it?

Mitchell: But when asset prices go up, when the share market rocketed in that 2020-2021, you trade on these big premiums. When the taxi driver is talking about the share market, asset prices are high and then you get the cherry on top, which is the premium. But the flip side to that is when the market is fearful, you trade at a discount. And you think about it. What’s also happening at that time? Well, asset prices are depressed. So, for Steven and I, who like to think longer term, this is a huge opportunity for us and hence why we’re investing because we’re saying, well, we can buy a dollar in our fund for $0.90. I can’t promise this to your listeners, but we think that we’ll generate good returns in the future. And when everyone is piling back into the share market and your Uber driver is talking about the shares that they own, the share market is rocketing, then that’s when we trade in a premium because everyone is coming back.

And the experience during COVID was interesting. So, we went from trading at a premium the previous year to a 15% discount in COVID in 2020. If you invested then OPH on the ASX – and we said on the webinar, we did at the time, like March 2020, this is a great time to invest – if you invested then, you would have made circa 125% in the next 15, 16 months. But the net asset value only went up about 65%, just showing how that all works. So, that’s what we really like about the discount versus the premium. But we owe it to our investors to try and narrow that as much as we can.

So, we have several mechanisms. One, we tell everyone now when we’re investing – so, on our webinars and the likes, which are publicly available, you can hear when we’re investing and that’s been recently. Two, we need to make sure communication is always up and so people understand how we’re seeing the world. And it’s not just communicating via a monthly letter or a quarterly letter. We do lots of other things. We’re on LinkedIn, podcasts or whatever it is, but give lots of mediums to communicate how we see this as an opportunity. And then, once you’ve exhausted communication, the last one we have, which we’ve done before, is put the buyback on. And so, if you can buy a dollar for $0.85, then giddy up because that accrues, that $0.15 accrues to the unitholders. The mechanism we do that is that we have a model that looks at what we think are the peers that we should be most compared to. We look at the discounts they trade on and if we ever go to a certain amount, then we put on the buyback. And it came very close a couple of months ago, the buyback coming on and we’ve got no hesitation to put it on when that happens.

Hand: So, in your investment process, if I can go into that, how much do you feel you are company-specific and how much do you factor in the macro environment?

Mitchell: So, if you’re not thinking about the macro environment, it’s like trying to swim with an arm behind your back. You’re not going to be too successful. So, we’re always thinking about the macro environment because that will drive the bottom-up of companies. But we are bottom-up investors. So, for us, it’s getting out there, seeing companies, looking in the whites of the eyes of the CEOs, speaking to as many people as possible and finding companies that are experiencing some change. We really focus on the earnings of a company. So, if a company is going through an accelerated growth period, we’ll really narrow in and try and identify why that is. But as I said, the macro will drive certain elements of companies, be it a retailer – you’re going to be pretty hard going if you’re selling houses and interest rates are going up through the roof. But yeah, we’re really bottom-up investors and trying to do work that other people aren’t able to get an edge and work something out that the rest of the market hasn’t on a company.

Hand: And so, obviously, the rising interest rates and inflation and what that’s done for the market has been one theme. Do you feel there’s a theme out there which has been dominating your thinking in the last year or so?

Mitchell: I’ve got so many themes dominating my thinking. I think probably the one that would be most interesting is U.S. small caps are firmly in a bear market. U.S. large caps are trading well above their historical averages.

Hand: Magnificent Seven in particular.

Mitchell: Exactly, the Magnificent Seven. So, for those who don’t know, the NVIDIAs, Metas, Amazon, Alphabet, Apple, Tesla, I think I’ve forgotten one out of it – Microsoft, that’s the seven. I think they’re up 65%, 70%, even more percent since the start of the year while you’re not getting that participation across the rest of the share market. The S&P 500 outside of that, it’s pedestrian, how much the rest is up. But those big seven are actually driving the S&P 500. If you then look at small caps, they’re trading – the Russell 2000 is trading at I think around 14 times historic price to earnings multiple. The average is about 18.5 times. So, it’s trading at a big discount. The S&P, for reference, is trading at about 23 times. So, a big premium. So, the big opportunity, I guess from our perspective, is looking at that small caps and just understanding that there’s a lot of risk priced in. Be patient and invest in the good businesses because the market will come back for them at some point and there will be a lot of money to be made. It’s not a matter of if, it’s just when, and we don’t know the when part. But this will be a time that we’ll all look back at and say this was a great opportunity. I’m not sure whether you could say that about the Magnificent Seven, and I’m not all over NVIDIA. It’s obviously a fantastic business. It just trades at, I think, recently 20-25 times plus forward sales which is huge.

Hand: I was going back looking at some of the articles you’ve written for Firstlinks. You’ve also written about how investors are often their own worst enemy. How have you seen that manifest itself?

Mitchell: Well, because I’m my own worst enemy as well. So, you learn over time and we’re always going through a self-reflection process over mistakes that we make. And behavioural biases as an investor are something that we all have. And it’s fine to have them, but you have to acknowledge that you have them and work on them. So, when you see yourself doing it, you need to stop yourself and think. So, confirmation bias is a big one for us. We’re always out on the road talking to people. And the easiest thing to do is speak to someone who supports your investment thesis on a company and you’re like, well, that person is obviously very smart. I should put all my attention on what they said. And then someone tells you something that’s against it. And then you discount them because they worked at, I don’t know, Arthur Andersen the accounting firm 25 years ago.

Hand: I find myself – very often I realize I’m reading the articles that confirm my view. And you’ve got to really watch for that.

Mitchell: And that’s what social media does. All it does is try to put stuff in front of you that you’re going to want to read because it confirms your view, which is a big problem for all the confirmation biases on a big global level. So, going out and working on all your biases and identifying, there’s lots of them to find. And what I’d suggest to people who are listening is to actually buy a book, as there’s many out there, on behavioral biases. But just think about the investments that you make and where you’re committing these because these are each and every one of our Achilles heels and we all have them. It’s fine. Don’t be ashamed. But gee, a lot of people think that they made all this money out of NVIDIA because they’re stock market geniuses. And I don’t know – I speak to them about NVIDIA, these people. We’ve got investors and I meet people who are invested in NVIDIA, and they don’t know much about the company at all. And I know that I know very, very little and I know more than them. So, I pick my battles, and it’s very easy to think you’re a stock market genius when NVIDIA has just tripled for you. But maybe it’s luck.

Hand: Okay, thanks very much, Andrew. Appreciate those ideas. I’ve been speaking to Andrew Mitchell, the Founder and Senior Portfolio Manager at Ophir. Thanks for coming in, Andrew.

Mitchell: Thanks very much for having me, Graham.