By Andrew Mitchell & Steven Ng
Co-founders and Senior Portfolio Managers
In our March 2020 Letter to Investors we review the historic nature of the month of March, the challenges and opportunities that lie ahead and how we are positioning the Funds.
Dear Fellow Investors,
Welcome to the March 2020 Ophir Letter to Investors – thank you for investing alongside us for the long term.
Month in review
March of the year 2020 will go down in history for many different reasons. First and foremost, it should be remembered for the spread of COVID-19 globally, rising from 86,013 (predominantly Chinese) cases at the start of the month to 854,039 (predominantly ex-China) cases by its end, with the loss of around 70,000 lives at the time of writing. The impact on day to day life from the spread of this coronavirus around the world is without precedent for most of us living today.
For financial markets, March saw the swiftest share market falls on record, punctuated by an unprecedented level of volatility. It was almost as if we were watching some aspects of the GFC repeated again on fast forward. Sharemarket falls were followed up by new lows in many government bond yields as key central banks returned interest rates to 0% and resumed quantitative easing, fiscal stimulus packages were hastily put together by governments to plug the demand hole, many companies came to market with capital raisings to stay afloat and we have seen a plummeting of the oil price as OPEC+ negotiations fell apart.
Whilst many elements of this will seem similar to the GFC, there is good reason to believe the impact of the COVID-19 crisis will be much shorter and sharper on the economy and financial markets. The recent market falls (and subsequent partial recovery at writing) have been precipitated by a biological event leading to a severe but time limited economic downturn and which hopefully, and most likely, will not lead to a financial crisis. The GFC began with a severe financial crisis, which in line with the history of other financial crises, led to a deep and prolonged economic recession. Whilst there are many uncertainties about how and when countries will be able to contain and supress the virus which has precipitated this downturn, history gives us comfort that this too shall pass. Moreover, recent experience in certain countries provides evidence of a timeline when those regions most impacted may begin returning, at least some way, towards normality in the weeks and months ahead.
For the month of March, global shares, as measured by the MSCI Developed Market Index in local currency terms, fell -12.8% and into bear market territory during the month. The MSCI Emerging Market Index dropped a little heavier down -17.4% as investors worried how successful social distancing measures would be in lower income countries where communal living is more prevalent. As some indicators of economic activity in China began returning to normal during the month, its sharemarket was the clear relative outperformer, falling only -4.5%. The other relative outperformer was the tech-heavy NASDAQ index (-9.0%) where some of its constituents are likely to see a net positive impact of more consumers working from home.
The local Australian sharemarket saw some of the largest losses with the S&P/ASX200 index down -21.2% for the month. Small caps were down even more at -22.9% as investors at the margin sought the greater liquidity in large cap names. Sector wise in Australia, all were down for the month, though the spread of performance was wide and mirrored the result seen in major overseas sharemarkets. Energy, unsurprising on the back of historic falls in the oil price, was down the most, falling -38.0%. This was closely followed by Real Estate Investment Trusts (REITs) which fell -35.1% as serious concerns were raised about the ability of tenants to meet their rental obligations when many have seen their business revenues dry up. The best performing sectors were Consumer Staples (-4.4%) and Healthcare (-5.6%) that saw more modest declines as demand for necessities and health related products and services remain less impacted, and in fact for some constituent companies, demand has increased.
Ophir Fund Performance
The Ophir Opportunities Fund returned -19.7% for the month after fees, outperforming its benchmark by +2.7%. Since inception, the Fund has returned +20.7% per annum after fees, outperforming its benchmark by +17.6% per annum.
Growth of A$100,000 (after all fees) since Inception
|Since Inception (p.a.)||5 Year (p.a.)||3 Year (p.a.)||1 Year||3 Month||1 Month|
|Ophir Opportunities Fund*||27.3%||16.6%||13.8%||0.6%||-22.9%||-18.7%|
|Value Add (Gross)||24.1%||14.1%||15.1%||21.6%||3.8%||3.7%|
|Fund Return (Net)||20.7%||12.4%||10.7%||-5.1%||-24.0%||-19.7%|
* S&P/ASX Small Ordinaries Accumulation Index (XSOAI). Past performance is not a reliable indicator of future performance
The Ophir High Conviction Fund investment portfolio returned -16.1% for the month after fees, outperforming its benchmark by +6.4%. Since inception, the Fund’s investment portfolio has returned +14.1% per annum after fees, outperforming its benchmark by +10.3% per annum. The Ophir High Conviction Fund’s ASX listing provided a total return of -17.1% for the month.
Growth of A$100,000 (after all fees) since Inception
|Since Inception (p.a)||3 Year (p.a.)||1 Year||3 Month||1 Month|
|Ophir High Conviction Fund (Gross)||19.3%||13.5%||-0.6%||-12.5%||-13.7%|
|Gross Value Add||15.5%||14.9%||19.4%||14.3%||8.8%|
|Ophir High Conviction Fund (Net)||14.1%||9.5%||-6.5%||-16.5%||-16.1%|
|ASX:OPH Listing Total Return||n/a||n/a||-22.0%||-20.1%||-17.1%|
* 50% S&P/ASX Small Ordinaries Accumulation Index (XSOAI), 50% S&P/ASX Midcap 50 Accumulation Index (XMDAI). Past performance is not a reliable indicator of future performance
The Ophir Global Opportunities Fund investment portfolio returned -14.8% for the month after fees, outperforming its benchmark by +0.3%. Since inception, the Fund’s investment portfolio has returned +20.1% per annum after fees, outperforming its benchmark by 28.4% per annum.
Growth of A$100,000 (after all fees) since Inception
|Since Inception (p.a)||1 Year||6 Month||3 Month||1 Month|
|Ophir Global Opportunities Fund (Gross)||30.1%||37.3%||4.4%||-5.7%||-14.6%|
|Gross Value Add||38.4%||45.6%||18.7%||11.9%||0.5%|
|Ophir Global Opportunities Fund (Net)||20.1%||25.5%||0.1%||-8.6%||-14.8%|
* MSCI World SMID Index TR (Net) (AUD). Past performance is not a reliable indicator of future performance
The macroeconomic profession is without doubt struggling to find historical precedents from which to base is forecasts for the next 6-12 months. The range of outcomes possible in the major economies for growth, inflation and unemployment over the next year is wide and much depends on the rate of transmission of this coronavirus, when it will be slowed globally, and when and to what degree economic activity can resume.
As seen in the chart below, China and South Korea have been key examples where deaths from the virus appear to be under control at present, whilst they appear to be plateauing in Italy and Spain, the two countries that have seen the most deaths at the time of writing. Worryingly, the US and UK, despite perhaps some early glimmers of hope most recently, have not shown any sustained reduction in daily new cases or deaths.
Source: Financial Times, 5 April 2020.
Here in Australia, there are better signs that containment measures are working to stem its spread, with the percentage increase in daily new cases as a proportion of the total dropping below 5% over the last week. New daily cases also seem to be reducing and community transmission rates appear to be relatively low.
Australian COVID-19 known cases by day
Source: Financial Review
The endgame though for the virus and its impact on economic activity here and abroad still remains highly uncertain. Key unknown factors include the impact of seasonality on the virus (e.g. will the upcoming summer help northern hemisphere countries?) and what level and duration of immunity can those recovered from the virus expect. Amongst this uncertainty it remains hard to escape the conclusion that we may remain in a waxing and waning state of containment measures (a kind of game of whack-a-mole), until/if a sufficient degree of the population develop immunity or therapeutics or vaccines can curtail it. Even countries such as Singapore that did not initially go into lockdown, relying more on less disruptive measures of containment, are now moving to close schools and most businesses as virus spread appear to be increasing. The threat of second waves of the virus remain real, such as was seen in Australia during the Spanish flu pandemic of 1919, and we watch closely to see how the most progressed countries such as China and South Korea fare in this regard.
Despite the aforementioned forecasting difficulties for the global marcoeconomy, most high-quality economists see economic growth, as measured by real GDP, falling faster than the GFC, but recovering much quicker, with a rebound that is also much stronger (see below forecast example from UBS in red).
Global growth (real GDP)
Source: UBS, Haver
This is predicated on the fact that the current slowdown is due to an exogenous shock, as opposed to a housing and credit bubble during the GFC that took a long time for financial, corporate and consumer balance sheets to repair. Providing the current social containment restrictions are not too elongated and financial institutions, corporations and individuals have sufficient liquidity and income support (in part through government and central bank assistance) balance sheet health for most companies should be maintained to survive the drop in demand. For those sailing too close to the wind, expect capital raisings which we have already seen being initiated over the last week or two.
What took many months to put in place in terms of liquidity support for the economy from central banks during the GFC, has now taken a matter of days, with announced 2020 counter cyclical fiscal policy support from governments already double that (as a percentage of GDP) implemented in the depths of the GFC during 2009. It has been truly historic the speed at which authorities have provided economic support.
Importantly for investors, what would a short sharp drop in economic growth look like for global corporate earnings? Again, while hard to calibrate, and a wide range exists at this early stage, the forecast below from Citi Research is typical of a number of others, highlighting a 40-50% drop is quite possible in 2020.
Global EPS Growth Forecast
Source: Citi Research, MSCI, Factset Consensus
Perhaps due to the long duration of the bull market pre-COVID-19, the strong returns seen in 2019, or how personal and panic inducing the impact of the virus has been, the move into bear market territory (falls above -20%) for most sharemarkets has been the swiftest on record (see chart below for the Australian sharemarket). It took over a year for the Australian sharemarket to fall 50% during the GFC, but less than a month for the market to fall 35% this time.
Source: MST Marquee, Ophir. Data up to 4 April 2020.
To give you some idea just how eye-popping volatility was during March in share markets, below is a chart of the bellweather Dow Jones Industrial Index. It shows the absolute percentage change each month in the Dow for the last 100+ years. The absolute percentage change is simply the sum of the absolute percentage daily movements in the Dow over a month. It indicates that March 2020 was the most volatile month over this entire period (!), easily eclipsing the months of October 2008 (the GFC), October 1987 (stock market crash) and October 1929 (during the Great Depression). We were truly living in extraordinary times in March.
Dow Cumulative Absolute Percentage Change by Month
Source: Bloomberg (OfDollarsAndData.com)
Note: Dow price data does not include dividends. The average cumulative absolute percentage change in a given month is 15.6%
Amongst this volatility, starting from around late-February when we first noticed the issues resulting from the virus were broadening from just supply chain disruption stemming from China, to more general demand destruction across advanced economies, we have been executing on a multi-step plan to protect our portfolios. It is worth noting this plan is integrated into our investment process which already considers stock holdings in a stressed market environment, but acknowledges each recessionary environment is unique and must be adapted to.
This plan encompasses the following four key steps:
1. Modestly increase portfolio cash positions. This has seen cash positions in our Funds move from our typical 8-10% range up to around 13-15% during most of March, a little under the maximum of 20% we would generally see as our ceiling. This has provided some portfolio protection during March as we await further clarity ahead on the path of the virus and direction of markets, but just as importantly optionality to initiate positions in new companies or top up existing holdings should volatility reveal more attractive entry points.
2. Reduce exposure to those companies most vulnerable to the impacts of the virus. This has generally focussed on three fronts:
a. Companies with the greatest earnings risk or uncertainty. For example, companies with exposure to industries such as travel, certain forms of out-of-home entertainment, discretionary retail and financials. For financials, in a downturn we are reminded of the old proverb “If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem”. Shareholders of financials are feeling this right now as “forebearance” becomes the word of the month and bad debts will no doubt rise significantly.
b. Companies with high fixed costs including debt. Generally, our process steers away from companies with high debt levels at any point in the business cycle, though we have found ourselves at the margin pairing back exposure to even modestly geared companies.
c. Companies with refinancing risk. Following on from point (b) above, even moderately geared businesses can find themselves in cash flow trouble if they have to refinance at higher interest rates during a downturn, possibly forcing them into a dilutive, and share price destructive, capital raising.
3. Redeploy capital to those companies less/neutrally/positively impacted but oversold. Pairwise correlations between stocks in Australia has recently doubled and gone back to GFC levels indicating the relatively indiscriminate nature of selling that has been occurring. This has been providing opportunities in the recent market volatility to top up existing positions, and add new positions, in companies we believe have been unfairly sold during the downdraft, as investors seek liquidity. We have been happy to provide them with this liquidity, particularly in our favourite type of opportunity: those that we already like for their structural growth characteristics but are also seeing a cyclical boost at present. An example of this in our Global Opportunities Fund is Hello Fresh, the global food box delivery service. Hello Fresh has seen a cyclical boost in demand from more people self-isolating at home. We believe some of these new customers will likely become longer term customers when isolation measures are relaxed as they get used to the ease and convenience of meal delivery (and provided recipes) compared to going out to buy ingredients. Another example in our High Conviction Fund is the Australian company NextDC, Australia’s leading Data Centre operator. The company is benefitting from the increasing use of online digital technologies including those that support working from home, and video streaming and gaming, that are seeing increased use at present. After initially being sold off like the rest of the market in early March, the company re-affirmed earnings guidance in the middle of the month and initiated a capital raising in early April to help fund its growth agenda. After dropping to $6.58 in the middle of the month during peak fear in the market, the share price is above $8.70 and around all-time highs in early April.
4. Allocate a portion of our Funds to oversold, but quality growth companies, that suffer from the issues in 3(a) above, when its clear they will make it through this economic downturn. It is important to note we are not at this point yet and we fully expect this will only represent a relatively small portion (5-15%) of our Funds. We know from experience though that this area is often where some significant value can be found given the benefits of operating leverage in what is likely to be a significant cyclical economic rebound.
We also note that it is in times like these where the benefits of our business model really comes to the fore. This stems from two key areas:
1. A stable capital base. The capital base of our three investment strategies has either been stable (in the case of the “hard closed” Ophir Opportunities Fund and the “closed-ended” High Conviction Fund) or in net inflow (in the case of the Global Opportunities Fund which had a ratio of 6-to-1 applications to redemptions in March). This means we have been able to put investor capital to work in our best ideas without the worry of having to sell quality companies to fund any redemption requests – threat that often faces fund managers after the market has fallen.
2. Capacity constrained Funds. By keep our Funds small, it ensures we are able to quickly manoeuvre in to, or out of, positions during volatile markets. This means we can trade without unduly moving the market price or have to cross large bid-ask spreads, assisting investment performance.
To finish, the time ahead for the global economy is likely to be difficult over at least the next 3-6 months. Markets have already fallen a significant way (even taking into account the most recent rebound) in acknowledgement of this. We are continuing to find a large number of great secular growth ideas both in Australia and overseas for our Funds. We are content to take a medium to longer term view with our core portfolio holdings, in recognition that no one can consistently pick the bottom of bear market downturns. We see are seeing plenty of opportunities to incrementally invest ours and our investors capital in the expectation of a high probability of making attractive risk adjusted returns on a 3-5 year horizon.
With that we’d like to leave you with two quotes, both related to Warren Buffett. One from his business partner Charlie Munger at Berkshire Hathaway, and one from his teacher at Columbia Business School, Benjamin Graham.
“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get.” – Charlie Munger
“The investor’s chief problem — and even his worst enemy — is likely to be himself.” – Benjamin Graham
They serve to remind us that large market falls go hand in hand with share investing, and that maintaining the right temperament is very important to investment success. Both important points to remember after an historic March 2020.
As always, thank you for entrusting your capital with us.
Andrew Mitchell & Steven Ng
Co-Founders & Portfolio Managers
Ophir Asset Management
This document is issued by Ophir Asset Management Pty Ltd (ABN 88 156 146 717, AFSL 420 082) (Ophir) in relation to the Ophir Opportunities Fund, the Ophir High Conviction Fund and the Ophir Global Opportunities Fund (the Funds). Ophir is the trustee and investment manager for the Ophir Opportunities Fund and the Ophir Global Opportunities Fund. The Trust Company (RE Services) Limited ABN 45 003 278 831 AFSL 235150 (Perpetual) is the responsible entity of, and Ophir is the investment manager for, the Ophir High Conviction Fund. Ophir is authorised to provide financial services to wholesale clients only (as defined under s761G or s761GA of the Corporations Act 2001 (Cth)). This information is intended only for wholesale clients and must not be forwarded or otherwise made available to anyone who is not a wholesale client. Only investors who are wholesale clients may invest in the Ophir Opportunities Fund and the Ophir Global Opportunities Fund. The information provided in this document is general information only and does not constitute investment or other advice. The information is not intended to provide financial product advice to any person. No aspect of this information takes into account the objectives, financial situation or needs of any person. Before making an investment decision, you should read the offer document and (if appropriate) seek professional advice to determine whether the investment is suitable for you. The content of this document does not constitute an offer or solicitation to subscribe for units in the Funds. Ophir makes no representations or warranties, express or implied, as to the accuracy or completeness of the information it provides, or that it should be relied upon and to the maximum extent permitted by law, neither Ophir nor its directors, employees or agents accept any liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. This information is current as at the date specified and is subject to change. An investment may achieve a lower than expected return and investors risk losing some or all of their principal investment. Ophir does not guarantee repayment of capital or any particular rate of return from the Funds. Past performance is no indication of future performance. Any investment decision in connection with the Funds should only be made based on the information contained in the relevant Information Memorandum or Product Disclosure Statement.