December 16, 2020
Letter to Investors – November

By Andrew Mitchell & Steven Ng
Co-founders and Senior Portfolio Managers

In our November 2020 Letter to Investors we review what drove markets in an historic month for sector and style rotation and touch on how we have been positioning the Ophir Funds.

Dear Fellow Investors,

Welcome to the November 2020 Ophir Letter to Investors – thank you for investing alongside us for the long term.

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Dear Fellow Investors,

Welcome to the November 2020 Ophir Letter to Investors – thank you for investing alongside us for the long term.

Ophir Fund Performance

The Ophir Opportunities Fund returned +3.2% net of fees in November, underperforming its benchmark by 7.1% and has delivered investors +25.1% p.a. post fees since inception (August 2012).

Download Ophir Opportunities Fund Factsheet

The Ophir High Conviction Fund investment portfolio returned +5.9% net of fees in November, underperforming its benchmark by 2.5% and has delivered investors +19.4% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +6.0% for the month.

Download Ophir High Conviction Fund Factsheet

The Ophir Global Opportunities Fund returned +10.8% net of fees in November, outperforming its benchmark by 1.4% and has delivered investors +34.8% p.a. post fees since inception (October 2018).

Download Ophir Global Opportunities Fund Factsheet

Rotation sensation: The five big themes that dominated November

November: A year’s worth of returns in a month

November was a month to remember for equity markets. The ASX200 rose 12%, its best month in 32 years, while the MSCI World index rose 10.2%, reaching all-time highs.

As seen in the chart below, almost all the major equity markets posted +10% returns for the month. That’s more than the long-term annual expected returns from these markets.

November total returns

Source: Goldman Sachs

The goldilocks US election result and a wave of positive vaccine news were the catalysts for the market surge. Investors turned a blind eye to sky-high COVID-19 cases in the northern hemisphere and renewed partial lock down measures, looking forward to the better economic days ahead that a vaccinated populous may produce in 2021.

In this letter we look at the 5 major themes and rotations that developed, or continued to develop, during November that could inform equity markets’ movements in coming months.

We outline how our core earnings-focused philosophy and the small size of our Funds are allowing us to be both disciplined and flexible in navigating these changing markets.

We also look at why trade tensions between China and Australia may have peaked, and why A2 Milk likely won’t be affected. And we take a peek at how low bond yields will continue to be a key positive for equity markets.

1. Value losers turn to winners

In November you could forget about the benefits of bottom-up stock picking – it was all about sectors and styles.

You could own the company with the best performing operating metrics (profits, growth, margins etc) and it would not have mattered. The most beaten-up sectors in the first ten months of the year had a huge rally, with Energy and Financials (including Banks) the standout performers on a sector basis, both domestically and abroad.

These ‘value’ type sectors benefited from both higher oil prices and an expected faster recovery in economic growth as effective vaccines raise the prospect of a faster reopening of economies than expected next year. This largely came at the cost of the ‘winners’ so far in 2020, with Healthcare, IT and Consumer staples, funding the value rotation.

2. Small caps outstrip large caps

This theme played out both in US large cap and small cap segments as well. The latter being particularly relevant for our Global Opportunities Fund that invests a significant (around 60%) portion of its portfolio in the US small cap segment.

US small caps had a rip-roaring month, with the Russell 2000 up 17.3%, with the value style (+18.9%) outperforming growth (+15.9%), though both types of investors could be nothing but pleased (see table).

U.S. Large, Mid and Small Cap total returns to end of November 2020

 

Source: FactSet, Morgan Stanley Research as of 2 Dec, 2020

As highlighted last month, US small caps (+15.8%) have dominated large caps (+2.9%) over the last quarter. Smaller companies tend to be more levered to the expected economic recovery in the US.

But this is not just a US phenomenon. Aussie small caps have also outperformed their large-cap counterparts since the COVID-19 induced lows in March this year.

While it isn’t a large part of our investment process, we tend to increase our exposure to higher-market-cap companies (though still within the small and mid-cap parts of the market) during market downturns and reverse this process during market recoveries.

We do this to take advantage of investors’ heightened preference for liquidity during market corrections/bear markets, whilst also benefiting from their lower risk aversion and typical outperformance of small cap companies during the market rebound.

3. Reopening theme comes to life

Unless you had a crystal ball (or had the inside scoop on the content and timing of the Pfizer vaccine news) heading into November, it is unlikely you could have perfectly timed the select themes that did well or poorly in November in the Australian small cap part of the market we invest in.

‘Reopening-theme’ type companies were clearly in the winners list. The top of the list includes Westfield (+73.1%), Webjet (+65.3%), Flight Centre (+52.0%), Corporate Travel (+37.0%) and Village Roadshow (+31.4%).

All of these companies benefiting from people getting ‘out and about’ again for retail, entertainment, and travel experiences.

4. Lithium boost

Another big winner domestically in November were lithium stocks, including Pilbara Minerals (+69.1%), Orocobre (+61.3%), Galaxy Resources (+56.4%) and Ioneer (+54.3%).  Lithium producers received a boost as more favourable treatment of the electric vehicle (EV) industry is likely under a Biden presidency, Chinese demand rises and the UK planned to bring forward the ban of petrol and diesel cars to 2030.

5. Gold fades

On the losers list, Gold stocks were the worst performing stocks during November in Australia and offshore.

Six of the ten worst performing domestic small caps (including Silver Lake Resources (-16.1% and Ramelius Resources (-12.7%)) — and three of five worst performing mid-caps (including Saracen Minerals (-16.5%) and Northern Star (-15.0%) — were gold miners.

The big falls followed a breakdown of the gold price as investors dumped the safe-haven precious metal in favour of riskier asset classes as vaccine news buoyed investors’ hopes.

Sticking to our philosophy

We don’t position our Funds to take big bets on these thematics either way as that’s not where our edge lies. We’d rather seek to neutralise our exposure to these themes, focussing instead on bottom-up research on those companies we believe are growing their earnings faster than the market expects and have a long runway for doing so.

That said, any attempts to neutralise our exposure to these themes, the timing of which we believe is more or less unpredictable, will be imperfect. When the outcomes of these themes is so extreme, as it was in November, we can expect it to have varying effects on the short term performance of our Funds.

Ultimately, though, earnings matter. Six-monthly or quarterly earnings reports provide the best means to judge whether we are holding the ‘right’ companies. Today is a challenging environment for fund managers as the full extent of the lasting impacts on consumer behaviour from COVID-19 are yet to be seen.

For us, while the style of investing we implement is closest to what is known as ‘Growth at a Reasonable Price’ (GARP), today it could also be called ‘Certainty at a Reasonable Price’.

Here we seek to avoid those companies that would force us to make big calls on the outcome of COVID-19 that we do not have good precedents for. Instead, we would rather look for companies with greater clarity of revenue and earnings, but we believe are still mispriced by the market.

Trade wobbles resume

The other major news we were frequently asked about during November and early December was the increasing trade and political tensions between China and Australia. China has recently increased tariffs on wine and barley following anti-dumping investigations. There have also been reports of non-tariff measures implemented on coal, copper, timber and lobsters, among others.

While this has had some painful direct impacts for some Australian industries and companies, most notably for the listed Treasury Wine Estates (ASX: TWE) in a macro sense the impact on Australian GDP is pretty ‘small fry’.

As seen in the table below, Iron Ore, Gas (LNG) and Education exports to China make up the lion’s share of our trade and have yet to be touched.

So far, the macro impact of China’s trade restrictions on Australia has been small

Source: Goldman Sachs Global Investment Research, ABS

It would be a different story if one of these categories of export was to be materially impacted. Iron ore is notable given its size; however, China does not have enough high-quality alternatives which, greatly reduces the potential for this commodity to be targeted.

We think China has sent the message it wanted after Australia joined the US in calling for an investigation into the origins of COVID-19. We believe President-elect Biden will take a less aggressive stance against China than President Trump. So we may have seen the peak in tensions, or at worst, they will remain limited to second and third tier exports.

That said there is a risk Biden ups the rhetoric against China, dragging Australia in, which could mean this story has further to play out, though it is not our base case.

Our holding with the greatest potential impact in the Ophir Funds is A2 Milk, given its sale of infant milk formula into China. Here, beside the fact it is a New Zealand company, we believe it would be well down the list of targeted products by China given political fallout from the effect on mothers who don’t wish to substitute products for their baby. There is also the matter of ownership and financial linkages through State Owned Enterprises (SEOs) to the A2 Milk supply chain that reduces the prospect of it being targeted. However, we remain vigilant and are cognisant of the risks and will never say never with China and its relations with its trading partners

Rotation sans inflation?

The recent rotation into value and cyclical sectors has been extreme, with managed fund flows (first chart below) and returns (second chart below) causing whiplash for some investors.

Somewhat surprisingly though, bond yields, which would typically rise significantly off the back of higher expected growth and inflation in such an environment, have generally not.

Greatest inflows to value vs. growth ETFs in history

Source: BofA Research Investment Committee, EPFR

Cyclicals rage whilst bonds stand still

Source: Goldman Sachs

This likely reflects investors’ expectations of rock-bottom near-0% central bank rates for some years yet, as economies take time to ‘catch up’ the lost growth inflicted by COVID-19.

This, combined with key central banks wanting to see ‘the whites of the eyes’ of actual inflation, not just forecast inflation, mean central bank ‘puts’ – the notion central banks will prevent big market falls — are likely to be supportive for equity markets for some time yet.

One way to see this is the gap between the income you can earn from the equity market compared to the bond market in the US is now at 70-year highs! (chart below).

The gap between dividend yields and bond yields is close to levels from the 1950s again

Data for S&P 500

Source: Robert Shiller, Goldman Sachs Global Investment Research

We think long-term bond yields are likely to gradually head higher, though, through 2021 in the major economies, as growth improves, and the rotation into value and cyclical sectors has further to run.

Positioning for normalisation

Across the Ophir Funds we have been gradually repositioning our portfolios since mid-year for a normalising global economy throughout 2021 and into 2022.

We have added some new names in each Fund that are positively exposed to re-opening economies, but just as much, we are re-weighting existing positions (both up and down) in companies that better reflect their prospects in the short to medium term.

Importantly, by keeping our Funds small in size, through strict capacity constraints, we can make these portfolio changes quickly and with virtually no market impact cost.

It is times like these rapid market rotations where keeping our Funds small helps us reflect our updated views rapidly in our portfolios, allowing us to take better advantage of the new opportunities the market is providing us.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior 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. 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 Global Opportunities Fund and 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. 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.

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