In this month’s Investment Strategy Note we have included a curated list of the toughest questions asked at our recent investor events and our responses.
We recently rounded the country in August updating investors on the performance of our Funds, recent market dynamics and our outlook for the next year.
We held several Meet the Manager events in most major cities. It was an amazing opportunity to see many of our investors, old and new, face to face, either for the first time or the first time in a long time. There is nothing like seeing our investors in person when we have something important to say.
There were some really insightful questions asked. Given investors could not benefit from the best questions asked – and our answers – across all the events, we thought we’d include a curated list of the toughest, with hopefully the most insightful answer, here.
We’ve tried to stay truthful to the answers we gave at the events. But with the benefit of time and reflection, we have also provided some more detail where appropriate.
We hope you find the answers helpful in understand our thinking, and as always, please don’t hesitate to get in contact if you have any further questions.
You mentioned you believe you made a mistake early this year in Jan/Feb in your Global funds by “buying the dip” in consumer-orientated businesses. Does this mean you are now gun shy and not taking risk anymore?
We are not removing risk from our Funds in any wholesale fashion. The market consensus earnings growth on a weighted basis for each of our funds over the next year is still 20-25%+ (on our numbers, earnings growth is higher).
Our level of conviction in our holdings, as measured by the number of positions and their weights, has not changed materially.
And remember, we both (Andrew and Steven) have all our investable wealth in the Ophir funds and a long investment horizon (hopefully at least another 25-30 years). We want to compound the returns at as high a rate as possible (without taking undue or unrewarded risk) over the long term for ourselves and our family, and of course you, our fellow investors. Our alignment with you on this remains very strong.
You highlighted that you have increased the allocation to companies with more resilient earnings growth and have increased liquidity within the Ophir Funds. Is this a more permanent change or something temporary?
We are responding to the new realities of the current situation. But while we are conscious of the new market and economic dynamics that have increased uncertainty, we are staying in our lane and investment style. The changes are well within our remit as a small and mid-cap equities manager focussed on investing in growth-orientated businesses at reasonable prices.
We have in the past and will continue to manage risk within our Funds based on the outlook and range of possible outcomes. This may mean allocating more to companies with resilient earnings growth profiles and increasing liquidity (through higher cash allocations and investing in businesses up the market cap curve) when risks are skewed to the downside, like present.
In the broader scheme of things these changes are relatively modest. We are NOT, for example, becoming a large-cap manager, skewing to a value style, or buying ‘cigarette butt’ type businesses. We will always remain true to label.
I understand the macro has been driving markets over the last year or so. How much is macro analysis part of your investing process and, given the experience of the last year, have you changed your investment process as a result?
You are spot on that share markets have been very macro driven over the last year with things like inflation and interest rates playing a much larger role than usual in determining which companies are the share market winners or losers.
We don’t completely ignore what is happening with these top-down macro forces. But we do not have a strong edge in pricing of these factors. So we deliberately constrain how much influence they have on portfolio management.
It is much easier to get an edge through bottom-up analysis of individual small and mid-cap companies because there is less competition. So we want to maximise our exposure to this bottom up stock picking risk while limiting macro-specific risk.
To limit exposure to macro-specific risks, we are spending more time in our daily and weekly investment team meetings in understanding these risks and how our portfolios might respond under different outcomes. We believe this will help provide some added protection to absolute and relative returns through the macroeconomic cycle.
This is just one way we continue to add enhancements to our investment process, like we do every year, given investing is a continual evolving and learning process.
On your monthly factsheets that disclose performance, you put the since inception performance numbers first over more recent returns. Are you trying to hide more recent underperformance?
We made the change almost three years ago. And it was for the opposite reason.
Starting with our November 2019 factsheets, we moved to displaying longer-term returns first (on the left in our performance tables), before more recent monthly returns (on the right). This is the reverse of what we used to do and what the majority of funds do.
We made the change when short-term returns were very strong, with the Global Opportunities Fund, Ophir High Conviction Fund and Ophir Opportunities Fund returning 38.2%, 24.0% and 33.6% respectively net of fees over the previous 12 months.
We changed the display because we simply did not want strong and likely unsustainable short-term returns to attract short-term-orientated investors to Ophir.
Having a stable, long-term orientated investor base is incredibly important as a small-cap equities manager. The last thing you want is “fast friend” investors who join because of strong short-term performance, then leave at the first sign of market falls or short-term underperformance, which would require us to focus on selling investments to fund redemptions at exactly the wrong time.
We were of the view back in November 2019, as we are today, that presentation of investment results is one small way we can help focus investors back on longer-term horizons and returns which should be of greatest importance to investors.
Fund managers can get lucky with results in the short term, this is much less likely to occur over the longer term.
In your presentations you have shown other ‘growth’-orientated indices. These indices have recently underperformed “style-neutral” indices including the benchmarks for your funds. Are these growth indices better benchmarks for your funds?
This is an excellent question! At a surface level this might seem like a better solution: mark growth managers against growth benchmarks and value managers against value benchmarks. Problem solved!
Unfortunately, it’s not that simple. Firstly a ‘growth’ benchmark may not exist. It doesn’t for small-cap growth companies listed in Australia.
And, secondly, if a growth index does exist, it is often not a silver bullet for several reasons:
- It may not be investable. Being investable is a hallmark of good benchmarks so investors can obtain passive exposure to that style should they wish.
- Growth as a style is a ‘broach church’. Different managers have varying levels of growth. Some also have a combined value lens, including us, where there is a clear focus on not overpaying for growth.
- Given the complexity of the above two issues, industry consensus has so far generally fallen on the side of using a style-neutral (neither growth nor value) benchmark for most publicly available performance reporting at a fund level.
To help deal with the problem, in our communications, including our Letter to Investors, Investment Strategy notes and in-person presentations, we have tried to provide a broader array of market indices so investors may better understand which parts of the market are outperforming or underperforming, and how that may impact performance of our Funds at any given time.
As an advisor, I’d like to incorporate your funds into my clients’ portfolios. However, I am worried they wouldn’t make much of a difference to their overall returns given the typically small allocation to a small-cap manager. Why should I bother?
Within global equities, financial advisors generally allocate 15-25% to global small and mid-cap equities. So it is often much less than allocations to large-cap equities.
But small caps have historically outperformed large caps by around 2% per annum, though with more volatility. We believe this will continue.
That outperformance has a massive effect on how much wealth you can build.
Source: Credit Suisse Global Investment Returns Yearbook 2018
Despite small caps ‘only’ outperforming large caps by 2.3% per annum in the US over the last 100 odd years (see chart), that outperformance has resulted in an investor ending up with more than 6.5x (!) times the amount of wealth ($38,842 v’s $5,767).
Now perhaps you don’t have a 100-year investment horizon unless you are investing for multiple generations, but even over more common horizons like 30 years, history suggests investors should expect that small caps can build significant wealth.
At Ophir our internal investment objective is to seek to outperform the small-cap benchmarks of our funds by at least 5% pa over rolling five-year periods. An objective that we believe is more achievable in the small cap part of the market given its lower market efficiency. An argument we believe underpins the case for an allocation to small caps.
Given the very significant time you spend researching global companies for your Global Funds, could any of those businesses make it into your Australian funds, such as the Ophir High Conviction Fund or Ophir Opportunities Fund?
Possibly, though we see it as rare. Our Australian funds are permitted to invest a limited portion in global shares and our Global Funds are likewise permitted to invest a limited portion in Australian shares.
The reality, though, is we think the universe of Australian and global shares are separately large enough that we don’t need to go seeking out other pools to fish in for returns.
We also don’t want to provide ‘double-up’ exposure on certain companies across our Australian and Global funds for two key reasons:
- Many of our investors, ourselves included, own both the Australian and global funds for diversification purposes. We don’t want to pollute that through common holdings.
- We don’t want there to be any doubt in investors’ minds that performance of our Australian funds has been from Aussies stocks, not the addition of some from our Global funds, and vice versa.
So, while we wouldn’t completely rule it out, we think it would be unlikely and only in exceptional circumstances. Importantly, any common holding would have to include sufficient liquidity that both our domestic and overseas funds could hold without creating issues.
To finish, we just wanted to say how impressed we were by the quality of the questions asked at the events. We appreciate the candour of so many of you in expressing how you are feeling, what we are doing well and more importantly, what we can improve on. It reminded us again of how grateful we are for the high quality of investors we have invested alongside us in the Ophir Funds.
We look forward to seeing many of you again at our future events.
Andrew and Steven
Co-Founders & Senior Portfolio Managers
Ophir Asset Management