17 Jan 2019

Quarter in review

The beginning of this quarter saw the end of the long upward trend of equity markets. US equities were particularly savaged, while local markets performed better. There is plenty of expert discussion currently circulating on whether this is a “healthy” correction, or the start of a longer downturn. The average gestation time for a correction by the market is around three months, a bear market takes more like 18 months. Whether we are nearing the end of a correction or are at the beginning of a bear market only time will tell. We don’t profess to be expert market timers but have given some opinion on the outlook for equities in the commentaries below.

 

Ranger Fund

The Ranger Fund was down 7.96% for the quarter, with most of the negative return sustained in October. While the general market declines undoubtedly had an impact, the fund would have been down regardless in October as four of our companies suffered from negative announcements, which were unrelated to the market or the economy. Having such a large amount of unique and unrelated bad news coinciding with a very nervy market is unusual and unfortunate. The subsequent fall in these four companies share price contributed to most of the fund’s negative return.

Michael Hill announced that an adjustment in its market positioning had resulted in a 10% decline in revenue. AfterPay suffered from news articles speculating that the Australian Securities and Investments Commission intend to review the consumer credit space in which it operates. Kogan issued a negative trading statement, as changes in GST treatment impacted volumes. Corporate Travel was the target of a negative report issued by a respected short seller, VGI. While the headlines were pretty dismal, digging deeper reveals that, in our opinion, the long-term outlook for these businesses is not as bad as the market is currently assuming.

The trading statements from Kogan and Michael Hill are for the least important quarter of the year. Shares of these companies have been impacted substantially more than the actual financial impact of this quarter. These differences in impacts are because the market is now adjusting all future expectations as a result of these announcements. Even though AfterPay was frequently mentioned in the news articles citing the commission's review, in our opinion, it is the least at risk. We understand that the model of many payday lenders and finance businesses is to capture the consumer into debt and earn profits from excessive interest rates and lending fees. This is not the business model of AfterPay, which generates most of its revenues from charging the retailer. Tightening regulation in this area might actually be to AfterPay’s advantage. VGI's research report on Corporate Travel has been comprehensively rebuffed by Corporate Travel's Board. However, the report knocked investor confidence resulting in a sharp sell off. Looking longer term we continue to see excellent prospects for this business and for it to continue its strong track record of growth.

In November it was the turn of Boom Logistics, Redbubble and Australian Vintage to suffer from negative news. Boom Logistics announced an employee dispute and strike action in New South Wales which has subsequently been resolved. Redbubble's Thanksgiving trading results appear to have been weaker than market expectations, but it continues to grow strongly. Australian Vintage's outlook statement at its AGM appears to have been less bullish than the market was anticipating, partly due to frost issues. In our opinion, the negative news on these companies is all very short-term and has no impact on our long-term investment thesis for them, in some cases creating great buying opportunities.

Focussing on recent news and extrapolating that into the future is a well understood investment bias, and negative news in a period of market anxiety will certainly amplify that effect. However, looking longer term, we would expect to see price recovery as these news announcements and the recent wave of fear flowing through markets moves into more distant memory. We have topped up our investments in these businesses. While the prices of these companies might remain volatile for a while, short-term price volatility should not be of concern to a long-term holder.

Our Put Options were the only positive contributors for the quarter, but the contribution was modest. Most of the currently volatility is coming from the US market. While negative, the NZX and ASX price movements, to date, have not been as extreme or volatile. The option portfolio is there to cover more extreme events. In terms of material activity within the fund, during December we re-established a 5% position in Kogan.com. We had previously reduced our investment to a 2.5% position earlier in the year when the share price was around $9. Since then Kogan.com was hit by some short-term headwinds and the share price fell considerably, to a point that implied that the market believed that the business can grow earnings modestly at best. In our opinion, the long-term prospects for significant earnings growth have not changed and this was an attractive level to increase the fund's holding.

5 Oceans Fund

The 5 Oceans Fund was down 3.26% for the quarter (after fees) which, at first glance, is a disappointing result. This was, however, the first meaningful test of the capital preservation focus of the fund and the risk protection measures it has in place. Looking at some of the other balanced funds in the market their returns appear to be more like -5 to -6% for the quarter.

Going deeper into the underlying strategies, the Castle Point Ranger Fund was down nearly 8.0% which, as noted above, was more stock specific than due to overall market movements. The two global equity strategies were down, but both outperformed the MSCI World Index in a down period, which is one of the traits we were looking for (Acadian was -10.7% vs MSCI -14.4% in NZD, and Schroders was -9.0% vs -11% for MSCI in AUD). The tail risk strategies from Kohinoor were up over 20% which helped moderate the quarter’s losses, although there is a lot more return to be had from the tail risk hedges if markets move from a correction to a bear market.

The bond managers all contributed positively over the quarter, with AMP and Daintree continuing to deliver modest but positive returns. T. Rowe Price, with its greater focus on diversification and negative correlation with equities, had particularly good months in October and December (when the biggest sell-offs occurred) and was the best performing bond manager over the quarter.

We made one small change through the quarter which was to add a small allocation to our Trans-Tasman Fund and down-weight the Ranger allocation accordingly. This occurred on 20 November and the Trans-Tasman Fund was a modest positive contributor over the remainder of the quarter.

Overall, while disappointed to be down, we are pleased that the underlying strategies performed their respective risk reduction roles as they were designed to do, resulting in a material mitigation of downside risks and therefore reduced losses versus the traditional balanced funds.

Trans-Tasman Fund

Trans-Tasman Fund was down 7.5% versus its benchmark, the S&P/NZX50, which was down 5.77% (after fees but excluding Imputation credits).

Most of the damage was done in October. The main detractors were Kogan.com, Corporate Travel, AfterPay and Michael Hill which were all down significantly as they all suffered from negative news flow.

Michael Hill announced that an adjustment in its market positioning had resulted in a 10% decline in revenue. AfterPay suffered from news articles speculating that the Australian Securities and Investments Commission intend to review the consumer credit space in which it operates. Kogan issued a negative trading statement, as changes in GST treatment impacted volumes. Corporate Travel was the target of a negative report issued by a respected short seller, VGI. While the headlines were pretty dismal, digging deeper reveals that, in our opinion, the long-term outlook for these businesses is not as bad as the market is currently assuming. The trading statements from Kogan and Michael Hill are for the least important quarter of the year. Shares of these companies have been impacted substantially more than the actual financial impact of this quarter.

In November it was the turn of Boom Logistics, Redbubble and Australian Vintage to suffer from negative news. Boom Logistics announced an employee dispute and strike action in New South Wales which has subsequently been resolved. Redbubble's Thanksgiving trading results appear to have been weaker than market expectations, but it continues to grow strongly. Australian Vintage's outlook statement at its AGM appears to have been less bullish than the market was anticipating, partly due to frost issues.

The market tendency to overreact to bad news was amplified as the bad news occurred during a sharp and broad share market correction. We continue to review and monitor these investments but remain of the view that the long-term future of these businesses has not been materially affected by recent events.

TradeMe was the only material positive contributor, being currently subject to a takeover offer.