Introduction: Two Types of Variables
This quarter—as with this year—the AlphaWealth Prime Small & Mid Cap (AWSM) Fund experienced the major headwinds of sour investor sentiment in a recessionary, post-downgrade South Africa as poisonous domestic politics drags on. As a proud South African, this makes me sad. As an investor, I look around and see numerous opportunities.
That aside, AWSM’s concentrated portfolio will tend to be volatile. Likewise, sometimes we will likely be on the wrong side of that volatility. Unfortunately, this quarter has been one such period, aggravated by the above headwinds.
The way we see it, there are two types of variables in markets: controllable and uncontrollable variables. In other words, there are variables that we can directly influence and those that we cannot.
There are two major variables that we can control in a portfolio:
- What companies we hold as investments (within our mandate’s restrictions), and
- What companies we do not hold.
All the rest of the variables, from the global and domestic economy, to the vulgarities of politics, to the whimsy of natural events are all variables that we cannot control. We can (and do!) try to anticipate, defend and hedge against these, but we cannot directly influence or change them.
While the uncontrollable variables are currently negative (see the above-noted headwinds), how are the variables that we can control doing?
(1) The Stocks We Hold
Given that we aim to invest in high quality, fast growing businesses and we try to underpay for investments into these businesses, here are some interesting statistics:
AWSM Fund Fundamentals versus Benchmark & All Share Index (as at 3 October 2017)*
AWSM Fund Valuations versus Benchmark & All Share Index (as at 3 October 2017)*
The above two graphs illustrate that the AWSM Fund’s portfolio holds less debt, achieves a higher margin, return and growth rate and is valued on cheaper multiples than its benchmark and, indeed, the entire JSE market.
Finally, although very subjective, we currently view our portfolio as undervalued by an average of c.30%. Rolling this forward at a standard Cost of Equity of c.15% implies a twelve-month return of c.45% that gives us confidence in our investments’ forward alpha.
Thus, we are comfortable that we are correctly managing what stocks we hold.
(2) The Stocks We Don’t Hold
As you can see from the above, the companies that we are invested into are good quality, safely geared, profitable and growing. In fact, our investments’ average better than our benchmark and the rest of the market on these key fundamental metrics. Finally, their share prices are arguably cheaper on a relative basis than the rest of the market.
This implies that, on average, the rest of the market has stocks that are worse than the ones that we hold.
Thus, we are also comfortable that we are correctly managing what stocks we don’t hold.
Conclusion: Short-term Volatility, Long-term Conviction
In conclusion, we are comfortable that we are executing on our mandate in the AWSM Fund. Despite a tough quarter and a tough year, we consider the AWSM Fund to be well positioned for the long-term.
As a reminder, the AWSM Fund strategy remains the following:
- Quality: We try to find good quality, fast-growing listed small cap
- Value: Of these, we invest in the cheapest of them, though limit our individual investments to different sectors, markets and geographies.
- Concentration: Finally, we limit the number of stocks we hold to only the very best fifteen to twenty stocks (we currently hold nineteen stocks).
In this way, we like to think that AWSM Fund holds a diverse, relatively lower-risk collection of only the best small cap investments out there and that it holds these investments in sufficient quantity to be really meaningful to us as investors.
As a co-investor into our Fund with the majority of my liquid net worth, I have absolute conviction in what we are doing and I am confident in our Fund’s future.
* Sources: Bloomberg, Iress, various company reports and AlphaWealth workings
For more on the AWSM Fund see here: