Copied below is my narrative:
Introduction: Honesty, Insight and Logic
The AlphaWealth Prime Small & Mid Cap Fund (AWSM Fund) is -5.87% for the Q2:17. We are both managers of the Fund and investors in the Fund, thus we are disappointed. That said, our benchmark collapsed -9.24% (or, -8.36% after dividends) during this period. As ironic as it may sound, we are quite proud of the +2.49% alpha we added to the Fund during this particularly difficult quarter.
It is the nature of small cap investments that we will be down over certain periods. But, as both an investor and manager, it is imperative to us that we make back the downside and then some more. Thus, right now, it is the future that intrigues us:
In this regard, since launching AWSM Fund in 2014, our underlying portfolio has never traded as cheaply as it is doing so now (at the time of writing this – 7 July 2017). On average, our portfolio is c.23% undervalued against our view of fair values of the underlying businesses. These discounts range from a 5% discount to a massive 72% deep undervaluation against our view of fair value.
(Note: These fair values are after we have hiked our risk-free rate from 9.0% to 9.5% in our models and softened our organic growth rates to adjust for a post-downgraded South Africa. Yes, we do risk-adjust and this helps us build margins of safety into our investments.)
Our average Cost of Equity across the portfolio is c.17%, thus assuming our fair values are correct, share prices move efficiently and rolling these fair values forward at CoE for a year, the implied twelve month return on our investments average c.40%.
This is not a forecast, but basic financial arithmetic. The future will likely differ wildly, but I am using it to justify my original statement: our underlying portfolio has never traded as cheaply as it is doing so now.
A couple other metrics* about AWSM Fund may interest you:
- AWSM Fund is currently trading on a Price Earnings (PE) of c.10.4x,
- It’s Price-to-Cash Flow (P/C) ratio is 9.7x,
- It’s Price-to-Book (P/B) ratio is 1.3x, and yet
- It’s Return on Equity (ROE) is currently 13.3%**.
If the AWSM Fund was a stock, these metrics alone would look attractive. Interestingly, AWSM Fund is intuitively safer than any single stock, as it is a collection of stocks and therefore diverse in nature. Hence, adding to its attractiveness.
Honestly, though, this has been a tough period to invest in South Africa and the politicians are not making things easier. Domestic investor sentiment is deeply negative and whimsical foreign capital flows are propping up our currency. With roughly a third of AWSM Fund as rand hedge / foreign businesses, we are also not entirely linked to this economy (in theory) should be able to perform in most investment climates.
New Investment: Sirius Real Estate Ltd (SRE)
Sirius Real Estate (SRE) is an example of a foreign business we are invested in. It is a new investment that we have added during the quarter and, although we are negative on (domestic) REITs and retail, Sirius is neither of these things.
Sirius operates exclusively in Germany and has a large property portfolio focussing on the industrial, office and storage space with both blue chip tenants and short-term, flexible workspace products.
More importantly from an equity-perspective, Sirius has an internal ManCo that has both plenty of spare capacity for additional assets (read: returns to scale) and adds significant value to structural and cyclical vacancies (read: organic growth).
The Group’s internal ManCo, Sirius Facilities, adds this significant uplift by redeveloping the vacant or void space into “smart space” with short-term, high margin leases into the German SME sector.
This both adds to the Group’s income and creates valuation uplift in the properties.
Sirius ticks a lot of boxes for us and made a sound addition to the portfolio during the quarter:
- Quality: >10% EUR-based ROE from strong strategic execution while the internal ManCo both aligns incentives with shareholders’ and captures margin.
- Growth: A great track record of growth and a long runway for more growth going forward, helped by the likely long-term ZAR depreciation against the EUR.
- Valuation: Relatively cheap against our fair value of €0.74 per share (c.12% undervalued).
- Portfolio: Sirius is both unlike any other company that we are invested in and offers us direct exposure to another economy other than South Africa (adds diversification to the portfolio).
Conclusion: Short-term Volatility, Long-term Conviction
Through all the recent chaos, noise and uncertainty, our strategy in the AWSM Fund remains:
- Find good quality, fast growing listed small cap businesses.
- Of these, invest in the cheapest of them, though limited to different sectors, markets and geographies.
- And, finally, limit the number of these 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-of-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 extremely excited about our Fund’s future.
* Data from Bloomberg (06/07/2017); ** Various company reports and AlphaWealth workings