Ask a Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In Part 1 of this edition, Kardinia Capital's portfolio manager Kristiaan Rehder explains when his fund goes long and when it decides to short ASX shares, along with 1 sector investors should steer clear of.
Fund snapshot
The Bennelong Kardinia Absolute Return Fund was launched in May 2006. That makes it one of the longest running absolute return funds in the Australian market. Bennelong assumed responsibility as a replacement trustee in August 2011.
The fund employs a long/short strategy. It invests in ASX shares with the goal of making positive returns, whether the broader market is rising, falling, or flat.
Over the past 12 months, the fund has returned 14.04% as at 30 April. The 6 months to 30 April saw the fund return 15.01%.
Now, on to Part 1 of the Motley Fool's interview with Bennelong Kardinia Absolute Return Fund's portfolio manager, Kristiaan Rehder.
Starting with the long side of your investment strategy, what triggers a buy signal for an ASX share?
We're very much fundamental stock pickers. We do our analysis from a bottom-up basis. What we're trying to do is identify companies with as many winning attributes as possible. Only companies which have our targeted attributes become contenders for our long portfolio.
What are some of those winning attributes?
First of all, we look for companies with a strong balance sheet, good earnings quality, cash conversion, and higher returning businesses.
We like to see businesses in large potential markets. If you can find a company that's operating in a large potential market that has an industry that's growing, and they're growing that market share within that industry, then you've got multiple powerful tailwinds for that business.
Governance is also important. And if anything, it's becoming even more important, with ESG [Environmental, Social, and Corporate Governance] considerations a real focus for investors.
Ultimately, we're after good quality companies at a fair price. We're not looking at dirt-cheap valuations. Because the reality is when you're trying to identify quality companies you often need to pay for those. But we are looking for companies with fair valuations.
On the other side of your strategy, what do you look for in ASX shares before you might short sell them?
I don't want to get bogged down in too much industry jargon, but we're what's referred to as a variable beta strategy. That means we can adjust our net exposure, depending on how bearish or bullish we are.
It's probably not much different from how you or I might invest in the market. If you are bearish, you have the ability to sell your shares and go to cash. And we have the same flexibility in our strategy. A lot of long-only managers are forced to be fully invested, but that's not the case with us.
How does that impact your short strategy?
What that actually means is that we need to make money off our shorts. That might sound obvious, but there are other absolute return funds who are happy to lose money on their shorts, because they approach their shorts as a hedge. As long as they make more money on the long side of their book than they lose on the short side of their book, they are satisfied with that.
We're different. They [shorts] need to make money in their own right.
So we approach our shorts the same way we approach our longs. We go through the same investment process with them. We're looking for companies that have weak balance sheets, poor earnings quality and cash conversion, low returns, and operating in a small potential market. Hopefully a shrinking market. At best the business is also suffering from market share erosion.
If you can find those sorts of 'loser attributes', if you will, then they can be contenders for our short portfolio.
Any areas you think our readers should look into shorting?
Broadly, a sector that's caught us a little by surprise is the mining services sector. It's a sector that should be doing incredibly well in theory [with high commodity prices].
Unfortunately, the issue of inflation is starting to creep into the mining sector. We've had a number of miners come out recently complaining about inflation. And often mining services contractors will win their contract on a fixed price basis. When inflation starts to occur, that causes issues to their margins.
We're seeing real signs of inflation right across the industry, particularly in Western Australia where labour is becoming increasingly hard to find. So mining services is one area at this time we're staying well away from.
Do you take the macro picture into account as well?
By virtue of our strategy, we need to take into account our outlook for equity markets. That helps us set the net exposure for the strategy. Splitting it up, about 30% of our time is focused on top down macro considerations and 70% of our time is focused on bottom up, fundamental stock picking.
What factors determine when you decide to exit your long and your short ASX share positions?
If there are changes to our investment thesis, including valuation, we'll close our positions. We generally live by the old adage that we let our profits run and cut our losses early.
We have a very disciplined stop-loss limit in place.
Once a stock falls by 15% [from the entry price] we close that position out, no questions asked. We actually have 2 stop losses that run parallel with one another. One is reset each month, so if the market moves against us by 15% that month, even though it might be profitable, we close it out.
This helps limit any losses to 15% and also forces us to lock in those profits when prices turn.
You normally hold 20–50 shares in your portfolio. What's the breakdown there between long and short positions?
Our short book is typically smaller than our long book. It's harder to find good quality shorts. On average our short book will contain between 5 and 12 individual names while our long book would be on average between 30 and 40 names.
And what's your average holding period for those shares?
Our typical holding period for our longs and our shorts is about 12 months. But our portfolio is made up of core positions and trading positions. The core positions make up a much larger component of our portfolio than our trading positions, which can move quite quickly.
We typically hold our core positions for 2–3 years.
Tomorrow, in Part 2 of our interview, Kristiaan Rehder reveals 2 small-cap ASX shares with huge potential and explains why his fund remains bullish on CBA.
