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 2 of this edition, Kardinia Capital's portfolio manager Kristiaan Rehder reveals 2 small-cap ASX shares with huge potential. And he explains why his fund remains bullish on CBA.
(You can find Part 1 of the interview here.)
The Bennelong Kardinia Absolute Return Fund employs a long/short strategy with the goal of making positive returns, whether the broader market is rising, falling, or flat. How did that strategy play out during the viral market meltdown and subsequent recovery in February and March 2020?
During the meltdown last year, our stop losses came into play. Our short strategy really came into its own. We saw the strategy doing exactly what it's designed to do during periods of extreme market dislocation. That's to grow the invested capital when you come out of it, but first and foremost, to protect it in the first instance.
Our short book has never been so profitable. I've been running this strategy for 15 years. I've never seen the profits generated in such a short period of time. That really provided a huge amount of protection for our long book. That meant the Kardinia Fund only drew down 3.9% when the market fell over 36%.
It was certainly a difficult, stressful time.
The number of names on our long books collapsed. We were forced out of lots of positions through our stop losses. We were also actively selling our positions when we thought we were holding too much.
On the other side of the ledger, our short book became incredibly fat with profits.
Any observer looking in the depths of March 2020 would have seen the portfolio was unbalanced. We immediately responded to that by looking to replenish our long book.
The biggest risk was that if markets were to bounce, as we ultimately saw at the end of March, an unbalanced portfolio could cause a huge amount of damage to the underlying investors.
We were quickly moving to buy back into long positions in the quality end of the spectrum. And we moved quickly to lock in our profitable shorts so we could bring the portfolio back into equilibrium.
What was your best performing investment over the past 12 months?
Sorry to bore you, but it was actually CBA [Commonwealth Bank of Australia (ASX: CBA)].
What we recognised in March and April last year was that this was an earnings issue for the banks. It wasn't a balance sheet issue, unlike what we saw during the GFC in 2008 and 2009.
We saw [in 2020] over 10% of borrowers switching off their interest and principal payments and deferring payments for 6 months. That put a huge amount of pressure on the banks. But the government came out with the JobKeeper initiative to allow a lot of businesses to stay afloat. And then you saw the quick response by central banks. So the banks weren't going to go bankrupt.
That's when we entered CBA.
What's your outlook for CBA and bank shares more broadly now?
We think asset growth is looking very favourable for the banks in this market. We've seen business in the large institutional lending side of things; strong credit growth; we've seen M&A [mergers and acquisitions] really starting to pick up. But we think that's just the tip of the iceberg. There's a lot more [M&A] coming.
The owner-occupied housing credit growth, based on the last data we saw, shows credit growth running at 6-7%. Owner-occupied is so important because 55% of all mortgages and 41% of all loans are written by owner-occupiers. It's the real engine in the housing market and growing incredibly strongly. And we're starting to see investor demand for credit starting to pick up as well.
The most exciting, I think, is the capitalisation of the banks.
CBA has a tier-one core capitalisation ratio of around 13%. We calculate that it translates to about $10 billion of surplus capital that's going to be returned to shareholders in the way of dividends or buybacks. And I think that's going to start this year.
A huge amount of capital return is going to find its way back into shareholders' hands. So we have a very positive outlook towards CBA and the banks in general.
Atop the banks, can you offer a few ASX shares you think our readers should consider adding to their portfolios?
There are a lot of good companies out there with strong prospects.
One name at the smaller end of the spectrum to keep an eye on is Proteomics International Laboratories Ltd (ASX: PIQ). It's very small, with a market cap of around $120 million.
They've developed a test to predict diabetic kidney disease. Approximately 40% of diabetics go on to develop diabetic kidney disease [DKD]. The issue with DKD is that most sufferers are asymptomatic when their kidneys start to fail. They often don't present with any kidney issues until it's largely irreversible, leading to dialysis or a full kidney transplant. DKD is costing the US Medicare system around $40 billion a year.
Proteomics' test can predict whether a sufferer is actually going to contract DKD with an 84% predictive measure before it starts. So that's a very interesting company that is looking to commercialise their product within the next 12 months.
One other, which most may not have heard of before, is Neometals Ltd (ASX: NMT).
The business is run by Chris Reed and his father. They've had a very successful mining career in WA, and they collectively own 10% of the company. They owned [a stake in] the Mt Marion Mine, a lithium mine, which was recently sold to Mineral Resources Limited (ASX: MIN) for over $100 million. They returned that capital back to shareholders.
And they've developed a process to recycle lithium batteries. This is going to be a big issue. In Europe, most of the discarded batteries are incinerated, where 90% of their mass is released into the atmosphere. Volkswagen alone is estimating they'll have 1 million tonnes of discarded batteries by 2030.
Neometals has a solvent extraction process which can extract key commodities from the batteries — lithium and nickel being the 2 most valuable. Through their process, they are one of the lowest global cost producers of lithium and nickel.
They've developed a successful pilot plant and are in the process of building their demonstration plant, which is only 2 months from completion. Then they'll move straight into commercialisation.
