How going long and short in Australian Equities can generate returns for investors

Our first speaker today is Simon Shields from Monash Investors.

Simon is a principal of Monash Investors, which he co-founded in 2012.

Monash Investors is a longshore Australian equity manager.

The fund ends to deliver double-digit returns while limiting the loss of capital over a full market cycle in the medium term.

The fund is long biased.

Simon's topic today is how going long and short in Australian equities can generate returns for investors.

Welcome, Simon.

Hi there.

Hopefully you can see me and hear me now.

I'm also going to share my screen.

So I'll just put my stopwatch on because I know we've got a timed, it's very tight day today.

Okay.

So

Monash investors manages to a flexible mandate.

Purposely, so when Shane Fitzgerald and I founded the company in 2012, we wanted to be able to implement investing how we thought it was done the best way.

And after a long track record, working for some very large institutions across a range of styles.

So we want to make money for our clients going long as well as short.

And that is what I'm going to talk to you about today.

The aim is to put investors first.

We have a differentiated investment philosophy and we invest in a way that we believe clients can't do for themselves.

It's not just getting in, seeing the companies, doing the sophisticated modelling.

It's also the actual application of that information to how we invest the money, the position sizes that we short, how active we are.

If you've been following us for a while, you see that we are very good with the communication.

You'll get a report every month.

We do webinars regularly as well.

Two ways to invest.

We have our unlisted managed fund, which has been going now for 12 years, but we also have a listed fund, the M-A-A-T, which you can buy on the stock exchange.

It's an exchange traded managed fund.

So since inception, we've done about 10% per annum after fees, impacted a little bit by the recent downturn in the market, had been averaging nicely above that until recently.

You can also see the average cash way, it's about 20%.

So we're not forced to invest in the market.

This is the longer term numbers that we've been doing.

You can see generally we do quite a bit better than the ASX200 or the small loads, although the last year has been a bit of a struggle, particularly the last three months.

The portfolio is quite biased towards small cap.

So on average, I think about 80% of the stocks in the portfolio have been small cap as opposed to large cap stocks.

That's where we tend to find most of the opportunities.

And as I said, generally we do better than both indices, but there are times when it can be more difficult to outperform one or the other.

This puts the level of shorting that we do in perspective.

You can see that the light blue is our net exposure and the net exposure over time, as I said, has averaged about 80% to the market.

The gross exposure, which is what extra exposure we have on an absolute basis,

including the shorts.

You can see that, you know, sometimes standards are 100%, not to gear the portfolio, because the net exposure is still under 100%.

But it just shows you that it keeps you in proportion.

I suppose you can see that the shorting, while significant, is not dominating the portfolio by any means.

In terms of the contribution the shorts make, however, it's been very, very worthwhile.

So again, you can see over these time periods, the average weight of the shorts in the portfolio, let's pick on the three years, 6% on average.

Having said that, they've contributed an absolute 5% to the portfolio.

And that's a very significant part of the overall 17% per annum that the portfolio did over that period.

You know, when we short, we're aiming to make money.

We're not trying to put the shorts on so that they can underperform our longings and sort of add money in a relative sense.

We're doing it in an absolute sense.

That's why we call ourselves an absolute fund manager.

It doesn't mean that we don't go up and down with the market.

It just means that when we're investing in stocks, we're doing it to make money on an absolute basis, not on a relative basis.

Of course, for those that don't understand what shorting is about, it is when you can sell a stock that you don't own, right?

So you go and borrow the stock, you sell it, you don't own, if the stock goes down, you make money.

So we're able to make money for you from falling stock prices, as well as rising stock prices.

But what is our investment philosophy?

Well, Shane and I have been in the markets now for a long time.

We've been joined by other people over the years.

Sebastian Correa, for example, is also a fellow portfolio manager.

with us and our view is that most of the time the share market's pretty good for most stocks, but significant mispricing does occur at a stock level and also for the whole market from time to time.

So sometimes these stocks can be identified in advance because of recurring business situations and recurring patterns of behaviour.

That's what we're focusing on.

Those stocks that we can, you know, that at the end of the year you can look back on and go, oh gee, they really outperformed or they really underperformed.

We try and identify those stocks in advance

But we can only do so if we can find these recurring situations.

And that's what we focus on.

Okay, so what are some of these recurring situations?

Well, the big one is underestimation of significant change that could happen for many reasons could be a new product, it could be a change in regulation, it could be a store rollout, it could be a change in technology that's really disrupting or impacting an industry.

It could be a change in power between suppliers or competitors or

customers, for example, all sorts of things.

What we find is the market's very, very difficult incorporating those significant changes into the earnings outlook and the pricing of the stock.

There's a whole list of other things, whether it comes down to the way analysts manage their reputations or the way managers and boards of companies act, the way they have limitations and what they can say to people or the signals that they send.

There are many, many things, but the big one really is that underestimation of significant change.

So what I'm going to do for you today is I'm going to give you a couple of case studies just to illustrate what I mean.

So store rollout is a big one.

There's a company on the stock exchange at the moment called Lavissa.

It's a jeweler, has its own stores, and it's going through a very substantial store rollout program at the moment, not just in Australia where it's sort of completed, but more in Europe.

The United States started in Asia very significantly, Middle East as well.

And I'm going to compare that to

Other companies that have gone through similar store rollout programs, Harvey Norman did it in the mid 90s, Flight Center in the late 90s, JB Hi-Fi in the mid 2000s.

So let's see what happened when those companies had their store rollout program.

So JB Hi-Fi in the course of the mid 2000s was rolling out 30 to 50% store growth generally each year for a few years and had like for like growth at each store.

That led to some very significant

earnings per share growths, as you can see.

And as a result, the share price went up three or four times easily over that period.

It's not the whole life of the company.

It's only during these particular times when these store rollouts are going ahead.

Likewise, we can see with Harvey Norman, something very similar, not quite as strong on the store rollout, but still you've got that tripling, quadrupling of the share price as well as a result of that very good combination of the like-for-like growth and the store rollout.

Flight center, similar thing exactly

Good store growth, good revenue growth.

As a result, very good earnings per share growth.

This brings us to LaVissa.

LaVissa's done quite well already, actually.

You can see it's gone up over the last six years.

It's gone up a few, you know, tripled over that time.

But the store growth is actually now accelerating.

So in the prior five or six years, it was doing 15% per annum store growth.

We forecast in the next five or six years, it's going to be doing 22% per annum store growth.

So that's one of these situations.

The market has a great deal of trouble trying to value.

So if we're right about the store growth, you will see the share price go up multiples as long as they don't crop their bundle on the store profitability.

Now to talk about shorting.

because that's of interest to people.

And remember, shorting is when you sell a stock that you've borrowed, the stock price goes down, and you make money from the company going down.

And then you cover, that is you buy that stock back so that you can give the stock back to the person that you borrowed it from.

Now, the thing with shorting is in general, stocks tend to go up over time.

So it's quite a dangerous thing to do.

We don't short

Just because a stock's expensive, we're looking for particular opportunistic things that indicate to us the stock is likely to come off quite significantly.

We tend to hold our shorts for a much shorter period of time than we do our longs.

And so we've got some examples here of shorting strategies.

The key one I'm going to show you, this is the case study, is what we call abrupt management exit.

But there's also other situations when, again, the flip side of positive things happening

In terms of industry structure and competition is when negative things are happening so emerging structural challenges to earnings.

Companies that are going through high cash burns and their growth is slowing.

Also when they're accounting regularities or other catalysts.

So this abrupt management exodus is one that we've made a lot of money with over the years.

It is one of these situations where the share market has a lot of trouble incorporating this information to the share price quickly.

And we're not talking about the normal situation when a CEO

departs.

Normally, you get some notice, there's a there's going to be an executive search, there's going to be a handover period, and the company's doing fine during that period.

This is the situation where it's abrupt, where it's completely unexpected, where it sort of goes against what the management's been saying about their intentions for really driving the growth of the company, they might have plans in place that they're sort of walking away from before we've seen the results of them.

That's that's an absolute classic.

In general, management is unlikely to abandon companies that are doing well.

And there's been lots of examples.

And so we haven't named the companies in these examples, because that just causes people to be upset.

But we've given you the sort of companies that they are.

And you can see we've got about 10 examples here.

And these are all the ones that we saw in the last year or so.

And on average, the share prices fell between 50 and 60%.

over time from the point at which the management announced the resignation.

The other major factor in being able to achieve good returns is having a selling discipline.

And, you know, every time we invest in a stock, we're investing for a price target.

And that incorporates our expectations for the future earnings and balance sheet of the company.

And so once it gets to that price, even if it happens rather quickly, that share price is then incorporating all the good future news that we're expecting, and we exit.

But sometimes things don't go so well.

We call that investment thesis violation, we exit the stock.

And sometimes we have to start exiting early.

We're not 100% sure there's investment thesis violation, but there is an early warning trigger.

So it could be that other investors are shorting the stock, it could be an unexpected downward earnings revision, or it could be some sort of signpost that we're expecting gets missed.

In those situations, we sell a third of the stock.

And if it misses its signpost twice, we're completely out of the stock.

So this is what our portfolio looks like at the end of February.

In fact, we have a high turnover.

So since that time, we've been putting some more shorts in the portfolio.

But you can see it's a relatively concentrated portfolio.

Our main long positions, 14 of them there being about two thirds of the portfolio weight.

So I hope that's given you a bit of a flavour for what we do at Monash Investors.

As I said, if you're looking to invest in a portfolio that is predominantly small cap, taking advantage of opportunities that you couldn't otherwise take for yourself, long and short, relatively high turnover, then I think we've got something that you might be interested in.

Thank you, Simon.