Ask any group of market veterans the key to investing success, and some will inevitably say you need to regularly trade in and out of shares.
Ask Sam Granger, the fund manager for the Totus Capital High Conviction Fund, and he’ll readily refute that concept.
Sam has a long-term investing horizon, telling The Motley Fool he hopes to find investments his fund can buy and hold forever. And a look at his fund’s performance over the past 3 years adds significant weight to his words.
Since the High Conviction Fund’s inception in January 2017, it’s delivered 18.5% in annual returns, net of all fees (as at the end of October). That compares to the 5.4% annual return from the All Ordinaries Total Return Index (ASX: XAOA), which includes dividend payments.
The past 12 months has seen an even stronger outperformance, with the High Conviction Fund returning 26.0%. That compares to a loss of 6.5% for the All Ords Total Return Index.
The fund is ASX focused, investing in both small and large-cap businesses. It’s also able to invest globally in developed markets when opportunities present.
The Totus High Conviction Fund currently has $12.5 million of total assets under management.
Sam explains that the fund’s small size, relative it its peers, provides a key competitive advantage, saying, “It enables us to invest up and down the market cap spectrum without compromising our liquidity.”
Read on for the full interview as Sam Granger reveals the methods behind his fund’s stellar track record.
What attributes do you look at before investing in a share?
We have a rigorous due diligence process that we put prospective investments through before they can be included in the Totus High Conviction Fund. The three key attributes we are looking for are:
- Deep and sustainable competitive advantage – we are looking for great businesses that have unique characteristics that allow them to earn high returns on capital for long periods in to the future.
- Runway for growth – we are looking for businesses that have opportunities to grow their earnings through time with high returns on incremental capital deployed.
- Excellent management team – we are looking for management teams that have a track record of outstanding operational performance and shareholder focused capital allocation.
Once you have found these three characteristics, the fourth consideration is price. Overpaying for good assets can lead to poor investment outcomes.
How important is broader macro analysis in your decisions?
We place no emphasis in our research process on macro forecasts of interest rates, exchange rates, commodity prices, etc. These variables are important but unknowable, in our view. We instead focus on building a portfolio of companies with robust business models and strong balance sheets that can thrive under a variety of macroeconomic outcomes.
Whilst we are not interested in macroeconomic forecasts, we are interested in structural shifts in consumer and business behaviour and how that impacts businesses. We generally favour companies that are benefitting from structural tailwinds that can aid future earnings growth.
ESG (environmental, social, and governance) investing continues to be a growing trend. Does this impact your investing decisions?
We have no specific ESG mandate in the Totus High Conviction Fund. That said, we think it makes good investment sense to look for businesses which are creating value for all of their stakeholders. Unsustainable relationships within the business value chain are a good sign of a management team too focused on the short term.
Knowing when to sell can mean the difference between a profit and a loss. How do you determine when it’s time to sell?
It’s a good question and one that I think about a lot. Unfortunately, there is no rule of thumb here which will enable you to make good sell decisions all the time.
One thing I would say is that if you read the letters of the investment greats, one of the recurring lessons is that selling a truly great business because it has gotten expensive on near term earnings is a mistake. My own experience selling great businesses too early suggests that this is a valuable piece of advice.
Do you use stop-losses of any variety? What types of risk management do you employ?
No, we do not use stop losses. The key piece of risk management for external investors is alignment. The Totus High Conviction Fund is by far my largest personal investment and for that reason we are focused on risk as well as return. We have also set ourselves a limit of no position being larger than 20% of the fund at cost.
What was your top investment over the past year? Why did you choose to invest in it? And what is your outlook for this share?
The top investment for the Fund over the past year was Objective Corporation Limited (ASX: OCL), which delivered a 186% return.
We chose to invest in this business because it met the 3 criteria I mentioned earlier – deep moat, runway for growth and excellent management. Objective sells mission critical software into government, which is very sticky once implemented. It has been undertaking a transition to recurring revenue, which has greatly improved the earnings quality of the business.
We think earnings and cash flow growth from here will be strong and it remains one of the largest positions in the Totus High Conviction Fund.
Flipping that, can you share your worst performer with us?
Our worst performer has been Gentrack Group Ltd (ASX: GTK), which sells customer billing software to energy retailers. Our key error was overestimating the stability of Gentrack’s end markets.
Energy retailers operate on thin margins in a highly competitive market. Regulatory changes in Australia and the UK impaired retailer profitability, which subsequently stymied their investment in software systems like Gentrack’s. We were too slow to recognise this business model pressure and then underestimated its impact on Gentrack. We also failed to act aggressively enough in cutting the position when we discovered some accounting red flags.
What’s the average holding period for shares in the High Conviction Fund?
We are long-term investors and hope to find investments we can buy and hold forever. We subscribe to Charlie Munger’s belief that “the big money isn’t made in the buying and selling, but in the waiting”. We have owned Objective Corp for 3½ years and many of our other largest investments for a number of years.
When we are entering new positions, we tend to start small and slowly build the position as our knowledge and conviction grows. Sometimes you quite quickly discover you have made a mistake and need to exit a position after a short period of time because the business or management are not what you thought they were.
How did COVID-19 impact your investment decisions? How do you see that moving forward over the next 12 months?
Financial history teaches us that unanticipated shocks such as credit crunches, wars and pandemics will inevitably rear their head over an investing life time.
Our view was that COVID-19, whilst devastating to some communities and businesses in the short-term, would not impair the long-term earnings power of the businesses we owned. For that reason, we used the COVID-19 sell off as a buying opportunity, deploying our cash reserves into existing holdings at very attractive prices. Cash levels in the Fund fell from 21% in January 2020 to 11% in March as equity markets sold off.
Ideally, we would have all our cash deployed in great businesses at fair prices. The movement in our cash holdings from here will be a function of how successfully we find new investment opportunities and more broadly whether equity prices become attractive. We can’t predict this in advance.
What do you see as the biggest opportunity for retail investors in year ahead?
We continue to like Microsoft Corporation (NASDAQ: MSFT) as an investment proposition. It’s got two huge growth businesses in Office365 and Azure, both of which look to have significant runway for future growth.
Office365 has the opportunity to further penetrate the office installed base and increase price through time. We are users of the software and derive a huge amount of value from it relative to what we pay in monthly subscription fees.
On Azure, as recently as last quarter, CEO Satya Nadella estimated cloud infrastructure is only 20% penetrated for existing applications. In addition to these 2 large growth assets, Microsoft owns a collection of high-quality businesses such as Windows, Xbox and LinkedIn.
And what do you believe is the biggest threat to share investors?
The biggest threat to investors is always their own emotions and behaviours. Trying to time markets, using leverage and over trading are just a few examples of perennial threats to long-term wealth creation in the share market.
As Warren Buffett says, “The stock market is a device for transferring money from the impatient to the patient.”
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