south african hedge fund

Lunar BCI Worldwide Flexible Fund Two-Year Review

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Two Years On

On 1 June 2018, we celebrated two years since the launch of the Lunar BCI Worldwide Flexible Fund.

We are proud of our performance of 8.27% (after costs and fees and including distributions) for the two years to 31 May 2018. This performance ranks the Lunar BCI Worldwide Flexible fund as 6^th out of 55 Worldwide Flexible Funds in the South African market over the two-year period and well ahead of the average fund performance of 0.04%.

The main drivers of our performance were:

We held a number of quality businesses through most of the period (Discovery, FirstRand, Amazom, FaceBook, Nvidia, Aspen, Amgen, PSG, Shoprite) and these have done well over the period, with a few exceptions;
We held higher levels of cash through most of the period (approximately 20% of the portfolio) awaiting better entry levels in the market;
Negatively, we were impacted by the poor performance of Small cap shares and the contagion from Steinhoff (we held no Steinhoff shares, but PSG was impacted). Rand volatility also impacted the portfolio negatively during the period.
Our best performers since inception are:
- South Africa in ZAR: FirstRand (51.15%), Shoprite (34.79%); Discovery (29.55%), Equites (12.96%).
- Offshore in USD: Amazon (103.82%), NVDIA (90.29%), Facebook (48.79%)

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We would have liked to have performed better than we did but are satisfied that most of our major investments have performed well. Our positioning was somewhat risk averse during the period. Where an investment did not pan out the way we envisaged, we analysed the reason/s for it and used that to improve our investment process. We are confident of our Investment Process.

“The stock market is a device of transferring money from the impatient to the patient.” Warren Buffett.

We have been patient and will be until we think it is time to be more aggressive.

Our Portfolio

Our portfolio composition is as follows:

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We recently reduced our stake in Discovery as our view was that it was trading at elevated values. We do however believe that it is a quality business and it is still part of our Top 10 holdings. We also sold our holdings in AliBaba at a good profit. We were concerned about the high number of acquisitions that AliBaba was undertaking.

Recent acquisitions include Glencore and Naspers. We like the mix of commodities mining and commodities trading in Glencore. It is also well placed to take advantage of the demand for cobalt and copper which are core components required for electric car and cell phone battery technologies. As for Naspers, it is trading at a deep discount to net asset value and its holdings in Tencent is an entry into the growing Chinese technology sector. The recent drop in Naspers share price provided us with an opportunity to invest.

Our portfolio is geared to taking advantage of demographic trends such as:

The growing middle class in emerging markets;
Ageing populations, especially in developed markets;
Technological changes creating opportunities for disruption and innovation;
The changing preferences of millennials;
Rapid urbanisation, especially in megacities; and
Climate change and the shift to cleaner energy sources.

We continue to assess these demographic trends, and how to position our portfolio given the opportunities that present themselves. We aim to invest only in those companies that provide growth at the right price and those that provide the potential rewards for the risk that we take. We wish to obtain above average and real returns at a portfolio level for our investors.

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Thank you to our clients, staff, directors, and business partners for your support, guidance and friendship. Whilst there are always significant risks in the financial markets, there will also be opportunities from which to profit. It is left to us to identify these risks and opportunities through our investment philosophy and methodology. Our aim is to provide a platform for growing the wealth of our families and communities.

We look forward to our third year as a fund, continuing to provide investment insights, and managing the fund for the benefit of all our stakeholders.[/fusion_text][/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

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Hubris

Investors are faced with a multitude of risks in any investment decision that they take. With the recent results from Famous Brands, Mediclinic, Taste Holdings and also not so recently Woolies and Old Mutual; one can’t help wondering if executive hubris^* is not one of the bigger risks that investors face.

Offshore Expansion

In the name of offshore expansion, too many South African companies have lost significant shareholder value:

Woolies was forced to write off R6.7bn after their disastrous acquisition of the David Jones business in Australia;
Old Mutual finally through in the towel in their London listing and foreign acquisition spree that began in the mid-1990’s. They significantly overpaid for foreign acquisitions. Just compare Old Mutual and Sanlam since they demutualised: shareholders who re-invested their dividends would have received a 553% gain if they invested in Old Mutual versus a 2,822% gain if they invested in Sanlam^**. Old Mutual went on an aggressive international expansion, somewhat neglecting its home market; whereas Sanlam stayed at home built its base and cautiously expanded into niche overseas markets;
Famous Brands, once a darling of investors is now struggling with its acquisition of UK’s Gourmet Burger Kitchen and closing some of the brands that it acquired offshore;
Taste Holdings, similarly is in a dire financial position as result largely for over-paying to bring big-name franchise brands like Starbucks into South Africa.

It is not only South African companies venturing offshore that get it wrong:

Massmart has struggled since it was acquired by the giant Walmart group. So much for bringing international best practice and significant buying power to a previously well-performing business.

The list can go on and on. Too often expansion plans don’t pan out how management paint the picture. Some records also show that most acquisitions don’t meet the original return criteria. One has to question why management do those deals in the first place. Does management overrate their own importance, or do they want to have their names emblazoned on iconic deals, or are they driven by perverse incentive schemes? Executive hubris?

Beware the trophy head office

Hubris takes another form in fancy new head offices. I’m certain there is a study somewhere that shows companies beginning to underperform after they move into fancy new head offices.

In the name of productivity, attracting top human capital, or branding; substantial amounts of money is spent building or leasing new offices, but it is never clear that the required return on investment is actually achieved.

It must be a great kick and boost to self-importance to drive into the fanciest offices in town.

Should we paint all with the same brush?

We know however that not all acquisitions or expansions are bad and that it does make economic sense at times to upgrade to newer, more efficient business premises. We argue that investors should be sceptical of acquisitions, international forays and trophy business premises. Too often, these in fact tell you more about executive hubris than about business strategy.

A good indicator of money well invested is Return on Capital Invested (ROIC) and ultimately also Return on Equity (ROE). Businesses that are able to allocate capital efficiently significantly outperform those that follow some grand footprint or flag planting strategy over time. We gave the example of Sanlam versus Old Mutual earlier. Another great example is FirstRand versus Standard Bank. FirstRand has been much better at capital allocation than Standard Bank and this is reflected in their comparative share price performance over the long-term.

Both Sanlam and FirstRand have also acquired businesses, expanded offshore and moved into new buildings. Arguably, they have been more selective and disciplined about the investments that they made and how much they paid for them. Their shareholders have benefitted substantially more than those invested in their competitors, and who may have not been as selective and disciplined in their investment decisions.

Beware executive hubris!

^* hubris = excessive pride or self-confidence; arrogance; feeling of superiority

^** Source: Business Day 18 March 2018; https://www.businesslive.co.za/bd/companies/2018-03-16-returning-old-mutual-will-find-sanlam-ahead/