Ask A Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In this edition, Tribeca Investment Partners’ Alpha Plus portfolio manager Jun Bei Liu reveals why her fund will be staying the course with Afterpay and how investing is an art, not an exact science.
The Motley Fool: What’s your fund’s philosophy?
Jun Bei Liu: The fund’s called Tribeca Alpha Plus. It is a long-short fund. We have the ability to buy good quality companies and at the same time we can short companies where we feel the share price would fall. The fund size is about $830 million, and it has been around for over 15 years.
We’re very much focused on that fundamental research where we look to engage with companies and talk to the management and the like. What’s also unique about this fund is that we’re very return-oriented.
We’re not a buy-and-hold type of fund because we do believe return is generated through active investing, especially where we can short as well. When we do make 100% in the stock within a short timeframe, we will look to take profits and then we will look to move to the next business where they will give us the special amounts of return.
So very much active and follow where the return is.
JBL: That’s a really good question. We are very much neutral. So I like to buy, be it a growth company or a value company or somewhere in between, [with] as much flexibility as possible to generate returns for our investors.
I find it interesting in the marketplace, [often] I think that “value” term is very ill-defined. For example, as recently as March when the market had a sell-off, pretty much all companies were “value”. We thought Afterpay Ltd (ASX: APT) was a value company at $10.
It’s all about whether you get the future earnings correct and then estimate where you can make money. Because as an investor I always want to buy things cheaper than what I can sell them for.
MF: That’s a good point — back in March, pretty much everything was value.
JBL: That’s right. What’s interesting, you speak to a lot of fund managers and you would know that most of the Australian market really do struggle with growth companies, they just struggle with in terms of how do you value them and what is the right multiple and what to do. Whereas if you compare that with the American investors, they’re quite different because they’re used to that being part of tech in the index, and then they know how to value those businesses.
It’s just the maturing process. Our investors are becoming more sophisticated now and actually now, we have a lot more tech and growth companies listed. So hopefully we’ll see more of them, more innovation, and then we’ll get better at valuing those businesses.
MF: How has COVID-19 affected the fund?
JBL: Our fund has performed incredibly well. Our [benchmark] index is the S&P/ASX 200 Index (ASX: XJO). It’s managed to pull almost a flat performance for this calendar year, [despite] the tremendous volatility and uncertainty in the middle of the year. We have outperformed the index close to 9% by this calendar year. So we’re very, very pleased with the results.
This market, because of the volatility and because there’s uncertainty and different earning expectations for the positive recovery, it’s actually representing a phenomenal environment for active management. I think next year will be the same because the positive recovery will be very different for different companies and sectors, and so that means there will be a lot of earnings hits and misses. So if you get your stock right, you can actually generate a lot of returns.
Buying and selling
MF: What do you look at closely when considering buying a stock?
JBL: There’s a number of things. It all depends on where the stock falls into.
If we look at a company that generates really high growth, we look for the addressable market and we look for their execution. Execution as in terms of earnings momentum, new customer gains or new merchant adds… That execution is very important. That gives us confidence that they will be able to capitalise on the overall addressable market opportunity.
However, for businesses such as Treasury Wine Estates Ltd (ASX: TWE) for example, clearly we look for very different things. Because of the trade conflict or the tariffs being posted by China and the like, the share price pretty much collapsed. You can’t value a business like that on the earnings at this point.
So what we look at, in that case, is essentially ‘what do you pay for’?
We worked out [that] we became very comfortable in terms of the asset backing… The majority of value is sitting in premium wine, and we know these are highly sought after by consumers globally and we know this inventory will carry value really well, and they will be able to sell those. At the same time, I’m not really paying for ongoing earnings really, not paying for a brand franchise at all.
So this is on the value end, where we look at ‘what am I paying at the current price’? I can work out my downside is reasonably limited and while there’s uncertainty about the trade [conflict with China], I don’t need it to resolve for me to take a position in this company.
So yeah, it’s quite different depending on the sector, but ultimately I like brand. I like a company with a unique business franchise. I like a company that has a pull strategy where its customers, its suppliers needed this business to generate returns for everyone involved. If something’s special and unique, a strong business franchise is very important.
Brand is something that is incredibly difficult to build, and if you have a longstanding brand, it becomes incredibly valuable in today’s world. And especially, if you talk to any luxury brands, it’s just almost impossible for competition to build a brand from ground up.
So these are what we’re looking for. Balance sheet is important for some businesses. It’s important because it ensures you have enough capacity to support your growth. And for some mature businesses, cash flow is very, very important as well, because that just demonstrates the clear earnings that’s been coming through.
MF: Rather than having a single fixed formula, context has a lot to do with your decisions, it sounds like.
JBL: Yeah, that’s right, because we find investing is an art.
If you’re not flexible and just have a fixed formula, it doesn’t work with a dynamic world like today where we have experienced so many unprecedented things like the pandemic or the negative interest rates or that unprecedented monetary support and fiscal support and money printing.
I think it’s a really interesting point because in the olden days, people used to look to book value. But that was during a time when book value was incredibly important because there were a lot of businesses dominated by heavy assets. So that’s why that’s the value. But today’s world, because of technological advancement, most of the CapEx are actually spent on intellectual property or intangibles.
The world is changing. You have to be very adaptable and really find what’s going to be the future and those intellectual properties, they’re not going to disappear. And those combined CapEx on those intangibles are increasingly becoming more valuable. You’ve got to adapt and move with the world.
MF: What triggers you to sell a share?
JBL: When we love a stock, we do a lot of research and then we understand the value proposition for the customer. The biggest question is always ‘why do you exist’? But when we do sell, we have seen some cracks where we ask that question.
When a company’s unable to deliver on its previous promises, and not because of short-term disruption. Because we can look through the short-term disruption because things go wrong in businesses and then good companies pull through and then they become stronger and better.
But sometimes, it’s more structural issues that have changed for the business. Say the industry dynamic is changing quite rapidly, especially say it’s a high-growth business and the like, industry dynamics changed, new entrants have gone into the market with aggressive behavior or they’re taking more share.
Over time, when we start seeing changes in the underlying business assumptions for our investment thesis, we do question. And then that’s when we make the decision to sell.
But of course, sometimes when we have made returns, because as I told you we’re an active investor, when we generate enough returns, we do look to trim. We will take some profits and move it to the next one that’s going to give us double all of that.
Because ultimately we manage a portfolio with limited capital. So we have to recycle the capital to keep delivering and outperforming the market.
What’s coming up?
MF: Where do you think the world is heading at the moment?
JBL: I think the world is actually looking pretty good. It’s probably the best time in many years, in terms of economics, in terms of corporate earnings and the like. Of course, right now it’s not — but the best time as in looking forward the next 12 to 18 months.
Yes, we are in a recession. The pandemic has affected earnings globally, has affected all of that. But the corporates have rebounded their earnings now. The lowest of the earnings we saw was really in August this year. If anything, very encouragingly, we are seeing earnings upgrades compared to earnings downgrades has been the best in 20 years almost. It’s been incredible.
So interestingly this is actually creating an earnings growth profile or economic growth profile for the next couple of years of very strong growth, which we haven’t seen for a very long time, to be honest, here in Australia.
Normally the equity market does very well supported by earnings growth and earnings upgrades.
Putting that aside, interest rates are low and all the central bankers have talked about not increasing the interest rates any time soon. That’s good for the market because that ensures enough liquidity in the market to support their value.
Also you’ve got the government support in place. Yes, in Australia, March we may see some fading, but there’s still fiscal support around the world to support employment. For our market, it’s good to see our housing market is doing quite well. Iron ore price is pretty good. So that just means fiscally, there will be a much better fiscal position. And then we think there’ll be more targeted government spend to continue that support for the economy.
So all in all, I think the equity market looks positive for the next couple of years. It is a good time to be fully invested. But look, I think ultimately returns will be dictated by active management, which is on the stock level rather than by the overall index.
MF: Is your fund fully invested or do you have some cash in hand?
JBL: Oh I don’t hold cash in hand. I hold probably, I don’t know, probably hold 50 basis points cash in hand… Because I always believe cash is not a productive asset. You’re not carrying any interest rate.
My mandate is to be fully invested in the equity market, but the fact is that also I can short as well. So I can always find cash if I need to buy something. I’m very positive on the equity market — I just believe there’s opportunities everywhere. I don’t need a strong equity market to find those opportunities because they can be short or they can be long.
Overrated and underrated shares
MF: What’s your most underrated stock at the moment?
JBL: We talked about Treasury Wine and its points… We just believe there’s a lot more upside in this business given its brand, given this strong brand franchise.
I don’t know when we’ll move past the trade issue. However, I do believe that we can make cheap money. This company is just not going to stay here at this price for very long.
MF: Yeah, it can’t get any worse for them, can it.
JBL: That’s how we saw it. The downside is very limited.
70% of its value now is sitting in those wines, finished wine sitting in the cellar, and the rest are those farmlands in Napa Valley and South Australia. China [dispute] might still be going on for some time… But look, it’s a global brand.
If anything, it might be actually really great for this business — it might be a pinnacle moment for this business to actually really diversify. Previously China had such strong demand and they haven’t had enough stock to supply other reaches — and now they do.
So once China returns, this will be a truly global business.
MF: What do you think is the most overrated stock at the moment?
JBL: The truth is I don’t really want to get into talking about which company I short. You don’t make any friends.
I think in terms of overrated sectors, in November, there was a massive rally across some of the travel agents. Now we do like some stocks in travel, but we just thought these stocks have rallied very hard and they’re no longer cheap. They used to be cheap.
But at this point, we do need the earnings to return pretty quickly to really justify the current share price. Those earnings, we’re probably not going to see international travel until mid next year according to Qantas Airways Limited (ASX: QAN).
Domestic will probably return sooner. However, international is pretty important and it just means that earnings expectation may be now already too high for the next calendar year.
MF: Which stock are you most proud of from a past purchase?
JBL: Yeah, well, very hard to talk about this year and not talk about Afterpay. We actually have been a shareholder of Afterpay for a very long time and we’ve been a supporter of the business. And gosh, it’s been a rollercoaster ride, this stock.
When the world was falling apart in March, we had seen an incredible amount of opportunity. We absolutely saw it as a value opportunity at the time. And then we essentially bought more of the stock around that base when it hit around $10. [Ed: it is now $105.99]
We’ve done very well. We just thought it’s an incredible business. One thing about those high-growth innovative businesses or an innovator of a sector is that many of them fail and rarely do you get one that actually makes it. And if they do, they’re your 10 baggers.
So Afterpay is the one that we watched for many years and followed for a long time. They have really shown the validity of its business model and its franchise and the value it’s offering its customers, retailers, consumers is incredible. Their ability to also build into other markets… is incredible. This is real.
They have invented this sector, and then this is a sector where you actually see a lot of corporate and institutions’ interest now into that space. We take a very long-term view with this business and short term sell-off is really providing buying opportunities.
Yeah, that’s the one we’re very proud of.
MF: Are you concerned at all about the low barrier to entry for potential rivals?
JBL: No, not at all. But this is how industry matures. Interestingly, we actually haven’t seen this taking place for so long because not many companies have invented their own area, their own niche. Afterpay invented this space and then, because of how successful they are, they attract competitors.
But also don’t forget, this is a star in an industry generating an incredible amount of return in certain markets. What this does is that it actually attracts a lot of institutional interest and publicity. It actually helps to grow the sector and helps to mature the sector.
This is just the natural curve of the competition coming, but the market is enormous. The US, yes, they’ve gone there. They’ve done really well. It’s already bigger than Australia. But in the US, it’s still at 1% of the market share for that whole industry. And then there’s other markets that are still very, very new.
My view is that there’s still a massive runway before you’re actually hitting the maturity points where you start seeing the return get grinded away.
MF: Have you sold off any of it or are you still holding on?
JBL: Holding on, absolutely. We do take some profit trim as they go because, obviously, we only have limited capital to move into other things, but it’s absolutely still one of the top holdings in the fund.
Today, there will be an announcement that they will go into the ASX 50. Afterpay is a real business. This company has demonstrated its business model. It is a little bit different from the rest of say, Zip Co Ltd (ASX: Z1P) and Sezzle Inc (ASX: SZL) and the others.
If you look at Afterpay on the earnings space, it’s actually never been cheaper because it’s growing into its earnings now. And of course, the share price has done well — you’ll see a bit of stabilisation at the current level.
But look, you don’t buy these stocks for the next six months, right? You don’t buy this stock for the next six months of earnings. You buy it because it’s a global business. That’s how I see it.
MF: Has COVID-19 changed your investment methods going forward?
JBL: I think COVID-19 has really shown the incredible human spirit, to be honest — how positive the equity market can be. Actually how efficient the equity market can be.
In terms of changing investment strategy? Look, we haven’t because, as I told you before, we’re highly adaptable. So we just go after wherever the return is. So by the end of March, we were buying retailers. We’re buying tech.
And then we’re buying Sydney Airport Holdings Pty Ltd (ASX: SYD) and the like. And right now, we look at the opportunities that we still see. We do see an incredible amount of opportunity in those blue chips that share price has yet to return to the previous levels.
So for us, it’s more stock-led. We think that COVID-19 has really definitely put structural pressure on some of the sectors, whether it’s e-commerce or the way we shop, the way we eat or how we visit supermarkets. Things are changing. I think some of them will remain.
I don’t expect Zoom Video Communications Inc (NASDAQ: ZM) to disappear completely when we return to normal because all of us have found how efficient it is. Travel will return, absolutely. But I just think that the level of corporate travel might be different because it’s just much more efficient to do it over Zoom.
Human spirit needs will still return to normal, but some sub-segments may be impacted more structurally.