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 1 of our interview, Pengana Capital senior fund manager Rhett Kessler reveals why a big bank is one of his fund's biggest holdings.
Investment style
The Motley Fool: What's your fund's philosophy?
Rhett Kessler: I run the Pengana Australian Equities Fund. I've been doing it for 14, almost 15 years. We started three months before Lehman's went bust. So it was an interesting time.
Fortunately we made money that year, which probably set us up pretty well for the future. Our investment strategy is essentially to a: preserve capital in real Australian dollars; and b: to deliver a low volatility return of 6% above the risk-free rate.
Essentially the way we do that… is to look for companies that with a high degree of certainty, [and] produce robust after-tax cash earnings yields. That means that if I can build a well-diversified portfolio of ever-growing annuity streams, then we've fulfilled our investment strategy, and we'll preserve capital, and make our clients a decent amount of money.
I've always felt that we offer – it's maybe a bit boring – a safe place for people to put their money, particularly in times of volatility. So that they can go off and punt their Bitcoins (CRYPTO: BTC) and cryptocurrencies if they want, or whatever the latest flavour is. But knowing that when they come back to us, we'll still be ticking along.
MF: Starting the fund just before Lehman went bust must be the equivalent of someone setting up a fund at the start of last year just before the COVID-19 crash.
RK: Yeah, exactly. And you know, it helps you hone your ability to not only have high conviction but also to really test your ability to reach it.
We call it reaching across the abyss. Buying things when the underlying fundamentals say you need to – but also get through your vomit factor, which is after you've bought something, wanting to walk around your desk and throw up. That's the hard bit.
MF: To give our readers an idea, what are your two biggest holdings?
RK: The two biggest holdings at the moment are Telstra Corporation Ltd (ASX: TLS) and National Australia Bank Ltd (ASX: NAB). We're a high-conviction fund, so there's quite a few that approximate those holdings, but those are the two biggest.
We think [Telstra is] the lowest cost producer of gigs on mobile data, and they've got a very nice inflation bond embedded in the NBN recurring revenue stream. It's a good business with a well thought through turnaround strategy by management.
MF: Is NAB more of a temporary cyclical play?
RK: We were very fortunate to be able to acquire a really big stake at the dip of the COVID crisis when they did that deep discount capital raising. We already had a holding, but that was really big.
We've taken a view that all the banks significantly over-provisioned. Also, I firmly believe that there are two great banking franchises in this country – one is Commonwealth Bank of Australia (ASX: CBA)'s retail, and the other is NAB's business banking franchise.
We think the new management has a plan, and the competency to be able to significantly improve the operating practices of the business, for our benefit as shareholders.
What did The Australian say, it was a great quote? It said "You can almost feel the economy going boom" – and not in a bad way, in a good way. The NAB Business Survey, that came out today, certainly demonstrates that in spades, with every single metric going through the roof. And if you want to leverage to this via banks, NAB's business bank again sits at the forefront of that.
Buying and selling
MF: What do you look at closely when considering buying a stock?
RK: As a chartered accountant, we always think about 3 things.
The first one is: Is it a good business? It's not relative to other businesses but in an absolute sense. The 3 things we look for within 'Is it a good business' is: can I say with a high degree of certainty… in what I'm actually buying? So underlying the different earnings components and risk components. Secondly, can I predict with reasonable certainty what the future holds for the company? Thirdly, most importantly, who holds the power in every stakeholder relationship? That's where we spend most of our time.
Secondly: Is management trustworthy and competent?
And then thirdly: Can we buy it at the right price?
There's a lot of qualitative stuff we look at. And we spend a lot of time trying to understand the language that management is using in describing their business in order to gain confidence. That they're focused on the right things and that their story is consistent.
MF: What triggers you to sell a share?
RK: For every investment we hold, we have an investment thesis that tells us how we're going to preserve capital and make money.
More importantly, we have milestones against which we test that investment thesis. At any stage, those milestones indicate [if] the investment thesis is not playing out as we anticipated, in a material way – then there's no reason for us to hold it.
So if it's not going to be an annuity stream sometime in the future; if management has lied to us and therefore we can't rely on anything they say; if the industry structure has changed; and sometimes quite simply, if the share price just gets so high that we can't get an after-tax cash earning sealed commensurate with our requirements, then there's no point holding it any more.
Tomorrow in part 2 of our interview, Kessler reveals the ASX healthcare share that's set to explode.
