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, Totus Capital portfolio managers Ben McGarry and Tim Warner reveal their two biggest stock holdings and why they have so much faith in them.
The Motley Fool: How would you describe your fund to a potential client?
Ben McGarry: The Totus Alpha fund, we’re a long-short fund started in 2012 and we basically try to find companies with a strong track record of earnings, tailwinds for growth, clean accounting, preferably with owners and management with skin in the game.
We tend to hold them for the long term and then, against that, we balance out our portfolio with [shorted] companies, in a range of industries, that are facing challenges. They might have red flags in the form of aggressive accounting, insider selling, unsustainable business models. Occasionally, [they] fall into the bucket of fads, frauds, and failures.
So we’re a sort of quality long book, balanced out by a range of companies and industries facing challenges. And our point of difference is that the fund’s been going almost 10 years. We’ve delivered about just over 15% per annum, net of fees, but we’ve done that with extremely low correlation to Australian and developed market indices.
Our fund tends to do well when markets get volatile. One of our investors described us as a traditional growth long book with a put option. By that, he means not a new business model, growth that is unprofitable and unproven, but more traditional companies at reasonable valuations that are growing form the backbone of our long book.
Then our short book provides that downside protection when markets fall.
ASX’s quiet achiever
MF: What are your two biggest holdings?
BM: I’ll give you one Aussie and one offshore.
Amazon.com (NASDAQ: AMZN) is one we really like at the moment and have recently uploaded in our portfolio, but we’ve owned it for a number of years. Our biggest holding in the Australian market is Objective Corporation Limited (ASX: OCL), which is a mid-cap Aussie software stock.
Objective is a company we’ve owned for 4 or so years now. It’s a founder-run business. The founder, Tony Walls, still owns 67% of the shares on issue. We think he’s an outsider CEO — he’s done a great job of both growing earnings, but also a fantastic job of managing capital.
The business has never raised equity since its IPO and has actually bought back 31% of the share count since listing.
The things we like about Objective Corp is that it’s profitable, it’s cash-generative, it sells mainly to local, state, and federal governments.
So it has a very sticky or a very safe customer base and its earnings are highly recurring. It’s also very conservative in the way that it accounts. It presents its earnings to the market and the software that it produces is in the area of compliance, and regulatory compliance in particular, which is a long-term growth industry.
We also like it because it’s not that well covered by investment banks and sell-side research. So, we think it’s still, despite a strong run in the last couple of years, a relatively undiscovered name.
MF: Just looking at the price graph now, it’s done very well the last few years, hasn’t it?
BM: Yeah, it has and it’s sort of knocking on the door of index conclusions, which can be very difficult, given the size of the founder’s holding.
They’ve also done well in acquiring bolt-on businesses and plugging them into their software backbone. And they spend a very high proportion of sales on R&D and we think that there is a nice potential pipeline of acquisitions out there for them.
So yeah, we’re still bullish — despite the strong run — over the next couple of years.
MF: It looks like it didn’t even dip that much during the COVID crash in March last year — pretty resilient.
BM: The beauty of having government customers is that when… the economy’s crashing, the governments, the last thing they want to do is cut back on spending. So [Objective’s] customers are still actively trying to pump money into the economy, and that’s still the case.
They pre-released results for the June half and there was strong growth across the board. 48% increasing cash, 45% revenue gross — it’s growing very nicely.
Why investors should hold onto Amazon
MF: As for Amazon, investors have spent the last 15 years wondering “Has the growth now plateaued?” Where do you see the business going in the next few years?
BM: Despite it being one of the obvious COVID winners and experiencing explosive earnings growth over the last 12 months, the shares have basically gone sideways, apart from the last month or so, they’ve started to move up. And in Aussie dollar terms, the Amazon share price has actually not done a lot in 12 months.
We think the business is in a much stronger position post-COVID and the valuation has been back-filled a lot and is now quite attractive in terms of a long-term entry point for Amazon.
The reason we think it’s very interesting here and have recently increased our weight in the stock is that the higher-margin parts of the business are becoming larger and larger and are experiencing the fastest growth in the overall business mix of Amazon. If you look at their cloud infrastructure business, AWS, its revenue growth has been decelerating in recent years, but in the last quarter started to reaccelerate above 30% revenue growth.
We think that bodes well, given the cloud hosting is a higher margin than their first-party retail business. The advertising business, which is the highest-margin advertising business in the world, [is] a very significant business already — about 1.5 times the size of YouTube. That’s growing very strongly and it’s extremely high margin because they don’t have to wear things like content moderation costs that Facebook Inc (NASDAQ: FB), Twitter Inc (NASDAQ: TWTR) and Instagram et cetera have to wear.
So it’s basically a reasonable valuation after the last 12 months of sideways share price and we think that it will be basically a margin expansion story from here.