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, James Hawkins, partner and head of the recently launched L1 Capital Catalyst Fund, explains how the fund aims to achieve private equity-style alpha from the publicly listed space.
MF: How would you describe your fund to a potential client?
JH: I would describe the L1 Capital Catalyst Fund as a best ideas, high conviction, long-only fund with an activist overlay.
As a high conviction fund, how many shares do you invest in?
We can invest in up to 10 stocks. They can be located either in Australia or offshore, but Australia is our focus given this is the jurisdiction in which we best know the market, the companies as well as management teams and boards.
To give ourselves some flexibility, we also can invest offshore, but our focus will be Australia.
For Australian shares, is it strictly S&P/ASX 200 Index (ASX: XJO), or will you consider slightly smaller cap shares as well?
We are primarily focused on the ASX 200, the larger cap end of the spectrum. We will consider stocks outside of the ASX 200, but that will be the exception and not the rule.
ASX 200 stocks are already covered by the L1 Capital Australian equities teams. Our competitive edge is that we can benefit from their knowledge base and also from their $4 billion of existing FUM [funds under management]. This provides us with access to management and boards that we wouldn't otherwise get access to.
We also value liquidity. Liquidity is obviously much better at the larger cap end of the market.
What are the key factors you look at before considering adding a share to the Catalyst Fund?
There are 3 key gates which stocks need to get through to go into the Catalyst Fund.
Gate 1 is they need to satisfy our value analysis.
Gate 2 is they need to satisfy our quality analysis.
And gate 3 is they need to have a catalyst that can accelerate their returns and assist us to achieve our objective, which is to achieve private equity-like alpha from the publicly listed space.
Can you offer a few examples of the types of catalysts you're looking for?
The catalyst could be a demerger of part of the business.
It could be a sale of a part of the business that the market is not currently fairly valuing as part of a conglomerate structure.
It could be undertaking an increased buy back at a higher percentage of the company's issued share capital than the market anticipates, which would increase EPS [earnings per share] accretion.
Another catalyst could be a board deciding to allocate more capital to a higher returning part of the business.
Finally, it could be the board deciding to increase the dividend payout ratio going forward, which would be warmly received by the market.
So, there are a wide range of potential catalysts.
What sets your strategy apart from other investing strategies?
What sets us apart is the combination of our dedicated catalyst team of 3, whose job it is to enact and accelerate the catalyst, with a highly experienced team of stock-pickers in the 7-person L1 Capital Australian equities team.
The skillsets and decision-making are all brought together under the Catalyst Investment Committee, comprising the L1 Capital Co-CIOs Mark Landau and Rafi Lamm, and myself.
And that's a unique proposition in this market.
Why aren't more people taking an activist approach on the ASX 200?
Australia is a very small market and people have been reluctant to initiate here what is a very well-accepted strategy globally, both in North America and Europe.
There are a lot of bigger, more open markets for offshore investors to focus on and a lot of low-hanging fruit. Not just in North America and Europe, but also in Japan.
Of all the various investment strategies, activism has actually been the best performing strategy across the last 3 years globally, returning over 14% per annum.
Part of the challenge with being an effective activist is that you need scale. In order to get a company in the ASX 200 arena to listen, you typically need to own 3-5% of the share register.
That's where L1 Capital, through its $4 billion of Australian equities in their long short and long only equities funds, have scale on day 1. That scale enables us to have access and have a voice.
Without scale, it's very hard for newcomers to succeed in the activist space if they want to operate outside the small cap end of the market.
How do your environmental, social and corporate governance objectives fit in with this?
We think ESG ties in nicely with the activist element of the fund. Each of these – the E, the S, the G – are important elements of what we are doing. Governance is a particular focus.
We think that companies that can improve their governance protocols, procedures and ways of doing business can very much contribute to a higher stock price over time.
What does the current opportunity set look like for you?
The current opportunity set is wide and varied.
In large part, that's because activism has been somewhat dormant in the last 18 months due to the global coronavirus pandemic. This meant that, quite appropriately, last year and into the first half of this year, management teams have been focused on steadying the ship and business as usual.
However, as we slowly come out of the pandemic and the world returns to a more normal state of affairs, we'll see a backlog of structural issues which need to be addressed.
That provides a rich opportunity set for the L1 Catalyst Fund.
The pandemic has also accelerated the onset of change in certain things, like technology, by anywhere from 3–5 years. This will require companies to be more adaptive than they otherwise would have been. This backdrop of change will create opportunities for companies that are more nimble and able to adapt to the changed circumstances more rapidly.
What's the biggest threat to shares on the ASX 200 over the next 12 months?
There are always threats.
I think the ASX 200, from a valuation perspective, is very much demarcated into 2 parts. One is the growth part, which is trading on high multiples. With the other being the value part, which is not trading on as demanding multiples.
If you break the ASX 200 into those 2 halves, putting aside resources and company specific exposures, I think what happens with the US 10-year Treasury rate will have a big impact on share price performances going forward.
The US 10-year Treasury rate is in the low 1% range at the moment. If that rate reverts to where it was earlier this calendar year, so closer to 2%, I expect that will have an impact on which companies investors allocate their capital to.
With a new fund, you probably haven't gotten to this stage yet. But what will trigger you to consider exiting a position?
Foremost, we will exit a stock when the catalyst has been achieved. The catalyst is the driver of the private equity alpha. So, when that catalyst is achieved, that is when we will exit.
Alternatively, when we think it is going to take much longer than anticipated or not be achieved for some reason, we would seek to exit our investment.
You don't employ any sort of stop-loss strategy?
No, it's all stock specific, depending upon the circumstances.
How important is the macro picture?
We need to take into account the macro picture, because it influences the markets. But we think this strategy will be quite resilient to different macro factors, because it is so stock specific.
And if the catalyst can play out, typically it can more than overcome the macro factors.
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For more information on the Catalyst Fund, please click here.
