Record volatility has led many investors to get in touch with us on a range of questions. What’s your strategy for navigating this crisis? How are you thinking about cash? What about Company XYZ?
We’re guessing many of you have the same questions so we thought it would be helpful to reach out to all our investors with our thoughts on the most frequent questions we are hearing.
Q: What is your strategy for navigating this crisis?
A: We haven’t abandoned our signature long-term, high-conviction investment process that emphasises quality growth and asymmetric outcomes. If anything, we’ve leaned even more into that strategy over the past two months.
Our view on the impacts of COVID-19 is a balanced one. On the one hand, the disease has created a genuine economic and public health crisis, introducing short-term risks around demand and supply chains that investors have been right to be concerned about. On the other hand, we are long-term optimists — a mindset that might seem quaint during bear markets but proves the most profitable far more often than not.
We acknowledge the record-breaking speed with which the global economy has stalled but also think it is important for investors to internalise the following:
- Prices have already fallen: Share prices here and abroad have already corrected — the benchmark for the Lakehouse Small Companies Fund is down roughly 36% in only five weeks — and thus a significant degree of fear and pessimism is priced into shares.
- Money is close to free: The RBA has cut the cash rate to a record low of 0.25%, injected billions into short-term credit markets, and signalled that we could be looking at years of ultra-accommodative monetary policy.
- Enormous stimulus is here: The US, Germany, and other major economic players are pushing forward with gigantic stimulus packages that could total 10% or more of their individual levels of GDP. These packages are unprecedented in their size, speed, and scope with the nickname of the Fed’s new plan, QEinfinity, summing things up nicely.
Our current strategy in terms of stock selection is consistent across both portfolios. On managing risk, we have pruned or exited positions in companies where we have concerns about demand shocks, supply chain disruption, issues with business continuity during a period of social distancing, and balance sheets that might have been fine during a typical recession but not in an environment where the economy grinds to a halt.
Meanwhile, we have opportunistically opened new positions and increased our holdings in companies that could prove medium-term beneficiaries, including market leaders that are likely to strengthen their position during a recession, or digital-first businesses who should see engagement and adoption pulled forward because of social distancing.
We’ve long said that our team does not feel a great compulsion to allocate capital to sectors that are notoriously cyclical, competitive, or capital-hungry, leading us to avoid the materials, energy, real estate, and utilities sectors entirely. We’re even more confident than usual to have 0% allocations to these sectors across both funds given that these sectors would struggle mightily if this sudden recession drags on for longer than any of us would hope.
Ultimately, the economy will get worse before it gets better, however, that is not necessarily true of the share market. Equity markets are forward-looking: that’s why shares have tumbled more than 30% before backward-looking economic data even began to hint at a crisis. We don’t know when the economy will bottom out but if history is any guide then the share market will have rallied long before the economy is once again on sound footing.
Q: We have seen other managers increase their cash levels on the back of continued uncertainty and heightened volatility. Are you of this view?
A: We appreciate the value of cash in a falling market and admire when investors change their minds when the facts change. To that end, we entered March with cash positions that were on the conservative side for our Funds — 14.1% at the Lakehouse Global Growth Fund and 14.4% at the Lakehouse Small Companies Fund — which provided some padding on the way down and has allowed us to play offense while markets are tumbling.
All that said, given the pervasive sense of panic in markets and with global equity markets down more than 30%, we think it is a tad late for managers to panic and swing towards cash, especially for those that call themselves long-term investors. We still have dry powder in both funds but have been selectively net buying throughout the month.
Q: How are you thinking about Company XYZ?
A: We’ve been asked about individual investments in both funds, which makes sense given we’re high-conviction managers. We plan to speak to many of them in next week’s monthly letters.
With the Lakehouse Small Companies Fund, the position we’ve been asked about the most is Afterpay. It’s easy to understand why as the share price has been all over the place during the last week as investors sweat over rising bad debts and slowing growth. We don’t doubt both will happen and we trimmed the Fund’s position in late January and then again in early March.
Unlike a big bank, though, whose loan book turns as slowly as a battleship, Afterpay has a much more nimble model because it turns over its receivables book 13 times a year. The company has already told the market that it has tightened lending standards and has multiple levers with which it can preserve cash. We’re also encouraged that three different directors bought stock in the last week. The Afterpay thesis continues to have a wide range of outcomes but we’re staying patient for now as the business still has significant growth potential on the other side of this crisis.
The position we’ve been asked about most at the Lakehouse Global Growth Fund is Facebook. Facebook is 28% off its highs as investors worry that the ad market will soften, a concern that Facebook acknowledged via a market update on Tuesday. Engagement has gone through the roof, however, as users in places where social distancing is occurring are turning to Facebook, Instagram, WhatsApp, and Messenger in order to stay connected.
We’re very pleased to see the pulling forward of this adoption curve and think that the engagement spike strongly validates the value Facebook’s networks bring to the lives of its users. We also expect that this crisis will force businesses to be more discriminating with their marketing spend, which bodes well for large online ad networks with wide and deep inventory, namely Facebook and Alphabet’s Google, as returns on spend are easier to measure and closer to the point of sale than, say, print, TV, billboard, or radio advertising.
Lastly, we note that Facebook is sitting on US$55 billion in cash — around 12% of its market capitalisation — with which it can make acquisitions during a distressed environment or buy back shares on the cheap. To the latter, we note that Facebook is selling with an enterprise value relative to trailing revenue of around 5.9, which is close to only half of its average of 10.2 over the past three years. Our investment thesis has not changed — if anything, it has strengthened given the acceleration in usage growth — and we remain patient holders.
Q: How liquid are you keeping the portfolios?
A: The Lakehouse Global Growth Fund is focused on mid- to large-cap global companies and so the liquidity in these companies is generally very high and remains so.
For the Lakehouse Small Companies Fund, we’re thankful to share that the Fund has had more dollars flow in than out over the past four weeks, which we think underscores the long time horizon of the Fund’s investor base. Meanwhile, in terms of liquidity itself, the market’s spiking volatility does have a silver lining in that volumes are up and thus it is easier than usual to maneuver.
It is worth noting that our turnover in both portfolios is very low compared to many of our peers and thus we have less need for regular liquidity to execute on our long-view strategy, but it is comforting nonetheless to see that both portfolios remain liquid allowing us to leverage selective opportunities.
Q: When will we hear from you again?
A: We’re aiming to release the Funds’ March letters in the first week of April. We’ll dig more into performance in those letters as well as provide more details on holdings we’ve introduced and exited. We also plan to host a webinar in the coming weeks and will get in touch via email with details.
Thank you all for your time and trust. We can’t promise performance or tell you exactly when markets will turn, however, we can promise that we will continue to hustle and stay true to our long-term, high-conviction approach.
Chief Investment Officer
Disclaimer: This report has been prepared by Lakehouse Capital Pty Limited (ABN 30 614 957 603, authorised representative of AFSL 400691) and by its officers, employees and agents (collectively “Lakehouse”) for the sole use of its clients as a record of the performance of their investment.
The information included in this message has been prepared without taking account of the reader’s objectives, financial situation or needs. All of the commentary, statements of opinion and recommendations contain only general advice. Past performance is not indicative of future performance.
The responsible entity for both the Lakehouse Small Companies Fund (ARSN 615 265 864) and the Lakehouse Global Growth Fund (ARSN 621 899 367) is One Managed Investment Funds Limited (ACN 117 400 987) (AFSL 297042). The information contained in this document was not prepared by OMIFL but was prepared by other parties. While OMIFL has no reason to believe that the information is inaccurate, the truth or accuracy of the information contained therein cannot be warranted or guaranteed. Anyone reading this report must obtain and rely upon their own independent advice and inquiries. Investors should read and consider the Funds’ product disclosure statements, which are available online, before deciding to invest in or redeem units from the Funds.