4 key criteria for our holdings

We ended our February 2020 newsletter with the warning that “it is highly likely that we see more volatility in the month ahead.” We didn’t realise how ominous this warning would prove to be.

As it turned out, March 2020 was the worst monthly performance for the Australian stock market since 1987. We were not unscathed with the fund falling 23% for the month, broadly mirroring the broader market’s fall of 21%.

We do not intend to discuss the coronavirus at any length in this commentary, except to say that its rapid spread and the ramifications for the world economy are phenomena that the market has not seen before, at least in living memory. The speed of the market reaction in March was unprecedented and reached panic levels seen only once every ten years or more.

Amidst the panic selling, we set ourselves 4 key criteria to review both our existing holdings, and assess new opportunities as they emerged. Full commentary below.

Top Holdings (alphabetically)

ANZ Banking Group Australia Financials

BHP Group Ltd Australia Materials

Caltex Australia Australia Energy

CBA Australia Financials

Contact Energy New Zealand Utilities

NAB Australia Financials

Spark New Zealand Ltd New Zealand Communication Services

Telstra Australia Communication Services

Viva Energy REIT Australia Real Estate

Westpac Australia Financials

We ended our February 2020 newsletter with the warning that “it is highly likely that we see more volatility in the month ahead.” We didn’t realise how ominous this warning would prove to be.

As it turned out, March 2020 was the worst monthly performance for the Australian stock market since 1987. We were not unscathed with the fund falling 23% for the month, broadly mirroring the broader market’s fall of 21%.

We do not intend to discuss the coronavirus at any length in this commentary, except to say that its rapid spread and the ramifications for the world economy are phenomena that the market has not seen before, at least in living memory. The speed of the market reaction in March was unprecedented and reached panic levels seen only once every ten years or more.

Amidst the panic selling, we set ourselves 4 key criteria to review both our existing holdings, and assess new opportunities as they emerged.

1) Liquidity.  In this environment its often the illiquid names that suffer the most. Being stranded with an illiquid position can accentuate a negative performance, and inhibit the funds ability to participate in more attractive liquid opportunities.

2) Survivability. Primarily focusing on the strength of the company’s balance sheet and their ability to get through a period where cash flows are likely to be materially impacted.  Looking also at the extent to which their business model might be impacted – Supermarkets for example are thriving.

3) Emerge Stronger.  Several businesses will not make it through the economic shut down. Well capitalised participants that prudently pivot their business (costs / online) during the downturn will emerge stronger on the other side.

4) Valuation.  Sticking to our focus on being able to acquire good businesses at the right price – clearly an easier hurdle now than has been the case for some time.

Applying this methodology, we have been fairly active throughout the month, capitalising on what felt like a period of panic selling. We feel we enter April with a higher quality portfolio, better equipped to endure the economic shut down, however long that may be.  We have been active both in selling and buying with the net movement resulting in our cash holdings reducing from ~10% to ~5%.

Notable additions include BHP and Rio Tinto (both have exceptionally strong balance sheets, offer USD earnings streams and are exposed to the economy which we believe will be the first to emerge from the coronavirus, i.e. China). We also topped up holdings in Woolworths, Contact Energy, Bapcor and APN Convenience REIT. On the sell side, we exited our positions in Tabcorp and Ive Group. We had already down-weighted both positions in the second half of February after they had disappointed us with their FY20 interim results. In short, our investment theses were not playing out forcing us to re-assess whether to continue to hold them. If you do not have strong conviction around any particular investment you are better off not owning it, more so than ever in the current environment.

So, where to from here? Our focus at Pengana is on fundamental analysis to identify companies we can invest in for the longer term. Value is an important concept and whilst, in the short term, there is a lot of disruption and forecasting risk, we believe that there is a lot of value available in the market. After a fall over ~30% over two months we believe that there are many more opportunities than before. Clearly there is more uncertainty and one way we are positioning for that is to have more stocks in the portfolio with smaller average percentage holdings.