24th March 2023
Identifying a margin of safety in each investment we make is at the heart of our investment process. Put simply, we are seeking to identify investments with convexity: the downside should be limited due to us purchasing at an attractive valuation compared to history, whilst the upside should be commensurately greater. An example would be buying an investment trust where we have confidence in the net asset value (NAV) and can access shares at a significant discount to that NAV, and where there is a strong Board of Directors looking after shareholder interests, potentially buying back stock, or with a continuation vote as a backstop around the corner.
One example of this is a purchase that we made in our Global Opportunities Fund recently, as we reintroduced a position in Hipgnosis Songs (SONG) on a c.46% discount to NAV. Industry peers have been reporting strong revenue growth driven by streaming growth, and performance income bouncing back now that we are all able to get pushed around a mosh pit at a live music performance again post covid. Indeed, listed investment trust peer RoundHill Music recently reported a Q4 2022 NAV up around 8.5%. SONG has the backstop of a continuation vote in September this year, whilst the investment manager also runs a private royalty portfolio for private equity giant Blackstone, who have been hoovering up music catalogues and may have interest in buying SONG’s high quality portfolio in the event the trust fails that continuation vote.
Zooming out from stock specific examples, we have carried out an exercise looking at the distance our Vanbrugh Fund is from its all-time high price and comparing that to the weighted average distance the underlying holdings are from their own all-time highs. On a price basis, Vanbrugh is currently around 7% from its all-time high achieved in November last year. By contrast, the weighted average distance from all time price highs of the underlying portfolio is over double that, at -15%. Intuitively, this makes sense in the context of the margin of safety we seek in each holding and the dynamism with which we manage the portfolio. For example, Schroder UK Public Private (SUPP) is off 90% from its all-time high but, having just been introduced to the funds in recent weeks, we haven’t experienced that fall, and expect to capture the recovery if our analysis proves correct, albeit we are not banking on it returning to its all-time high! As active managers, we are constantly seeking to ensure that the portfolio reflects the best opportunities we identify at any point in time.
There is a lot of dispersion around the weighted average 15% figure, but it is worth noting that 39 of the 47 holdings are at least as far from their all-time high as Vanbrugh’s 7%. A further 5 are 3-6% from their all-time high, and no holdings are currently at their all time high – although WisdomTree Core Physical Gold is very close and has risen in recent weeks as fears around the global banking sector has risen following the failure of Silicon Valley Bank and Credit Suisse.
Contrast that with a passive fund which is unable to shift its underlying holdings around. Picking on Vanguard Lifestrategy 40% Equity as it sits alongside Vanbrugh in the IA Mixed Investment 20-60% Shares Sector, and we find that it is -13% off it’s all time high. This will be equivalent to the weighted average distance of the underlying indices from their highs too.
Vanbrugh must rise around 7.5% to regain its all-time high price. Vanguard Lifestrategy 40% equity must rise 2x that (c.15%) to achieve a new high. By better protecting capital on the downside, and actively changing the underlying portfolio too, Vanbrugh is compounding from a higher base and with a more attractively valued underlying portfolio. Distance from all time high is a very simplified way of considering margin of safety. It is possible to have funds at highs with greater margins of safety and return prospects than those at 90% discounts to their highs. It’s all about getting under the bonnet. We invest with active managers who like us are constantly evolving their portfolios towards the most attractive opportunities within their respective asset classes.
A favourite quote on the desk is from Ecclesiastes: ‘Those who wait for perfect weather will never plant seeds; those who look at every cloud will never harvest crops.’ Whilst market conditions are currently volatile with the above-mentioned concerns around the banking sector, we continue to work hard in our fields, harvesting the investments that have done well but where returns going forward are less exciting, and planting the seeds that we believe will drive future returns.
Dan Cartridge – Assistant Fund Manager
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