– Glenn Freeman (Livewire Markets)
Note: You can read the Fund Manager Q&A with Montaka CIO Andrew Macken and Portfolio Manager Chris Demasi published originally on Livewire Markets here.
For all the devastation coronavirus has wreaked, the rapid acceleration it has spurred in virtual working, streaming of music and movies and online shopping present enticing opportunities for some companies and investors.
Digital transformation, particularly for businesses, has accelerated in the midst of the pandemic and will only accelerate as we progress out the other side.
“Almost all of our work, entertainment, and communication is being done digitally – usually over mobile devices.”
These rank among some of the themes the duo have harnessed in the Montaka Active Extension strategy. Available in the Montaka Global 130-30 fund since it launched last May, the strategy also underpins the Montaka Global Extension (ASX: MKAX) exchange-traded managed fund that opened in June.
Macken and Demasi’s increasing conviction in companies such as music streaming giant Spotify, Vivendi – which owns Universal Music – and the ubiquitous tech firm Apple hinges on these trends.
In the following wire the pair discuss how they shaped the portfolio and reveal some favourite stock picks. They also explain why they don’t view global tech stocks as overpriced, and why “superficial valuation metrics” are over-rated.
What is the Montaka philosophy, how has it developed and what are the main influences?
We look to own the long-term winners in attractive industries, when those companies are undervalued. The core tenets of high business quality and undervaluation have remained the same since Montaka launched more than five years ago, but we’ve evolved that over time.
It was a mutual understanding of the powerful combination of these elements that brought us together in 2014. We both had deep experience identifying great global businesses when they were being undervalued.
Andrew had worked at Kynikos Associates in New York after completing his MBA at Columbia, where he studied the same value investing course Warren Buffett completed decades earlier.
Around the same time, Chris had been working for LFG, the private investment group of the Lowy Family.
Over time, we realised our capital would compound quicker by focusing on buying the world’s best businesses in the most attractive markets, because these businesses are consistently undervalued by investors. Good things happen to great businesses, and that’s something often overlooked.
Your Active Extension Strategy carries no cash – what’s the reasoning behind this and how do you achieve this?
That’s right, our Active Extension strategy – including the listed Montaka Global Extension Fund (ASX: MKAX) and the unlisted Montaka Global 130/30 Fund – is typically fully invested. This maximises the probability of compounding at the highest rates over the long term, especially in the persistent low interest rate environment.
Our Active Extension strategy is 130% invested in a long portfolio, which is achieved using the proceeds of a 30% short portfolio. This way, investors own more of the winners in attractive markets by selling the deteriorating businesses in challenged industries.
What criteria and qualities do you assess most closely when deciding what stocks to buy? And what factors will trigger closing a position?
To begin, we want a high degree of confidence that the business will be a long-term winner – over the next decade and more. We want to see evidence of an advantaged business model, with an extraordinary moat – what we view as a strong competitive advantage that can’t be replicated by others. This typically shows up in:
- 1. leading and expanding market share
- 2. predictable and durable revenue streams
- 3. high profit margins and returns on capital
- 4. strong cash flows and a clean balance sheet.
We also want to see that the markets for the business are large and growing, brought about by structural change that will be sustained often for decades.
Then it comes down to price discipline, so that we only acquire a position when the underlying fundamentals of the business and its real growth options are underappreciated by the market. We look at discounted cash flow valuation measures, internal rate of return estimates, and scenario analysis to guide our assessment. We look at these in the context of interest rates, probabilities of success and downside risks, as well as overall portfolio impact.
In terms of selling out of positions, this is a consideration when our view of business quality and growth prospects change, or if the stock becomes substantially overvalued. But we’ve learned over time that valuation isn’t a precise science, so have become less sensitive to short-term price movements.
What are some of the most important structural trends you see in the world today?
Digital transformation, particularly at an enterprise level, has really accelerated coming out of the COVID-19 pandemic, and we’ve consolidated our portfolio around the winners in this space.
This is also happening at an individual level, of course. Almost all of our work, entertainment, and communication is being done digitally – usually over mobile devices. Our holdings in Spotify, Vivendi – which owns Universal Music – and Apple will benefit from this.
The increasing penetration of e-commerce around the world is a similarly powerful trend, and we own positions in Amazon and Alibaba.
Another theme we’ve also invested behind is the multi-decade demographic trend of ageing populations around the world. As people get older, the demand for healthcare and financial advice services will increase. Companies like UnitedHealth, the largest health insurer in the US, and St James’s Place, the UK’s largest wealth adviser group, are well-positioned to capture this demand growth.
Beyond these themes, we also believe the low-interest rate environment is likely to persist for a very long time, and this is still being underappreciated by the equity markets.
What’s a standout stock you’ve added to the portfolio recently, and explain why you made this call?
We added Salesforce (NYSE: CRM) to the portfolio earlier in the year as we increased our exposure to digital transformation of the enterprise.
Salesforce provides cloud-based technology for enterprises to manage their customer relationships, along with other enterprise applications. And it’s become the clear market leader in customer relationship management software, driven largely by its cloud technology and platform. This carries a high degree of customer lock-in and economic advantages for the business, with gross margins of around 80%.
We’re confident Salesforce will remain a winner in its markets a decade from now, and we think it will be hard to lose money on this investment. In fact, when the market realises the potential growth profile of the company, combined with very low interest rates, the stock could make a lot of money.
Tech is a big theme for you, but this segment is perceived as being pricey. Could you explain why you think these businesses have been consistently undervalued by equity markets? Can you share a current example?
Investors are sometimes too fixated on typical valuation fundamentals like price-to-sales, price-to-earnings, or price-to-book ratios. These rules of thumb are particularly unreliable, even dangerous, when it comes to assessing the long-term value of the world’s leading software ecosystem business models.
For example, in 2012 Facebook stock was trading at around 50-times EBITDA – which sounds pretty expensive – when the share price was under $30. But looking back, you probably would have been happy to have paid up to 300-times, because you would still have made incredible money with the share price at more than $300 today – up more than 900 per cent from when it first listed.
This shows just one of the many limitations of superficial valuation metrics. They don’t properly capture:
- 1. high growth rates for long periods
- 2. advantaged business economics, especially extremely low capital intensity
- 3. real growth options of new markets and new business lines
- 4. the low interest rate environment.
We think this continues to be the case today not only for Facebook, but other stocks including Microsoft, Salesforce, ServiceNow and Spotify.