90. A baptism of fire and the lure of addictive hobbies

27 August 2020 (pre-recorded 24 August 2020)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]
Juliet Schooling Latter (JSL): Hello and welcome to the Investing on the go podcast. I’m Juliet Schooling Latter and today I’m joined by Rosemary Banyard, manager of the [VT] Downing Unique Opportunities fund.

[INTERVIEW]
[0:14]

JSL: Rosemary, can you tell us a bit about the fund and what you look for in an investment?

Rosemary Banyard (RB): Yes, thank you. So, the fund is quite concentrated. It’s going to hold between 25 and 40 individual holdings, and it currently has 28. It’s going to be investing in UK equities and it can invest across all sizes of company and, including the AiM market. But my area of competence is small caps and mid caps. So, most of the investments will be in that, that sort of area. And the thing I’m looking for is, well the clue is in the title, so Downing Unique Opportunities, ‘unique’ is the word. And so I’m looking to invest in businesses, which, they might be the only one that’s listed in the UK, or there might be just a couple typically, that do what they do. Very occasionally, you might have a business where there are several in the industry listed, but then the business I invest in will be very distinctive in its strategy and culture. So, these businesses are… intentionally I’m seeking out companies that are unique and that have very high returns on equity capital. So, I’m an equity investor and I’m interested in businesses that can sustain very good profits on the capital that they’ve got. Cause that usually suggests that they’ve got something very special about them that keeps out the competition. And that’s what I really like.

[2:21]

JSL: Right, thank you. And your fund launched on the 17th of March, which was in the midst of one of the fastest sort of stock market falls in history, which must have been rather a baptism of fire. How did you go about allocating money to stocks, did you have a list of companies that you’d identified and did any of them change at the last minute?

RB: Yeah, so you’re quite right. It was right into the middle of the stock market freefall when the fund launched. You don’t have a precise say on when a fund launches, because it takes several weeks to go through the regulatory process. So, you know, it’s starting through that process in January and you know, then we found ourselves in the middle of March and off we went. And it was certainly a little unnerving initially I think, I think the market maybe bottomed about a week or 10 days after the launch.

So, I did go carefully, but it was fairly clear that the companies I wanted to invest in were trading at you know, very attractive valuations at that point. When you go through the regulatory process pre-launch, you put together a model portfolio for the FCA [Financial Conduct Authority – the industry regulator]. And I actually pretty much have stuck to that. I added I think two companies since launch, which weren’t in the model portfolio and they’re just new ideas. But everything else in the fund was in that model portfolio. So, I haven’t done anything differently from what I always intended. But I did take my time to build up the positions. I took only two companies into the fund which had placings – a lot of companies needed to raise money in April and May because of the sudden and damaging effects of the pandemic and the lockdown. And I had two in the portfolio which both raised a 5% placing, which was pretty minimal. But other than that, they’re all very well financed businesses with very strong balance sheets. And they haven’t needed to raise money. 23 out of the 28 companies have no debt at all. So, they’re very robust.

[5:04]

JSL: Right and am I right in thinking that you still have got quite a lot of cash in the portfolio, is that right? Sort of, about 19%?

RB: Yes, so you’ve got six months under the rules to become what’s termed ‘fully invested’, which means to have no more than 20% cash. And as I say, I took my time and was careful. And cash is in the 15% to 20% range now. And it varies day to day because I’m seeing daily inflows of money. And so, you know, some days I’ll invest more than others. And so you know, that’s roughly the range. Now, my history is that I tend to hold a bit of cash always, but more likely the 5% to 10% range. And that’s in order to have a little bit of firepower, if something suddenly becomes available, that’s very attractively priced and I want to nip in there and take advantage. So there’s, the cash level is a little elevated. But I wouldn’t read too much into that. That’s just me sort of continuing to build up holdings.

JSL: So that’s not because you’ve got sort of concerns about, you know, valuations and the, you know, the immediate outlook for equities at the moment?

RB: Well I’m quite clear that I don’t attempt to forecast macro, that I don’t invest with any macro view, I am very much investing in individual businesses that I think are going to deliver, you know, significant and above average growth over the long term. So, I’m not attempting to sort of second guess the macro or indeed the level of stock markets. So the one thing I would say is if something is, if a company’s shares are trading significantly and I mean, sort of 25%, 30% above what I consider their intrinsic value, I might try and hold off adding to a holding and add to something different that’s trading, you know, closer to fair value. So, you know, I will perhaps tactically buy certain things and not other things for a while, but that’s about as strategic as I get.

[7:46]

JSL: Yeah. Well, I know you’ve got a lot of experience because you’ve got sort of 30 years of experience in this industry. So you’ve obviously been through several stock market crises. Has that sort of helped you in the past few months with the recent crisis?

RB: I hope so. I think every crisis is individual in its own way. They’re never exactly the same. But I would say that in every crisis, having a majority of companies without much debt is hugely helpful. So, there’s nothing like having a lot of debt to destroy the value of equity, of the shares in a crisis, that’s always wise to remember that. But no, I think it helps one not to panic, but the interesting thing is, so I, you know, I do prepare a model for every company I own, and I forecast forward the sales on the profits and the cash flow, and then I discount that back to get to a value, that’s how I’ve value businesses. And what you find is if you put into the model one bad year, one really bad year, it actually doesn’t change the valuation of a business that much, because a lot of the value of a business is in the long term prospects. And so, yeah, it’s worth bearing that in mind, that one bad year, doesn’t, yeah, it doesn’t destroy the value of a good business.

[9:37]

JSL: That’s interesting. And I know the fund doesn’t look for companies specifically paying a dividend, but you hold Games Workshop, which is one of the few companies that’s maintained its dividend payout this year. I just wonder if you could tell us a bit about why you like this company and how’s the dividend managed to hold up?

RB: Yeah, so you’re right. I don’t specifically target dividend-payers, but companies that have got no debt and high returns, typically generate lots of cash. And so they usually are good at paying dividends that grow over time. So, you know, I have been historically and expect in the future, to see dividend growth, being good. Games Workshop’s interesting. I’ve known it since it came to the stock market, which is, you know, well, certainly over 20 years ago. It’s a business that pays out dividends from its surplus capital. So, when it’s done all its investing in its factories and in its licensing and research and development, anything that’s leftover, it will distribute as dividends. And I view that as a very healthy attitude to dividends.

Games Workshop you know, but many people will know it because it’s got the high street presence under the Warhammer brand. And put simply it’s making fantasy toy soldiers, which are used to play fantasy games and it’s a quite attractive hobby, people who get into it really get into it. They collect armies, they paint them, you know, it is quite, if you’re into it, it’s an absorbing hobby. And that’s, you know, that we almost might dare to call it an addiction or, you know, a hobby doesn’t change with lockdown. In fact, you know, one might take the view that it’s, you know, something that, you know, has some, some kids perhaps have had more time to play. But the thing that’s very interesting about Games Workshop is it’s starting to develop its licensing of its intellectual property.

And what’s interesting is that the license income, the royalty income, in the results to May 2020 was almost 20% of profits. And you know, that’s significantly up on the year before, and they’re talking about the fact that they’ve got over 17 licenses now, and that they’re adding licensees every two or three months. And they’re also talking about talking to licensees in China, which of course would be a huge market. So, I think we can expect to see that royalty income growing significantly over time. And it’s highly profitable. It’s almost pure profit. When you, when you give someone a license, you don’t have the manufacturing cost attached. So I, you know, I think that’s what we’re watching for.

[13:14]

JSL: Right, and I notice that you hold a couple of other stocks that supply the UK government. Kainos, which delivers digital systems for online transactions and Softcat, which supplies IT equipment. Is that a deliberate move, you know, is the government a more stable customer?

RB: Yeah, so good question. I mean, I think the government clearly is a more stable customer in these times. It’s not specifically why I own stakes in those two businesses. And I mean, if we talk about Kainos, it’s helping the UK government to digitalise its services to citizens. So certain things that would have been paper-based in the past, Kainos have helped to make them an online process. So, think your passport application or when you have a, your car having an MOT, the garage now records that online and sends it to the DVLA. And unless you particularly want to, you don’t get that piece of paper that you used to have to take to the post office every year with that MOT test result on. That’s all digital now. So that’s what Kainos do, it’s a huge growth area.

The benchmark for that is, would you believe is Estonia where 99% of state services are online. That’s because Estonia completely redesigned its whole government systems when it left the Soviet Union. And you know, e-Estonia is a big thing. So that’s the potential, that all government services will be online. Kainos is a leading player. And it’s not just the potential in the UK. It’s also in other countries. So, Canada is looking at our online passport application service. And so maybe we will see developments in you know other countries using Kainos as well. So yes, it’s government, but it’s more the potential for digitalisation which interests me, and Softcat really the same. It’s a very cash generative company, it’s supplying, not just you know, laptops but all manner of computing to companies and government, and with that comes quite a lot of technical knowledge and advice. And you know, it’s one of the two listed players in the UK that do that. So again, coming back to where we started the ‘uniqueness’ of the investment opportunity there.

JSL: That’s great, interesting stuff. Rosemary, thank you so much for your time today.

RB: Well thank you.

JSL: If you’d like more information about [VT] Downing Unique Opportunities, please visit fundcalibre.com. And don’t forget to subscribe to the Investing on the go podcast.