HM1 Weekly Investor Update: 19 October

Hi everyone,
 
I hope you are all well.
 
We released our September monthly report last Monday (hence no weekly blog), where we reported a pretty flat month for September (-0.4%), which was pleasing in light of the 4-5% declines we saw in the leading indices around the world. The NTA numbers we published for the end of the month were $4.01 (pre tax); $3.82 (post current tax) and $3.63 (post all tax).
 
This morning we published the latest NTA’s for our portfolio, which were $4.23; $4.02; and $3.78.
 
I keep mentioning all three numbers because different investors like to compare the growth in different NTA’s, meaning some like to compare the growth in pre tax NTA (this is closest to the portfolio's investment return), while others like to compare the growth in post tax NTA, as this represents the cash per share that would be returned in the event of HM1 closing out all positions. This will be a topic I will go into more detail on next week.
 
By any of the NTA’s you wish to compare, October has been a good month for the HM1 portfolio so far. As I said, the growth in pre tax NTA is closest to the gain in the value of the underlying shares we hold, and this has risen from $4.01 to $4.23, which represents a gain of just over 5% so far. Pleasingly, the share price has responded accordingly, and this morning topped $4.00 for the first time in our short history - remember that we floated at $2.50 in November 2018, so for those that have been along for the entire ride, we hope you are happy with our performance.
 
You may have seen an announcement regarding some amendments to our investment guidelines that we released via the ASX last Wednesday. If not, you can view it here
 
The crux of the amendments revolve around how much of the portfolio (in percentage terms) one stock may represent. As you are probably aware, the portfolio consists of between 25 and 35 stocks at any one time. 65% of the funds are allocated to the recommendations of the six core managers, meaning 18 stocks, and the remaining 35% is allocated to the conference managers, typically 10-15 stocks. Generally, we have allocated c3-4% per stock.
 
We can, and indeed have, had two managers occasionally recommend the same stock. Think about that for a minute. Two of the best fund managers in the world both have ultra high conviction in the same stock! When this has happened, our mandate has allowed for us to have a larger position in that stock, and I’m sure you are happy to hear that we have done that. The only downside to this is that it means there will be fewer stocks in the portfolio the more this occurs. Whilst we are a concentrated high conviction portfolio, we feel we still must have a minimum number of stocks in the portfolio. We think this number is 25. 
 
So how large should a position get before it becomes “too big”?

Warren Buffett, as you would expect, has some interesting views here.

Some years ago, after a period of extraordinary outperformance from Coca Cola, the stock represented 40% of Berkshire Hathaway’s portfolio. It led to many comments that Warren was over exposed. Buffet’s observation was brilliant. He essentially said that having to sell Coca-Cola because it had performed so well was like the Chicago Bulls having to trade Michael Jordan because he was too good!

As I have said many times before, we constantly 'check in' with all of our managers to see whether the conviction in their recommendations have changed. Obviously there are two reasons this could happen. First, that the investment thesis has now played out, and the stock is now trading at what it is worth, or secondly, that something unforeseen has occurred, and the original theory is no longer likely to play out. Often the prevailing share price will tell us whether either of these scenarios is playing out.
 
Within our portfolio, we've had a few stocks that have played out brilliantly. Everyone has seen what Tesla has done. We’ve also had a couple of stocks in the core portfolio, that we’ve held for almost two years now, perform so well that they have become a larger than expected part of the portfolio. When I have spoken with those managers, they still have just as high conviction in the stock, perhaps even higher than when the share price was far lower, and believe that there remains further substantial upside in holding onto the stocks concerned. I think this is akin to asking MJ, when he has scored 60 points in a game, who still feels good, and the game isn’t won, should we take him off? Do you retire Don Bradman in a game to give someone else a bat?
 
As a consequence, our Investment Committee has decided that a single stock holding may now have a maximum weighting of 15% before it must be reduced. For a high conviction portfolio that consists of only the best ideas from the brightest fund managers we can find, I think this is a very appropriate weight.
 
This is a quality problem to have - what to do when one or more of your stocks has performed so well. We want to let the returns from our best stocks continue to compound for as long as possible, so that our team can score as many runs as possible for our biggest supporters, you, the shareholders.
 

Stay safe, and have a good week,

Rory Lucas
Chief Investment Officer
Hearts and Minds Investments Limited

 

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