Markets were very strong globally in January, with the much anticipated “Santa Claus Rally” being pushed out to 2019 after a dismal December period. Listed Property was again one of the top performing sectors on the ASX up +6.2%.
The Atlas High Income Property Fund gained +4.3% in January, lagging the exceptionally strong index. The key driver of property index performance was strong returns from the Trusts whose earnings contain a significant proportion of development profits. With trusts such as Goodman and Charter Hall now being valued at over twenty times forward earnings, the market is pricing these trusts as if we were in the early days of a property boom, rather than in one that is visibly unwinding.
The Fund remains populated with trusts that offer investors recurring earnings streams from rental income rather than development profits. This should deliver a more stable stream of distributions throughout the property cycle.
Go to Monthly Newsletters for a more detailed discussion of the listed property market and the fund’s strategy going into 2019.
We tend to be generally sceptical about initial public offers, as the seller has a strong incentive to obtain the highest price. They achieve this by painting a glowing picture of the business they are selling and by choosing the most favourable moment (to them) in the business cycle to offer the shares for sale to the investing public.
Additionally, during the marketing period, new investors generally have only a few weeks to research the new company, mostly using financial data provided by the seller and carefully choreographed visits to inspect the soon-to-be-listed company’s assets. Today I am going to outline how institutional investors generally approach an IPO and the game of “Liar’s Poker” that goes on between fund managers and the investment banks running the IPO process.
Liar’s Poker
Liar’s Poker was the title of the 1989 book by Michael Lewis. It refers to a game played by bond traders at Salomon Brothers that involves gambling on the serial numbers of bank bills, where the strategy revolves around bluffing one’s opponents. In the case of an IPO or a capital raising , Liar’s Poker refers to the dance that goes on between institutional investors and the investment banks, especially one in which the pricing is yet to be determined.
The investment banks listing the company are motivated to exaggerate both the demand for and the superior investment merits of the company, whereas institutional investors will downplay their interest. Investors are attempting to develop a picture of the real underlying demand, and also are trying to talk the issue price down. This process will involve numerous conversations with the investment banks listing the new company, the company’s competitors, and other large institutional fund managers to gauge their interest.
In 2018, the Australian Securities and Investments Commission’s civil action against ANZ Bank around the bank’s $2.5 billion capital raising from 2015 revealed to the investing public how this game of Liar’s Poker is often played. The basis of the allegation is that ANZ did not reveal to the market that demand was muted, which left the underwriting banks with $791 million of ANZ shares to be sold as quietly as possible over the next few months. ANZ is defending the action.
At the time of the raising, ANZ and the underwriters, JP Morgan, Citigroup and Deutsche Bank, indicated demand was solid. Revealing the shortfall would have put ANZ’s share price immediately under pressure as hedge funds would have short sold ANZ shares, expecting they could cover their position later.
While there was a cacophony of outrage in the press, few institutional investors would have been surprised that the banks involved misrepresented demand to minimise their losses from underwriting the capital raising.
Who gets what?
One reason investment banks are keen to run an IPO process or a capital raising (other than the fat fees) is that in the allocation of holdings they can reward their good clients and use it as a lever to attract new clients. From my observations, large allocations tend to go to the funds that generate the largest brokerage commission, which are often high-turnover hedge funds rather than long-term owners of the company.
Occasionally the company runs the allocation process, as Amcor did in its 2009 $1.6 billion capital raising conducted at $4.30 per share, which mainly went to loyal, long-term shareholders.
When I started in the industry more than 20 years ago, the thought process for a hot IPO was to work out what you wanted and then bid for five to 10 times that amount.
Then when your fund is allocated a fraction of the bid amount, the fund manager can either stoically accept the allocation or engage in a high-drama scenario: threatening to reduce trading with the investment bank in question, while secretly being satisfied.
The investment bank running the IPO process is happy to indulge in this charade as it allows it to tell the company the issue was five times oversubscribed, implicitly highlighting the bank’s superior relationships with institutional fund managers.
In any IPO or capital raising, it is normally considered unfavourable to receive the number of shares originally requested. Getting your full allocation is rarely an indication that that company is very keen to have your fund as a shareholder, but rather reveals that the fund manager has misread the demand and investment merits of the IPO.
This article originally appeared in the Australian Financial Review
The investment banks listing the company are motivated to exaggerate both the demand for and the superior investment merits of the company, whereas institutional investors will downplay their interest. Investors are attempting to develop a picture of the real underlying demand, and also are trying to talk the price down.
In
December Listed Property was one of the top returning sectors on the ASX
gaining by +1.7%, significantly stronger than
the ASX200 return of -0.4%. The key driver of this outperformance was strong
returns from the Trusts with significant development earnings, with the market
ignoring the impact that a weakening residential property market will have on development
profits.
The
Atlas High Income Property Fund fell by -0.3% in December as the
rent-collecting trusts traded in-line with the overall Australian market. Atlas has
the strong view that
Trusts with recurring revenues from long-term leases will outperform those with
one-off development profits through the cycle delivering more consistent
returns to investors.
The
Fund paid a distribution of 4.6 cents per unit at the end of December.
Go to Monthly Newsletters for a more detailed discussion of the listed property market and the fund’s strategy going into 2019.
And although the number of M&A capital raisings was the lowest in 10 years, the amount of capital raised was the highest since 2011, with investors willing to put more capital into a smaller number of deals.
The “Dogs of the Dow” is an investment strategy that is based on buying the ten worst performing stocks over the past 12 months from the Dow Jones Industrial Average (DJIA) at the beginning of the year but restricting the stocks selected to those that are still paying a dividend. The thought process behind requiring a company to pay a dividend is that if it is still paying a distribution, its business model is unlikely to be permanently broken. The strategy then holds these ten stocks over the calendar year and sells them stocks at the end of December. The process then restarts, buying the ten worst performers from the year that has just finished. In this area, retail investors can have an advantage over institutional investors, many of whom sell the “dogs” in their portfolio towards the end of the year as part of “window dressing” their portfolio. Selling the worst performing companies avoids the manager having to explain to asset consultants why these unloved stocks are still in their portfolios.
In this week’s piece, we are going to look at the
“dogs” of the ASX, focusing on large capitalisation Australian
companies with falling share prices. Additionally, we are going to sift through
the trash of 2018 to try to discern any fallen angels with the potential to
outperform in 2019.
Unloved Mutts
The Dogs of the Dow was made famous by O’Higgins in his
1991 book “Beating the Dow” and
seeks to invest in the same manner as deep value, and contrarian investors do.
Namely, invest in companies that are currently being ignored or even hated by
the market; but because they are included in a large capitalisation index like
the DJIA or ASX 100, these companies are unlikely to be permanently broken. Inclusion
in a large capitalisation index such as the ASX100 indicates that the unloved
company may have the financial strength or understanding capital providers (such
as existing shareholders and banks) that can provide additional capital to allow
the company to recover over time. Smaller companies tend to face a harder road
to recovery with a greater chance on insolvency when they make it onto the
“Dogs” list.
Dogs over
the Past Five Years
The table below looks at both the top and bottom performers for the past five calendar years and their performance over the subsequent 12 months. As always this is measured on a total return basis, which looks at the capital gain or loss after adding in dividends received. Whilst sifting through the trash at the end of the year yields the occasional gem – such as Healthscope in 2018 (+9%), Qantas in 2017 (+65%), Fortescue in 2016 (+223%), Qantas again in 2014 – an equal weighted portfolio of the dogs of the ASX 100 has outperformed the index in three of the past five years. In 2018 an equal-weighted portfolio of the “Dogs” effectively matched the ASX200, perhaps a fitting outcome for an unpleasant year for investors.
Source:IRESS
Themes
Looking at the above table, finding the fallen angel
amongst the worst performers seems to work best where the underperformance is
due to stock-specific problems, rather than macroeconomic issues beyond a
company’s control. For example, Cochlear underperformed in 2013 after weaker
sales as the company waited for approval to sell its new Nucleus 6 product in
the United States. Subsequently, Cochlear’s share price has gained 202%, as hearing implant sales bounced back.
Similarly, BlueScope steel had a tough 2015, which saw the company seeking government
support to help restructure their Port Kemba steelworks. Concurrently, cheap
Chinese steel took market share at the same time as key inputs of iron ore, and
metallurgical coal was climbing upwards. 2016 saw a significant turnaround for
BlueScope’s shares which gained +147% as profits recovered due to cost
controls, stronger sales and the benefits of an acquisition in the United
States.
Additionally,
where the underperformance is due to a company-specific issue, the company in
question may receive a takeover offer from a suitor that believes that they can
snap up the company cheaply and then fix their problems. The best performing
“Dog” from 2017 in 2018 was hospital owner Healthscope (+9%) that is
now the subject of a bidding war.
The common factor among the underperformers that have continued their slide in the following year is when the underperformance is tied to factors outside the company’s control, such as a multi-year decline in a commodity. From the list of underperformers in 2014, continuing declines in iron ore delivered further pain to Arrium, Fortescue and BHP’s shareholders. Similarly, a several year slide in oil prices pushed down the share prices of Santos and Worley in the subsequent 12 months.
Unloved Hounds of 2018?
As a fund manager, the key question is whether there are potential show champions in the breed of unloved canines tabled below for the 2018 calendar year. Unlike previous years, the list for 2018 is more concentrated in a few sectors, reflecting industry-specific issues that have caused underperformance, rather than more easily fixed company-specific problems.
Source: IRESS
Looking
at the two vertically integrated financial advisers AMP and IOOF, it is tough
to see the near-term catalysts that will transform them into stars in 2019. The
final report from the Royal Commission into Misconduct in the Banking,
Superannuation and Financial Services Industry is due to be delivered in March
2019 and is not likely to be kind to these two companies. Similarly, the three
building materials companies in the above table are unlikely to see a reversal
of the trend of declining building approvals over the next twelve months.
Fund
manager Janus Henderson could be poised for a turn-around in 2019, with an
improvement in fund performance and further cost outs from the integration of
the two funds management companies. As the company is trading on a PE of 7
times with a dividend yield of 7%, investors have a margin of safety.
Similarly, a better than expected outcome from Brexit and an improvement in the
acquired Virgin Money business could see NAB spin-off CYBG stage a come back in
2019.
Our View
While the Dogs of the Dow
might work in a market populated with a diversified range of companies in
uncorrelated industries such as McDonalds, 3M, Merck and Microsoft, it does not
appear to be a broad strategy that one can use consistently in the ASX. We see
that amongst the companies in the ASX 100, the composition of the index is not
as broad as the Dow at an industry level. The ASX has a high weighting to
resource companies, whose profitability is primarily tied to commodity prices
(such as oil and iron ore) that are outside of management’s control and can be subject
to multi-year declines. Similarly, the ASX has a high weighting to financials,
all of which have suffered throughout 2018 from the Royal Commission.
Nevertheless, it can pay to sort through the dogs of the ASX. From the table above over the past five years, one of the top performers in the following year can be found by sifting through the dogs of the ASX100.
