Your questions: Fund Positioning
In a month characterised by pandemics and corrections, it has been fair to say the Montgomery team has been busy on all fronts. Our ongoing commitment to keeping our investors as informed saw us host webinars on both the domestic and global front. At each presentations, our investors were welcomed to ask questions directly of the Montgomery team. I have shared a number of the common questions here.
Q: What is the current positioning across the Montgomery strategies?
The positioning across the Montgomery and Montaka suite of strategies in terms of equity and cash as at close of business Friday 27 March:
Concentrated, high conviction equities
The Montgomery [Private] Fund – 35% cash, 65% Australian/New Zealand equities
The Montgomery Fund – 33% cash, 67% Australian/New Zealand equities
Montgomery Small Companies Fund – 21% cash, 79% Australia/New Zealand equities (generally ex-ASX 100)
Montgomery Global Fund/ASX:MOGL – 41% cash, 59% global equities
Alternative equities strategies
Montaka Global Fund (& Variants) – 7.5% net market exposure; 77% long global equities, 70% short global equities (generally 30 to 70% net)
Montgomery Alpha Plus Fund – 15% net market exposure; 161% long global equities, 145% short global equities (generally 0% net, or market neutral)
Q: For the funds that hold cash, has there been much movement in the cash over the month of March?
Looking at the domestic strategies first, there has been a small decrease in cash close to month end for The Montgomery Fund and The Montgomery [Private] Fund. Some of this has been deployed in two stocks, one existing and one new, where we believe the market has over-sold these businesses due to weakening, temporary outlook as a result of COVID-19 (stay tuned for the quarterly commentary to come out next month). Coming into the markets peak on February 20, the fund’s already held elevated levels of cash (just above 20 per cent), so the building of cash at the beginning of the month was partly due to the falling value of the equity component but more due to the de-risking of the portfolio or deliberate cash building in review of the envisioned impact of COVID-19 on some specific portfolio names.
The Montgomery Small Companies Fund started exiting stocks with potential 1st order COVID-19 impacts in February and consequently exited that month with 16.7 per cent cash, more than the normal 5 per cent targeted level of cash. The process of lowering exposure to certain stocks and sectors continued in early March, with the Fund reaching 40 per cent cash level early in the month. Whilst the ASX100 movement may have been surprising to some, it would be fair to say the volatility in the small cap end of the market has been absolutely dizzying. The investment team are conscious of some dramatically lower stock prices for many quality small caps, that in their view, would make it to the other side of the COVID-19 crisis, thought it more balanced to reduce cash weightings. The team took advantage of lower prices and put half of the funds’ cash balance to work – approximately 20 per cent. Around three quarters of that capital got re-invested into existing stocks in the portfolio, with the balance going into five news stocks in the portfolio.
Like the Montgomery Small Companies Fund, the Montgomery Global Fund/ASX: MOGL was more invested coming into the markets initial sell-off at the back end of February. This was based on Montaka’s house view that interest rates would remain structurally lower for longer at the end of calendar year 2019 and beyond, which given where credits markets were at and due to some geographic and stock specific mis-pricings (for example, long-term valuations being suppressed in the UK given the uncertainty of Brexit), they were more invested and held under 10 per cent cash. Initially as they observed a COVID-19 recovery in China, the team did further deploy some cash into some Chinese names they have held on a long-term basis. However, they also observed how under-prepared the Western World was for COVID-19, namely the U.S, and as such made the decision to build significant cash from positions of the portfolio they believed to be most at risk (namely financials, and some air travel specific names). The Montaka team recently shared a Q&A on their views in more detail, which can be accessed here.
Q: If I add to the funds now, will be invested in the market or will my addition form part of the cash component of the fund?
As each one of our fund’s represent a pooled, unit trust structure, the date the monies are received is the date you will be invested in the market. As such, your investment in the fund will represent the equity/cash mix in the fund as at that day. For example, if you invested in The Montgomery Fund as of last Friday’s unit price (27/03), you would have been invested 35% in cash and 65% in Australian/New Zealand equities. From an investment perspective, we will then deploy the accumulated cash if the total percentage held falls above the desired cash to equity balance in the portfolio. Current investors might recall that as part of the unit trust structure, each investor does not have a unique (or pro-rata) CGT investment experience for the assets the fund holds, and as such the investment make-up is always at the fund level as at a point in time.
Q: How will the sell-off impact the income returns of the funds?
The majority of our strategies can distribute realised earnings (including dividends, realised gains versus losses, and interest from the cash we hold) either annually or biannually. However, the only strategy across our investment suite that currently guarantees a distribution is ASX: MOGL, which pays a minimum distribution yield of 4.5% p.a, six monthly.
Although our other strategies can pay a distribution yield, is isn’t guaranteed in the product structure. By way of example, The Montgomery Fund’s yield up to the end of February is 6.19% p.a, which has traditionally been paid six monthly. The Fund, however, did not paid a distribution on 31 December 2015 and 31 December 2012 (noting the Fund only launched in August 2012).
In a situation where the realised earnings are less than the realised losses, or the income component is very nominal, the fund is unlikely to pay a distribution. This is dependent on our trading activity over the six-month (or twelve month) period, and of course how equity markets perform. As a lot of our strategies have accumulated cash year to date in a period where equity markets have been selling off in aggregate, it is likely the realised gains in our funds will be low for the quarter to date. However, there is still three trading months before 30 June and a lot can happen before then (remember this has only been going on for six weeks!).
Q: If things get uglier, can the funds use derivatives to protect investors capital?
In the case of The Montgomery [Private] Fund, The Montgomery Fund and Montgomery Global Fund, Montgomery and Montaka do reserve the right to use derivatives as per the respective Product Disclosure Statements. To date, The Montgomery [Private] Fund and The Montgomery Fund have not used any derivatives. If the team were to use derivatives in these funds, it would likely be in the form of putting a putt on the Australian market. The Montgomery team has chosen to not exercise this right and has favoured defensive stock selection and the ability to hold high levels of cash as the main means to preserve investors capital, as much as we can in equity markets. The Montgomery Global Fund, on the other hand, primarily uses derivatives for its many offshore currency exposures which is actively managed. This tends to be used in the form of currency forwards.
Q: What is the best way to track the team’s deployment of cash?
As the team’s primary focus is of the management of the various investment strategies, we would encourage existing and prospective investors to follow our monthly updates to track the deployment of cash at the fund level. Of course, as much as practically possible we will try keep our broader readership with our views on equity markets via our blog and other investor specific communications.
In terms of our thinking, please see below a number of things the team are tracking to give you an understanding of how we are considering cash deployment, noting we ourselves are unlikely to perfectly pick the bottom of domestic and global markets:
– COVID-19 test and case frequency, which we track globally daily. Gary has been keeping our readership up to date with key insights.
– Market volatility, both intra-day and over longer rolling periods.
– Global stimulus packages.
– Tracking liquidity in credit markets and closely monitoring business stress levels.
– Stock specific valuations. We are looking at a range of opportunities, namely business that are high quality and have been sold off in line or more than the market, high quality businesses with a temporary disruption of earnings that have been treated as permanent and high quality businesses that can lead a market recovery (work in progress).
In the meantime, if you would like to discuss a cash deployment strategy or dollar cost averaging, please don’t hesitate to contact a Montgomery team member to discuss further.
You can also see Roger’s answers to your questions on markets: Your questions: Markets and Macroeconomics