It was Nobel laureate Harry Markowitz who postulated that “the only free lunch in investing is diversification.” By this he meant that diversification can help investors generate decent returns while reducing their risk.
Sounds great, right? Well, maybe not. We only have to ask perhaps the most famous great investor in the world, Warren Buffett, for a rebuttal. the Oracle of Omaha once said that diversification is nothing more than “protection against ignorance; it makes little sense if you know what you’re doing.”
It seems that James Hawkins of L1 Capital would agree. As the man behind the company’s Catalyst Fund’s 10 “best ideas” for stocks, he believes that if investors are going to outperform an index, they must be completely different from it.
In Hawkins’s case, that means taking advantage of the activist opportunities available in the Australian market, looking for “catalysts” that can create value for a company’s shareholders and, as a result, cause its share price to skyrocket.
For those unaware, much-loved long-short stock house L1 Capital launched the new fund in July 2021, leveraging the stock-picking capabilities of L1 co-founders Mark Landau and Raphael Lamm from their ship L1 Capital Long Short Fund badge. From its launch to the end of August 2022, the Catalyst Fund has provided its investors with a return of 18.1%. at a time when its benchmark, the S&P/ASX 200, returned 0.1%.
This is an impressive feat, particularly given some of the losses suffered by some of the best stock pickers in the country.
So in this Expert Insights video, Hawkins shares how his skill set works alongside the minds of Mark Landau and Raphael Lamm, lays out the case for focus, explains how a stock makes its way into this “better idea” portfolio. and shares an action that passed the L1 filters.
Note: This interview took place on Monday, August 1, 2022. You can watch the video or read an edited transcript below.
L1 Capital Catalyst Fund
Can you tell us a little about yourself?
James Hawkins: I began my professional journey as a lawyer and worked at Clayton Utz for three years in mergers and acquisitions and project finance before joining Macquarie’s investment banking group in early 2004. I spent almost a decade with Macquarie in Melbourne and New York, working in a variety of industries. groups I then joined Flagstaff Partners, which is a leading corporate financial adviser in Australia, in 2011, and was an equity partner and managing director there.
My professional journey has been a brief period as a lawyer and the last two decades as an investment banker. And I think the key attribute of the Catalyst Fund is not my skill set in isolation, it’s a combination of my skills with the skill set of Mark Landau and Rafi Lamm.
They both have two decades of stock-picking experience, and we combined our skills as the three members of the Catalyst Fund’s Investment Committee.
What sparked the idea for the L1 Capital Catalyst Fund and why does it only have 10 shares (or less)?
The idea for the Catalyst Fund came about when Rafi, Mark and I had known each other for a couple of decades. And we thought there was a unique proposition in combining his stock-picking skills with my investment banking skills, and bringing those skill sets together into an investment committee and a decision-making committee for the Catalyst Fund. So, we formed the Catalyst Fund on July 1, 2021.
We are looking to achieve genuine alpha for the ASX 200 index. That is why we have a maximum limit of 10 stocks in the Catalyst Fund.
Now the fund is a “best ideas” fund of the L1 Capital Long Short Fund, but with an activist overlay. We believe that once you get more than 10 stocks, you start to not meet the definition of a “best ideas” fund. Once again, because activism takes so much time and work, we’ve limited our stock to 10.
And finally, we are not suggesting to our universe of investors that they invest 100% of their portfolio in the Catalyst Fund. It is a sleeve or a part of your overall portfolio, which will seek to generate genuine alpha for the market.
How does a stock get into your portfolio?
There are three, what I’ll describe as “gates,” for a stock to enter the Catalyst Fund:
- Worth: The stock must meet the value expectations of the investment approach of the L1 Capital Long Short Fund.
- Quality: The stock must meet the quality gate for the L1 Capital Long Short Fund.
- Catalyst: These may be related to operation or governance, but are things we can influence, enact or accelerate to generate returns on capital for investors.
It’s that third door, which is going to be different than the investment approach of the L1 Capital Long Short Fund. Rafi, Mark and I are on the investment committee of the Catalyst Fund. And for any stock to enter the portfolio, all three of us must unanimously agree.
The thought process there is that we have a pool of “best ideas.” So if one of the three doesn’t agree for any particular reason, we think it doesn’t meet the definition of a “best ideas” fund, and then that stock doesn’t enter the portfolio.
How has the positioning of the portfolio changed in the last 12 months?
What has changed in the last 12 months is the macro backdrop. We are not a macro fund, but of course the macro environment influences the markets considerably.
The opportunity set has changed in the last 12 months, due to the significant increase in the risk-free rate, as well as taking into account some of the geopolitical tensions around the world and the flow effects they are having on the markets. .
Because we are so stock-specific in our selection, we do take into account the macroeconomic context, but it depends on the situation, the opportunities related to that stock, and the value, quality, and catalyst, that could be enacted and accelerated relative to that stock in particular.
We have exited three or four positions that were in the portfolio when we started it on July 1 last year.
Can you provide an example of a recent addition to the portfolio?
Once I get to the stocks we added to the portfolio in the first year of the Catalyst Fund, it will be Ramsay Health Care (ASX: RHC). We liked Ramsay because it had an irreplaceable set of high-quality hospital assets across Australia’s east coast, and also in the northern hemisphere.
Ramsay was trading at a discount to the ASX Industrial Index from a P/E perspective. Historically, he traded at a premium due to the irreplaceable set of high-quality hospitals. However, it is important to note that he had a number of potential catalysts.
He had a joint venture in Malaysia, which was not being valued at all by the market, but mainly the real value unlocked was the real estate assets he owned in Australia which was largely freehold. They were an irreplaceable set of hospital assets and we thought there was a value unlock opportunity in valuing these real estate assets at around $9-10bn, at a time when Ramsay’s market capitalization was only $15bn. . We think that Ramsay could enter into a sell-leaseback type transaction and use some of that proceeds to repurchase shares at a time when Ramsay’s share price was, in our opinion, undervalued.
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