sma december 2018 update

Dear Fellow Investor

We currently have around $40 million in both our funds - the Marcus Today SMA and the Marcus Today Income SMA - and have around 400 investors.

Kerr Neilson built Platinum Asset Management, a multi-billion dollar business, by communicating with his investors on a personal level, through a monthly newsletter. That process has now been adopted by almost every big fund manager. As a Marcus Today SMA (Separately Managed Account) investor you have, up to this point, received, via your Praemium portal, a quarterly fund report.

With the market falling over and the Marcus Today SMAs now under rather than outperforming as they did in the bull market, I will be communicating with you more often and more directly, via these emails. I want these updates to be ad hoc when there is something to say, rather than periodic, but I will endeavour to get in touch with you a minimum of once a month at the end of the month starting today and continuing next year.

The Marcus Today Income SMA is, obviously, focussed on income stocks with the primary purpose of collecting income and franking. The stocks we hold in the income SMA are almost all large companies with high yields although in the periods between the traditional results and dividend seasons, in February and August, as well as May and November (for some of the banks), we have adopted the technique of adding some growth stocks to enhance performance in the ‘income dead’ periods between the results season. That has back-fired in the current market correction but will remain part of the strategy when the market settles down.

The green line is the Marcus Today Income SMA since 1st July 2017.

The Marcus Today SMA is a more balanced portfolio with a growth focus. After outperforming the market with a 23% rise last financial year, against the benchmark (ASX 300 accumulation index) up around 12%, we have given most of that outperformance away in the market correction. The green line is the Marcus Today SMA since 1st July 2017.

We have two processes when managing the SMAs.

  • The first is focused on the market and managing market disturbances through the level of cash in the fund. Most of the time we will be fully invested (less than 10% cash) but just occasionally the 'market', rather than stocks, will move centre stage and we manage that by raising or lowering the cash component of the SMA. We do that most of the time by selling a part of every holding in every stock, or by buying more of every stock we already hold. We keep our list of researched preferred stocks rather than selling stocks out right and buying new stocks. When managing the cash it is not about which stock, although in market sell-offs we do tend to tip out the more illiquid stocks first and in greater size if not whole holdings.
  • The second process is focused on stock selection and timing. Managing other people’s money and beating the market is about building a list of stocks that are better than the stocks you exclude. We manage that list on a daily basis but as a long duration fund looking for consistent outperformance rather than rockets under rocks, the list is quite well established. We are not traders. We might attempt to “time” some of our stock selections but generally speaking we buy with the utopian intention to hold forever, and mostly sell with the intention of buying back. Rarely do we have to get rid of a stock because the fundamental story has changed, but it does happen. Occasionally we will add a stock. The bulk of the fund is invested in large, well researched stocks with a track record of reliable earnings. Around that core we will target a handful of often smaller growth stocks which provide us, as they did last year, with a significant growth option. We have to manage these positions and their heightened risk more conservatively and we do that by pyramiding in and coming out a bit faster. Pyramiding means buying a small holding first and adding to it if the stock performs. It is a quasi-risk management technique used by a lot of fund managers.

In the last few months it has been all about “the market”. As I write the ASX 200 has returned -9.2% year-to-date thanks to a 13.6% drop in the last 3 ½ months. When the market fell over in February we ran our cash up to more than 60% very quickly, we can because we run small funds which allows us to be nimble, when you run billions of dollars (one day) you have liquidity issues. But at the moment we could pretty much sell or buy both portfolios in a day. We get some liquidity issues in the small caps which we have to manage but generally speaking we can pretty much do what we like when we like. So we could if we so felt, start a day fully invested and be 100% cash by the end of the day. When we cashed up in February the “cash management” added a couple of percentage points of outperformance.

When the market began to fall over in October we did the same thing, progressively raising our cash to a peak of 67% in the Marcus Today SMA. That was a big call and a big risk to hold on to. When the market began to rally we felt compelled to get involved again, and when the market hit what we considered to be frenzied lows recently we have ended up fully invested again.

Despite this cash management process, we have underperformed in this market fall. The reason is that our core holdings in large quality growth stocks have been sold off twice as fast and hard as the market (ALL, ASX, COH, CPU, CSL, MQG, REA, RMD, SEK, TWE, WEB). As the market went “Risk off” these high PE growth stocks, holding significant profits for most investors, saw those profits being taken and in the last three months some of these stocks have fallen 2 to 3 times more than the ASX 200. The first thing everybody did when the market wobbled was sell the high PE high performing stocks.

In hindsight you can see why these stocks were sold off. If the average market PE at the moment is around 17 times, all but two of the mentioned stocks were trading higher than that. But we have held them in the belief that there is nothing really wrong with the market, and when you look at the earnings and dividend growth in year one and two for all these companies, at the return on equity (10% would be “normal” they are all much higher than that) and look at the average broker target price compared to the share price there is significant upside on all these stocks. The bottom line is that these are growth stocks and whilst the share prices have been smashed the fundamentals haven’t changed and there have been no downgrades/disasters amongst this group. The problem is sentiment. Growth stocks attract risk-taking investors whilst the conservative investors hide in the low return on equity, utterly reliable but boring stocks. When the market falls over these conservative investment approaches suddenly look insired rather than unimaginative, meanwhile the growth stocks are deserted, they have been.

Where are we now? I am not about to restructure either of the Marcus Today funds after a significant correction to build a dull portfolio that would have outperformed in the fall. On the assumption that there is “nothing terribly wrong” (and that’s the bet) these stocks, as they have whenever the market rallied recently, will be the best performers in any rebound. On that basis I am sticking with them. We have also taken a bet that after falling 13-22% in the last year the banks, which are offering historic value, are somewhere near their lows. With APRA lifting their lending restrictions saying "they were always going to be temporary" the chances are that the housing market, which APRA rather unintentionally killed, and which has had its biggest peak to trough decline since the 1991 recession, will lift and take bank sector earnings forecasts higher for the first time in years and the bank share prices with them. 

So let me finish with this current view summary, a few bullet points to wrap up as we head into the holiday:

  • We are now fully invested again having cash up in the fall.
  • My observation is that there is nothing really wrong. See the article below. 


  • Australia is not the US - the bulk of the market problems are US rather than Australian centric. They have caught a cold, we should have a sniffle but we have got the flu.
  • We don't need to worry as much - The Australian market is a lot less volatile than the US (ATR of the All Ords is half that of the S&P 500).


  • We do not have the elevated share price risks that many of the US stocks, particularly the highly priced technology stocks, possess. We do not have a technology sector that matters to the index.
  • The Australian market is not expensive. Australian stocks are now trading at a below average PE.
  • 40% of the Australian market index consists of bank and insurance stocks. They were already in a sentiment hole. Downside is limited.
  • The growth stocks that have been slammed in the fall are still the same large quality growth stocks they were before the fall. They are carrying the ‘fear’ for the Australian market as the companies most are exposed to the US, but they are now 25% cheaper and arguably the fundamentals have improved because the Australian dollar is down from 74c to 71c this month. They will come back just as rapidly, more rapidly than the market, in the rebound.
  • A trade deal could come at any time.
  • The US interest rate trajectory is flattening - that may communicate some economic caution but in the longer term that is a positive for business, future growth and stock valuations.
  • Global inflation is benign and interest rates are still globally low by historical standards.
  • There is no sub-prime mortgage issue eating a hole in the balance sheets of the world's largest institutions.
  • It is too late to sell - we should buy when others are fearful - not sell. They are fearful. Given the excuse, if and when the sun comes out, this is an opportunity not a disaster.

We have made our bed. We are fully invested again and sticking with large quality growth stocks. I know the market is having a sell-off but the current view is that this is a re-pricing exercise that has arguably already overshot and whilst I hate to give you the “long term” excuse used by every financial adviser when things go wrong, this is a long game not a trading game and I have every confidence that the stocks we hold will deliver a consistent outperformance when the market finally starts to behave again. Which I hope is soon - it would be nice to get back to process 2 - worrying about "which stock" rather than process 1 - worrying about "the market".

It is in the teeth of the storm that the weather always improves.




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