Lipper’s Jake Moeller reviews highlights of a presentation by Tom Naughton, fund manager, Prusik Asian Equity Income Fund on June 20, 2014.
Prusik is an Asian specialist and a genuine fund boutique with tight private ownership, only two portfolio managers and a supporting analyst. It may not be on the tip of every investor’s tongue, having been predominantly marketed to family and private-wealth clients, but its reputation is now beginning to permeate the wider market.
This year Mr. Naughton picked up a Lipper Award and subsequently also collected a gong with Investment Week as a result of exceptional risk-adjusted returns in his sector. He is undoubtedly on the way to becoming a wider-known name, although this hasn’t prevented the Asian Equity Income Fund from reaching a critical US$850 million and now effectively being closed to new investment because of a 3% upfront charge.
A hedge-fund background
Mr. Naughton has analysed Asian stocks his entire career, but he plied his trade in the hedge fund world in Hong Kong, managing a plethora of hedge strategies there for eight years. Now settled back in the U.K. and the long-only world, it is his experiences of managing hedge funds that have formed the basis of his long-only philosophy to equities.
By his own admission, “There is still hedge fund DNA in there somewhere.” His universe is a “very intimate” one of no more than 500 companies overall in the region. He knows all of these stocks well and spends time interviewing suppliers, regulators, and lenders as primary sources of information. He uses sell-side research to complement his own work but relies primarily on the network he has built up in the region to keep abreast of new launches and corporate insights.
Table 1, 3 Year Performance of Prusik Asian Equity Income Fund within Sector to July 31, 2014
Philosophy and objective
His three-pronged philosophy is simple: (1) avoid loss, (2) focus on total return, and (3) don’t be constrained by benchmark or peer comparisons. His performance ambition is to beat the market by 5-10 percentage points per annum but effectively to double the fund in size every five years–implying an annual return of over 14%. While this may seem ambitious, it provides Mr. Naughton a long-term discipline. He is not concerned about what happens in the next three to six months but only with finding stocks that will help him meet his objective and generate an “attractive upfront yield.”
Typically, this means the portfolio will be light on cyclicals, technology, resources, and property development, since those sectors do not meet the expectations of his downside protection. He likens himself to a credit analyst who is constantly examining worst-case outcomes. Hence, he likes classical annuity-type stocks such as consumers and toll roads, along with companies that have strong earnings and dividend growth.
Finding opportunities in Asia
Mr. Naughton accepts that Asia generally is a very poor-quality universe, likening the risks of investing in the region to a novice skier going off-piste, but he notes the significant changes he has witnessed in the region since he started. The universe of stocks has increased ten-fold, and countries such as South Korea are increasingly benefitting from the discipline imposed upon them by domestic institutional investors.
However, he is quick to point out that it is wrong to judge Asian companies by Western governance standards. “There isn’t always alignment of interest between investors, majority shareholders, and regulators, and your ability to change things as a minority shareholder is very limited.” He refers to the high level of family ownership, which–being inter-generational–requires a different perspective to more developed companies. He warns Western investors to not work against a company’s prevailing culture.
Mr. Naughton’s portfolio consists mainly of stocks with strong franchise, i.e., high barriers to entry or monopolies as well as appropriate levels of gearing and a history of dividends. This leads him into a considerable amount of infrastructure stocks, but his hedge fund skills help him analyse other areas. For example, the Link REIT (4% of his portfolio) recently sold non-core property at 3%. Mr. Naughton recognised that REITs are valued at 4% over real rates (currently -2% in Hong Kong), allowing Link “to effectively arbitrage its own share price” through the deployment of capital.
Another stock he likes is Jiangsu Expressway, with a very high EBITDA margin on its toll road operations, but he recognises that China poses considerable risk. Toll roads, for example, suffered two years ago when the Chinese government forced companies to “de-toll” on public holidays, causing traffic chaos. While there are other A-share stocks he owns such as Daqin Railway (a stable high-margin coal-transportation business), he sees China’s nonperforming loans and overcapacity as the biggest risks in the region, and he is happy at no more than a 14% exposure to Chinese A-shares.
Table 2. Share Price Performance of CNOOC Ltd.
The sell discipline
He readily admits that sometimes things don’t go to plan, citing oil company CNOOC Ltd, where he “analysed an overseas acquisition that is taking longer to turn around than expected.” But he strongly believes that when a stock goes south it is more likely because of an error than its becoming better value. He is thus unemotional in his sell discipline, using earnings and price momentum indicators to sell an underperformer very quickly. With the market providing “a free mistake-identification service,” the portfolio therefore has against its peers a similar distribution of returns in its upper deciles but a much tighter distribution in the lower. This is reflected in its risk/ return characteristics:
Table 3. Risk Return of Prusik Asian Equity Income Fund within Sector (3Y to July 31, 2014)
The fund is currently soft-closed
Finding low-risk, noncyclical stocks with a good balance sheet at a low price might seem like the Holy Grail of investing, but in a market as inefficient as Asia’s Mr. Naughton uses his years of local knowledge and experience to generate superior returns. Unfortunately for those investors who haven’t already discovered this Lipper Award-winning fund, they will have to await the fund’s return to capacity or countenance a significant up-front charge.
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