INSIGHTS THE VALUE OF CONVICTION 30 TH APRIL 2015 BEING LONG TERM IN A SHORT TERM WORLD

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1 INSIGHTS THE VALUE OF CONVICTION 30 TH APRIL 2015 BEING LONG TERM IN A SHORT TERM WORLD

2 Only buy something that you d be perfectly happy to hold if the market shut down for 10 years. If you aren t thinking about owning a stock for 10 years, don t even think about owning it for 10 minutes. Warren Buffett, Berkshire Hathaway Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 2

3 WHAT TYPE OF INVESTOR ARE YOU? Generally determined by your investment time horizon Long term or short term? High risk or low risk? Income or growth focused? Liquid or illiquid? Does your desired return even play into what type of investor you are? Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 3

4 MARKET TRENDS Significant swing towards short term investing by traditional long term investors. Speculative funds have been moving into more long term investments with the wrong investment assumptions, believing they are short term opportunities. Key drivers of the shift to short termism are: Traditional low risk asset classes offer very low returns Flood of liquidity globally. Ability to borrow cheaply Increased market noise Shift in the demographics of OECD countries driving need for higher returns: Duration of investment strategies Asset profile by traditional long term institutional investors. Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 4

5 DEMOGRAPHICS EFFECT ON ASSET LIQUIDITY? Population Age in OECD Countries Are Getting Older 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% > Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 5

6 FUNDING LEVELS OF GLOBAL CORPORATE PENSION FUNDS 10.00% 0.00% % % % % % Estimated Funding Shortfall of Corporate Pension Funds Estimated Funding Shortfall Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 6

7 PRESSURE FOR HIGHER RETURNS Today, a typical interest rate on traditional 12 month term deposit in Australia is ~2.7%. In 2007 the rate offered for the same term was ~7%. Decline in interest payments from traditional short term investments, such as term deposits has led to a shift of assets towards more traditional long term asset classes such as; Equities Venture capital Real estate (listed and direct) Infrastructure While assets have moved into much longer term focused investments, sentiment and the mind set of investors has not. Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 7

8 ASSET CLASS LIQUIDITY VS TIME HORIZON Source: World Economic Forum, The Future of Long Term Investing Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 8

9 EVIDENCE & IMPACT OF THE RISE IN SHORT TERMISM Numerous examples of the rise in short termism by investors; Decline in holding periods of public equities Rise in high frequency trading Shortening average CEO tenures Rise of activist investing Increasing M&A Increase in share buyback activity Disproportionate focus on quarterly earnings announcements Companies releasing hot air announcements Impact of short termism is multi faceted; affecting, on an interrelated basis Companies, Investors and the operation of Financial Markets. Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 9

10 GROWTH IN ACTIVIST ASSETS UNDER MANAGEMENT (AUM) Activist AUM ($b) $ $ $80.00 $60.00 $40.00 $20.00 $ Activist AUM ($b) Source: Morgan Stanley Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 10

11 IMPACT OF ACTIVIST ACTIVITY ON PROFITABILITY & CAPITAL EXPENDITURE VERSUS PEERS The Wall Street Journal analysed what happened at large U.S. companies that were targeted by activist investors. Results were compiled from the arrival of the activist on the share register until 30 June companies assessed on the basis of: Total Shareholder Return Profit Margin versus Peers (Industry) Capex Ratio versus Peers (Industry) Median Versus Peers Total Shareholder Return +35% Profit Margin -0.62% Capex Ratio -3.00% Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 11

12 DISPROPORTIONATE FOCUS ON QUARTERLY EARNINGS ANNOUNCEMENTS $55.00 Sketchers Historical Share Price ($) $50.00 $45.00 $40.00 $35.00 $30.00 $25.00 $20.00 $15.00 Sketchers Historical Share Price ($) Source: Bloomberg Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 12

13 DISPROPORTIONATE FOCUS ON QUARTERLY EARNINGS ANNOUNCEMENTS $55.00 Twitter Historical Share Price ($) $50.00 $45.00 $40.00 $35.00 $30.00 $25.00 $20.00 Twitter Historical Share Price ($) Source: Bloomberg Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 13

14 IMPACT OF SHORT TERMISM; COMPANIES Under Investment: Privately held companies, free to take a longer-term approach, invest at almost 2.5 times the rate of publicly held counterparts in the same industries. This persistent lower investment rate among America s biggest 350 listed companies may be reducing US growth by an additional 0.2 percentage points a year. Dominic Barton (McKinsey & Co) and Mark Wiseman (Canadian Pension Plan Investment Board) Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 14

15 IMPACT OF SHORT TERMISM; INVESTORS 1. Long term opportunity cost of the potential return that can be generated by adopting a company s long term business strategy at an early stage. 2. Long term investors are also generally better able to capitalize on changing macro themes; as these can take a longer period of time to influence the market price of investments. 3. Lack of product or service innovation due to short term expense. 4. Inability to spend significant amounts of upfront capital for the potential long term gain i.e. Woolworths and Masters Hardware Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 15

16 CASE STUDY: QUBE HOLDINGS (ASX:QUB) QUB a 10 year success story due to the long term nature of its respective shareholders and the significant investment initially involved. $3.50 Historical Qube Share Price ($) $3.00 $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 5/01/2007 5/01/2008 5/01/2009 5/01/2010 5/01/2011 5/01/2012 5/01/2013 5/01/2014 5/01/2015 Historical Qube Share Price ($) Source: Bloomberg Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 16

17 CASE STUDY: QUBE HOLDINGS (ASX:QUB) Since FY2010 QUB has invested over $1.40 billion into acquisitions and capital expenditure. The market capitalisation of QUB at the end of FY2010 was $367 million. $350,000,000 Cash Flow From Financing Activities $300,000,000 $250,000,000 $200,000,000 $150,000,000 $100,000,000 $50,000,000 $0 FY2010 FY2011 FY2012 FY2013 FY2014 FY2015 FY2016 (Est.) Cash Flow From Financing Activities Source: Bloomberg Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 17

18 IMPACT OF SHORT TERMISM; FINANCIAL MARKETS The primary impact of a change in sentiment leading to the movement of assets and therefore the characteristics of markets is increased instability in the financial system. As more investors focus on short term returns sentiment holds a much greater weighting to overall asset price movements. During the Global Financial Crisis Notable long-term investors were the only sources of private capital willing to take on the risk of extending funding to financial institutions while most investors were moving their money out of illiquid and risky markets and into cash. World Economic Forum, The Future of Long Term Investing Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 18

19 IMPACT OF SHORT TERMISM; FINANCIAL MARKETS The ability of long-term investors to buy into a market that they feel represents good long-term value, without worrying unduly about short-term market losses, means they can act as a powerful countercyclical force. World Economic Forum, The Future of Long Term Investing A change in market sentiment which results in significant short term price volatility often creates the best long term investment opportunities both long and short. Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 19

20 Investment Update NAOS EMERGING OPPORTUNITIES COMPANY (ASX:NCC) Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 20

21 KEY HIGHLIGHTS 1. PERFORMANCE 1 Month (%) 3 Months (%) 6 Months (%) 1 Year (%) 2 Year (% p.a.) Inception (% p.a.) Inception% (Nom.) NCC +3.87% -1.28% -1.05% +0.90% +3.19% % % S&P/ASX Small Ordinaries Accumulation Index (XSOAI) Performance vs Benchmark +7.12% +1.36% -2.83% +2.43% -0.46% -1.07% -2.83% -3.25% -2.64% +1.78% -1.53% +3.65% % % Investment Portfolio Performance is pre fees and franking credits and post all operating expenses. Performance has not been grossed up for franking credits received by shareholders. Inception is 26 th February 2013 Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 21

22 KEY HIGHLIGHTS 2. RISK Standard Deviation Downside Deviation Positive Return Months NCC Investment Portfolio % +5.78% % Small Ordinaries Accumulation Index (XSOAI) % +7.68% % Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 22

23 KEY HIGHLIGHTS 3. GROWING FULLY FRANKED DIVIDEND PROFILE: $ $ $ $ $ $ $ $ $ $ $ FY2013 FY2014 FY2015 Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 23

24 KEY HIGHLIGHTS 4. POSITIONING: The Top-5 holdings represent ~75% of the Investment Portfolio: - Focus on quality company/industry information - Long term potential valuations (36 months) - No regard for liquidity/market capitalisation being reasons for valuation impairment NCC has been true to label with EGG, AIK, LAU, being held in the portfolio for over 30 months of the 33 month inception investment period. Current Top-3 Holdings: - EGG (Enero Group) - AIK (Armadale Investment Group) - LAU (Lindsay Transport) Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 24

25 Investment Update NAOS ABSOLUTE OPPORTUNITIES COMPANY (ASX:NAC) Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 25

26 KEY HIGHLIGHTS 1. PERFORMANCE 1 Month (%) 3 Months (%) 6 Month (%) Since Inception (Nominal) NAC Investment Portfolio Performance +3.54% +4.16% +7.88% % All Ordinaries Accumulation Index (XAOAI) +4.59% -5.47% -6.24% +1.04% Benchmark (RBA Cash Rate + 250bps) +0.40% +1.17% +2.39% +4.84% Performance vs Benchmark +3.14% +2.99% +5.49% +9.26% Investment Portfolio Performance is pre fees and franking credits and post all operating expenses. Performance has not been grossed up for franking credits received by shareholders. Inception is 12 th November 2014 Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 26

27 KEY HIGHLIGHTS 2. RISK Standard Deviation Downside Deviation Positive Return Months NAC Investment Portfolio +7.79% +0.44% % All Ordinaries Accumulation Index (XAOAI) % +8.16% % Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 27

28 KEY HIGHLIGHTS 3. POSITIONING: Capitalising on Key Macro Themes 1. Short US Biotech 2. Long Rising US Interest Rates 3. Short Equities with US Denominated Debt and Little USD Earnings 4. Long EU Quality Defensive Equities 5. Long Stock Specific Undervalued Growth 6. Short Stock Specific Low Quality Opportunities Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 28

29 SUMMARY McKinsey & Co summed up the key benefits for investors of Being Long Term in a Short Term World : 1. Better alignment of investment strategies with their fundamental investment objectives and liabilities. 2. Increased focus on long-term trends and fundamental value creation drivers versus short-term market aberrations. 3. Allows investors to capture illiquidity premiums embedded in less liquid asset classes, such as private equity, real estate, and infrastructure. 4. Allows for the development and implementation of house views on trends that can play out over many years, and avoid short term macroeconomic noise. Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 29

30 Disclaimer This presentation has been prepared by NAOS Asset Management Limited. The information in this presentation is only intended for Australian residents. The purpose of this presentation is to provide information only and the contents of the presentation doesn t purport to provide investment advice. We strongly suggest that investors consult a financial adviser prior to making any investment decision The presentation does not take into account the investment objectives, financial situation or particular needs of any person and should not be used as the basis for making investment, financial or other decisions. The information is selective and may not be complete or accurate for your particular purposes and should not be construed as a recommendation to invest in any particular investment or security, or Fund/Company offered by NAOS Asset Management, NAOS Emerging Opportunities Company Ltd or the NAOS Absolute Opportunities Company Ltd. The information provided in the presentation is given in good faith and is believed to be accurate at the time of compilation. Neither NAOS Asset Management, NAOS Absolute Opportunities Company Ltd, nor its directors or employees make any representation or warranty as to the accuracy, reliability, timeliness or completeness of the information. To the extent permissible by law, NAOS Asset Management, NAOS Emerging Opportunities Company Ltd or NAOS Absolute Opportunities Company Ltd and its director and employees disclaim all liability (whether arising in contract, tort, negligence or otherwise) for any error, omission, loss or damage (whether direct, indirect, consequential or otherwise). Performance figures quoted in the report are past performance. Past performance is not an indicator of future performance. Neither NAOS Asset Management, NAOS Emerging Opportunities Company Ltd or NAOS Absolute Opportunities Company Ltd nor its directors or employees guarantee or make any representation as to the performance of the Funds, the maintenance or repayment of capital, the price at which shares may trade or any particular rate of return. Conviction Long Short Investing Copyright 2015 NAOS Asset Management Limited 30