Five years ago, Forager had just turned 10 and we were emerging from two very difficult years of investor returns. Changes I wanted to make are outlined in the CIO letter from December 2019.
On 31 October this year, Forager will turn 15.
How is the scorecard looking mid-way through our second decade?
Five years on, Forager is in a much better place. I identified two key things we needed to do better: staff development and a better mix of businesses in both Fund portfolios. The scorecard on those two fronts is looking good.
Three of the analysts working for Forager back then are now Portfolio Managers. Alex Shevelev, now more than seven years with Forager, is co-portfolio manager of the Australian Fund alongside me. Gareth Brown and Harvey Migotti are now a combined 16 years with Forager and have been doing a stellar job managing the International Fund for the past four plus years. Attracting, retaining and getting the most out of talented investment staff was one of my biggest challenges in that first decade. It will never cease being a challenge, but we are now managing it better than ever.
Second, I wanted to get back to owning some better quality businesses. While the likes of ARB (ARB) and Sydney Airport (SYD) did very well for our Australian Fund in the early years, by the end of the first decade we had drifted into a portfolio of almost exclusively deeply distressed businesses.
“The big returns are still going to come from small, unloved and contrarian ideas. But there’s nothing wrong with higher quality, reasonably priced investments while we wait for those ideas to present themselves.”—December 2019 Quarterly Report.
There will always be a place for unloved stocks within Forager’s philosophy, and we have made investments in a few in both funds recently. But a better balance has been of enormous benefit to both portfolios.
These better quality businesses have generated the bulk of portfolio returns in recent years. Blancco (LON:BLTG), Norbit (NORBT.OL), Celsius (NASDAQ:CELH), APi (NASDAQ:API), Gentrack (GTK) and RPMGlobal (RUL) are all examples of companies that have seen healthy revenue and profit growth translate to the funds making more than three times their initial investments.
Not only have we benefited from reintroducing better quality businesses, we have done a much better job of maximising our profits from those where our thesis has played out. Gentrack and RPMGlobal, two Australian Fund holdings bought when their value was less than $200 million and traded volumes were tiny, have seen share price appreciation rewarded with inclusion in the ASX 300 index. CRH (NYSE:CRH), Ferguson (NYSE:FERG) and Flutter (NYSE:FLUT), three International Fund investments, are on the verge of potential inclusion in the S&P 500.
That we still own all four of them is a result of an intentional effort to recognise when we are on a winner and make the most of it. Two early Australian Fund investments, Dicker Data (DDR) and Jumbo Interactive (JIN), are also in the ASX 300 today. We left a lot of money on the table by exiting too early. It is never going to be perfect, but we have done a much better job in recent years.
Leaving less on the table
The one area we didn’t get right was risk management. The 2022 financial year is a blight on this part of the scorecard. We gave back far too much of 2021’s outstanding profits and ensuring that doesn’t happen again has been our primary concern and goal over the past few years.
A confidence beating
When working for Intelligent Investor in my mid 20s, we received a letter from a client. She wrote I have never met you, but I know you are young and male. Only young males could be that confident. Sexist? Yes. Accurate? Perhaps.
At 46 years old, I’ve had most of my overconfidence beaten out of me by the market. We are trying to predict the future and, as one of my good friend’s father puts it, “When it comes to the future, you just don’t know…”. He places those three dots at the end of most of his opinions and I love it as a philosophy. It’s a view as things stand, but the sentence is not finished.
The best we can do is take a sensible probabilistic view of the future and wait for the market to give us opportunities where those probabilities are heavily skewed in our favour. Things are still going to go wrong.
For that reason, we need to be careful about the proportion of your investment we have exposed to lady luck going against us. This is not an attempt to minimise share price volatility. Passive or ETF funds are now more than 50% of the market in the US and are getting close to that in Australia. The number of options for people to punt on the latest trends has proliferated. If you want to bet on artificial intelligence or cybersecurity, there’s an ETF for you. When the money floods in, share prices of everything included in the relevant index rise. When it recedes, everything falls in sync. That volatility is not a risk for us long-term investors. It is an opportunity.
Our risk is that we get the intrinsic value of a company wrong and that it ends up being worth significantly less (or more) than our investment price. That has happened often enough over the past 15 years to confirm that valuation is an inexact science and strange things happen in the world.
Portfolio management enhancements
We have tweaked our portfolio management to better reflect this inherent uncertainty. Limits on portfolio liquidity, sector, country and currency exposure are set to reflect the current environment and to make both portfolios more resilient to any single macroeconomic risk.
Whilst we are still running concentrated portfolios and you should expect up to 10% of the funds to be invested in the best opportunities, we are reserving the bazooka for situations where we believe the risk of a significant valuation error is low. We will usually have owned such an investment for at least a year, met management several times, been able to observe whether they deliver what they promise and monitored the business itself through a difficult external environment. Waiting for our investment thesis to have more certainty before upsizing the portfolio weight will likely increase the average purchase price of an investment. It will also mitigate the impact of inevitable mistakes.
The decades ahead
The failure rate is high in funds management. Few businesses make it to 15 years old. Fewer still make it to 15 while their founder is only 46. Early investors in both funds, many of whom we met on our recent investor roadshow, now have up to four times their initial investment assuming reinvestment. I want the results over the next 15 years to be better. We have the team, experience and process to give us every chance.
This is an excerpt from the September 2024 quarterly report