Ophir's investment philosophy

Andrew Mitchell, Co-Founder and Senior Portfolio Manager at Ophir Asset Management shares his investment process and philosophy.

This week's fund manager interview is with Andrew Mitchell, the Co-Founder and Senior Portfolio Manager at Ophir Asset Management.

Since leaving the renowned Paradice Investment Management with his colleague Steven Ng, Andrew has gone on to return 26 per cent per annum after fees, for close to seven years now.

In this interview, we discuss the Ophir investment process and a number of positions, including the implications of the AUSTRAC investigation for Afterpay.


Andrew, you and Steven came together at Paradice Funds Management. When you look back, what was it about your investment approach and both management styles that you thought you'd be suitable to be running a fund together and a funds management company together?

We had a great track record at Paradice, and I guess that's what gave us the confidence. We don't really know what other people are doing, but we could see that the performance was working.

Steven and I get along very well. For those who follow Myers–Briggs, we actually have opposite personalities in the sense that Steven's an introvert, I'm an extrovert, Steven's highly organised, I'm the person who's got paper all over their desk and the presentations stacked up on the side of their desk, and it works really well. I think we challenge each other in our different strengths and our different weaknesses. We make the other person better in the weaknesses and then the strengths certainly come through. We think that makes us a good team.

At Paradice, it worked pretty well. We managed money, importantly, during the GFC from 2007 to 2011, generated really good returns then, and that was why the super funds, who were our first investors, supported us to leave the nest, if you like.

When I look at top performing funds out there, Ophir has been a top-performing fund for a long time. When you do see those high performers, they tend to be doing something different, be it how they operate, how they view opportunities, how they think about businesses. What do you think the Ophir team do differently to give them that edge?

No, that's a great question. Look, I say to people, being a good fund manager is not about being the smartest person. Or being the smartest person doesn't make the best fund manager. I remember the guys at Paradice said if that was the case, then we'd have astrophysicists and all these brilliant people doing our jobs. It's not about that at all, it's about working really hard, being passionate about what you're doing, and thinking about how you can get an edge on a company, and that's what we do. We think about different ways of problem solving, if you like.

There's a great example, a2 Milk, that I was speaking about just recently. When we first invested in that, we bought around 5 per cent of the company at 50 cents, but what gave us the confidence to buy that was we knew that they were launching their infant formula, but we didn't know how well it would go. So we basically, as a team, we went out to as many Chemist Warehouse, Woolworths, Coles, and we looked at the bottom of the tins, and if you think about any tin, if you look at the bottom, there's a manufacture date, and the manufacture date compared to present time is actually really powerful if you look at it over time.

When they launched their a2 Milk tins, we started just following them week by week, and we saw the manufacture date, compared to present, day got narrower and narrower, which meant the velocity of those tins going through Woolworths, Coles, Chemist Warehouse, was improving, and we could see that it was really catching on. Those tins we were then seeing, as we went to China, we were seeing them pop up in China, so we knew that we were onto something really big here with a2, and that's what enabled us to get on.

So, getting back to that point, it's about being passionate, it's about really loving what you're doing and not being lazy. You've got to get out there, and unfortunate for our wives and girlfriends, they have to suffer this too, but it means going into Coles and going straight down in the back aisle and checking the tins, which they get annoyed at, but that's what we do and we're just thinking of new ways of problem solving.

That leads into my next question, actually. When you do talk to a lot of fund managers in the small-cap space, they use the phrase they want to turn over a lot of rocks.

Yes.

When you're out there, when you're looking at companies, when you're going through your screening process, what makes you actually stop, look at a rock and say that's worth me turning over and doing a little bit of extra work in to maybe potentially lead into an investment in the portfolio.

We basically identify all the companies on the ASX in our space that we think have got a competitive advantage or have something different about them that could grow into a big market. Those companies we need to know, and we need to know them very well, and we say we need to know them better than anyone else, and we always ask the companies where we sort of rank in terms of our knowledge, because we want to be up the top. So any company that has that, we're all over like a rash.

And then really, though, you need to be out there and just seeing as many companies as possible. You need to train yourself quite often on companies that, I don't like this company for whatever reason. Well the rest of the market probably doesn't like it for every reason, and maybe that's an idea as well, and so sometimes the companies you least want to see, they're the ones you force yourself, no, I need to actually see this because no one else is looking at this company that's been completely forgotten and they're doing something different, or they've just made an acquisition or something like that.

So it's really about turning over every rock and at the same time picking a few that you just make sure that you're turning over every, very often, because you need to know that rock better than anyone else.

Speaking of that, one thing I've seen on your website and in a lot of your writing is how you rely on or get in touch with industry contacts a lot as part of your investment process.

Yes.

I presume that comes in right at the start when you are initially turning over the rocks. You say, well, who do we know in this space, perhaps, or who can we maybe start chatting to, to get a bit of a better picture?

Yeah, that's right. If one of those rocks is a small pebble, if you like, in a big pond where it can grow and become a big market, we want to work out the customers, the competitors, the suppliers, the whole ecosystem around that company. Sometimes we might know someone who has worked at a competing firm, but we will get out there and try and speak to as many people.

We use LinkedIn a lot. We've got a few techniques that make people want to speak to us. One, you need to know what you're talking about rather than just tell me about an industry. If you can give them something, like you're helping them because you can talk about the industry and give them some information they don't know, then they're very happy to talk to you and give you references of other people to talk to.

Quite often we'll go down these rabbit holes and be gone for a long time speaking to all these different people and understand the industry, and then one person just gives you that bit of information that really sort of says, especially if a competitor says, hey, that company is really, really good.

I was speaking to a company today that's on the ASX that's going amazingly well, and we spoke to a competitor, and they absolutely trashed the company. It's hard when they do that to actually know, is the company really bad or is this just a competitor who wants to speak to me because they want to say how badly the company is? But when a competitor says they're really good, we have to be on our game to beat them, they're actually beating us significantly at the moment, then you know you're onto something.

So it's just speaking to as many people as you can and really just trying to get those insights.

Now, another thing I saw on your website was mention of a proprietary database and ranking system.

Yes.

I want to hear how that works, but also the industry contacts and who you know and do you put together that web of contacts, does that actually also go into the proprietary ranking system?

It does, subjectively, you're putting into the score. So the way it works is that we all have valuations on companies, but valuations don't take into a lot of subjective measures, so the subjective measures are things like the quality of the business, the quality of the earnings.

So we go and we rank things like, do we think this business is going to beat its earnings estimates? What's the valuation? Is there third party factors that can help it, i.e, could it make an acquisition? So, those are three, and you want to have at least two of those three, valuation being the most important.

But then we subjectively measure management, balance sheet and, importantly, how well the business goes in a downturn, because a lot of investors at the moment, or a lot of funds, have only managed money in bad times. I mean good times rather. Where we've managed money in bad times as well. And some companies go very well in good times but go horribly in bad times. We want to make sure that we've got a portfolio that we balance out the ones that go well in good times with the ones that go well in bad times, but also, we want companies to go well in good times and bad times.

So we subjectively score on all these measures, and that gives us a number, and then we put that against our valuation versus our expected return, and we can then move the weights around in the portfolio. Because a company with great management might not have huge valuation upside, but you need to value great management, because great management delivers great returns in the long-term, whereas bad management tends to, where you thought the company was going to beat its earnings estimates, it ends up downgrading because bad management can't be relied on.

Can you give me an example of a company in the portfolio right now that is suitable for the good and the bad times? Has it got defensive characteristics, or is it a moat?

A lot of companies, there is was one that just came to mind and then I went, actually, it's not super good but there are things that are good about it, but I'll give you an example. I just thought alphabetically so I started at A and I thought of Austal Ships.

So, Austal Ships, the reason that scores well, and we actually have a whole scoring system whether they go well in a bad time. The things to look at and whether companies go well in bad times are will the earnings go down if we go into an economic recession? Is that sector that it operates in, is it disliked? Or, in bad times, so financials, retailers, these are not liked for obvious reasons, what's the balance sheet like? What's the liquidity like? Does it have a yield that's sustainable? We manage all these scores. Oh, and the final one is, is it opaque? And when I say opaque, can people really understand it and know what's driving it?

So, Austal Ships, they are building LCS or like frigates for the US Navy. They get paid in US dollars, and I should say, actually, there's one more category which is the currency as well. They get paid in US dollars. They are paid by the US government and we know that military spending won't change, generally, in a downturn, so we think that that's a company that will go very well.

One, what will happen at downturn? Aussie dollar resources currency will get smashed, so they will make more money because they get paid in US dollars so they make more money in Aussie dollar terms. Number two, its liquidity. It's a billion dollar stock, so we'll have a look at how much it trades. Will the market like the sector? Yeah, they will like the US Navy part of the business. Is it opaque? It's pretty well understood, the margins, because you can see the consistency of the margins in the US and you know that they're building this amount of ships every year, so that part of the business... they've got another part of the business which builds ferries, which is a bit different and not as good, but that will score quite well, so that's how we do it.

So it's going well now, and we've done very well in the last year from this stock, but we think if it goes through a downturn, it will go reasonably well as well.

And looking at your portfolio, there's a fair few companies in there that have international exposure, so they're listed on the ASX, because your portfolio is ASX listed small to mid-caps, but they have international exposure. Now, is that a purposeful positioning of the portfolio today as a reflection of the Australian economy?

Yes, I actually think. But it's not so much a reflection of the Australian economy in the sense that the Australian economy's going badly. What it's a reflection of is that Australia economy only services 25 million people, and the global economy is seven billion people.

It's really topical at the moment because we spoke to the founders, the CEOs, the directors of these companies in Australia that are going very well offshore. If you think 10 years ago, going offshore was a disaster, it was an investment graveyard. You think the AMPs, the NABs and the likes, they blew up so much capital going offshore, whereas now you've got Afterpays, a2 Milks, Nearmaps, IDP Education, the likes, they're all doing very well offshore. So we went and spoke to the CEOs, the founders, for this very reason, and we said why is it that 10 years ago everyone lost money when they went overseas, and now five years, is it going really well?

From that standpoint, I can tell you that the answers are technology. You can centrally manage your business now from an office in Australia.  Shane Fallscheer from Lovisa was remembering when I asked him how when at Rip Curl he was running that business and they were trying to speak and do Skype calls in 2003 and it was an absolute disaster. The frames were frozen, you couldn't hear people. Whereas now, that morning when I spoke to him, he'd just done a call with all the country heads and it really worked well. You can see your daily inventory, and he was talking about that. The payroll is able to be run centrally from Melbourne.

So, to be a CEO running a global business now, you can pivot, you can see your inventory, you can change, you can speak to all your country heads very quickly, you can move your business very fast, and so we think that there's huge upside for Australian companies that are able to learn their trade and get a competitive advantage, which as all the guys said you need to have a competitive advantage to go offshore.

But the great thing about Australia is you can make a lot of mistakes here and learn without it costing you your business, whereas in the US it can, and then you can go offshore and do very well. So, that's what we're looking for, those companies that have those characteristics.

Another thing that came out is that all these businesses that are doing well offshore have got very good supportive boards with international experience, so we're looking for those boards with good management, but great boards that have international experience that can go offshore.

In terms of the Australian economy, we are looking for companies that are going to grow no matter what. They're growing market share, they're growing new industry, or this industry is growing at a huge rate because it's new, so we're not so much following the vagaries of an economy.

So probably the truth behind your question, no, that's not the reason we're offshore, but actually, deep down, that is the reason. Australia's a small place and it's a great place to learn a trade and go offshore.

Now, you mentioned Afterpay. It is one of the largest holdings in the fund. Under a bit of a cloud right now with the AUSTRAC goings on. What is your take on the current situation with Afterpay? But also, how did you guys actually originally come across the stock?

Well, I think Afterpay was one of those ones... We actually had an investor who owned privately... I haven't told them I'll mention their name, so I won't mention their name, but everyone will know them. They're in the millennial market selling lots of clothes, and they were foundation members when Afterpay listed, and they said, "Guys, this is really driving our online sales," because they were invested with us. So we went and had a look and we were like, "Wow, this is going really well." We spoke to a few more of the customers and they said this is going really well. So we got invested pretty early.

Then we were very lucky when the... Basically, in December, the ASIC stuff came out and it was looking like ASIC weren't going to do anything and they wouldn't come under the credit code, rather, consumer credit code. We actually went to the US when it was 12, $13 a share and everyone hated Afterpay.

We wanted to speak to Urban Outfitters, but we couldn't because Urban Outfitters we had to speak to investor relations, who didn't even really know much about Afterpay. So we went and spoke to Steve Madden Shoes over there who was a business and they said, "Yeah, it's going really well for us." We spoke about basket size and return rates and they said, "Yeah, it's really working and it's helping our business."

We weren't lazy. We went over there, and that's the investors in Ophir, that's what they pay us to do. We're their outsourced investor who goes over and does the hard work. We're not lazy back in Australia.

So back to your point, anyway. What is the view on the AUSTRAC? Look, there's a couple of precedents here. It's not good. It's not good in the sense that there is a real issue here. They should, you think, have had the checks and balances that this didn't happen, but they are a new industry and they are learning.

The market sold this off aggressively because they sold stock, and perhaps they could have known that something was around the corner. Whether they did or not, we don't know. But putting that all aside, we will not just sell a stock because we hate it, and when it went to $21... because we hate the fact that the CEO has sold stock. We act objectively.

Now, there's a couple of precedents here. One, Tabcorp, which is in gaming, they were fined. They were fined $45 million. If you think about the market cap of Afterpay, and they'll get nowhere near that sort of fine, we can't see that they would, off the market cap if they got a third that size fine, that would be big to us. It's nothing.

The other precedent is PayPal. In 2009, they had an enforceable undertaking, so that is you have serious issues with AUSTRAC. They were able, in the backend, to change things and to go skipping through. We didn't really see and we haven't seen much evidence that they missed a beat in 2009 being able to change their business in the necessary way in the background to be able to deal with it.

So, while it's important to understand this is a serious issue and not to be ignored, the amount this wiped off the market cap, the US 10-year treasury being 2.1 at the time, all the other long duration growth businesses really seeing their share prices accelerate, it sold off aggressively to $21. We think it probably would've been trading at $30 at that time.

To think about what that wiped off the market cap, it was just far too big a reaction, and we stay focused on the fact that it's so exciting that there is this Australian business that changes millennials' behaviour online with retailers. It increases how much they consume online, and it also reduces the returns, because it's a much more considered purchase.

To have an Australian company that's used by these huge businesses offshore, have Kim Kardashian tweeting about it, the likes of the Urban Outfitters and boohoo using it, I think it's fantastic and something that we should be proud of in Australia, and we think it's going to be a global business and it's going to do very well for years to come.

So worst case scenario in the short-term is a fine from AUSTRAC. They might have to spend a little bit extra money implementing the procedures that AUSTRAC recommend.

Yes.

However, when you stand back from the stock today, look at the growth runway that you still see happening, especially overseas, it's something that you're not too concerned about.

We don't see this as an absolute game changer, it's something to certainly look at and have some level of concern, but the precedent is you can deal with AUSTRAC, you can solve this issue. We might not actually even see what's happening in the background, but it can be done and that's the precedent from a very similar business in terms of PayPal to Afterpay.

We're not going to throw the baby out with the bathwater on this one and we haven't sold a share.

Andrew, thank you very much for joining us. It's great to have you in the office today and good luck for the rest of your roadshows.

Thanks very much for having me. Appreciate it.

That was Andrew Mitchell, the Co-Founder and Senior Portfolio Manager at Ophir Asset Management.


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