Pengana’s investment strategy delivers returns


by Carolyn Herbert

Transcription of Finance News Network Interview with Pengana Capital Australian Equities Fund, Rhett Kessler

Donna Sawyer: Hello I’m Donna Sawyer from the Finance News Network and joining me from Pengana Capital Australian Equities Fund, is Senior Portfolio Manager, Rhett Kessler. Rhett welcome back to FNN.

Rhett Kessler: Thank you, good to be here again.

Donna Sawyer: Pengana Capital Australian Equities Fund performed solidly in August. What were the key drivers behind those returns?

Rhett Kessler: There were several key drivers, although I must say we don’t like to look at things on one month only, we’re more long term investors. But the good thing was that the large, the majority of the companies in our portfolio did well and we only had one or two detractors, which is the way we like to have it. More specifically, the companies like ResMed (AX:RMD), Woolworths (ASX:WOW) and McMillian Shakespeare (ASX:MMS) paradoxically, were our best performers and performed solidly for us on underlying fundamentals.

Donna Sawyer: You say you’re in the business of preserving capital and making money, rather than beating the market. A key part of that strategy is your ability to sit in cash. How much cash are you currently holding and what’s the thinking behind that?

Rhett Kessler: So just to highlight, we like to think that our cash levels is an outcome rather than a predetermined amount of cash we want to have, because we’re either nervous or comfortable with the market. So currently our cash is about 27 per cent, which is quite high for us and it means that we haven’t been able to find enough high conviction ideas, to deploy the cash. Having said that, we’ve got three interesting ideas in the pipeline and so we may in the next week or so, have a much lower level of cash. But it really is an outcome, as a result of our discipline in only buying things when we’re comfortable we’ll preserve capital and make money.

Donna Sawyer: You made a somewhat risky play to buy more McMillan Shakespeare Limited (ASX:MMS) shares, at a time when there was a strong market reaction to the proposed regulatory changes, and that seems to have paid off. Can you explain in more detail why you made that decision and what the outcome was?

Rhett Kessler: Sure, I mean that was a very interesting development. McMillian Shakespeare for us, we’ve always been known as the McMillian Shakespeare house. So I had a lot of calls from clients concerned that we were overweight a stock that more than halved. What actually happened was that we’d - the company itself continues to deliver exceptionally well on its fundamentals. Fortunately or unfortunately, depending on which side you’ve been sitting on, it’s been more than reflected in the share price when it got above $17 to $18. And so we exited most of our position, because it was just too expensive.

Immediately after that announcement by our Prime Minister at the time, Kevin Rudd that he was going to change the regulatory framework, the company was sold off heavily by the market. To the point where, and this is I guess to answer your question, where we felt that all the bad news that could possibly happen and some, were already in the share price. We had a very small holding to start when that happened and as a result, we felt we were buying all the upside at approximately $7.00. And so we more than doubled our position at that point, and that stood us in good stead.

So guess understanding the fundamentals behind the company, we always say knowing for every dollar you put into a company, what are you actually buying? And we felt the bit that was affected was more than eliminated by the fall in the share price, and it stood us in good stead.

Donna Sawyer: McMillian Shakespeare was one of your biggest contributors. What was some of the other best performing stocks on your portfolio?

Rhett Kessler: Yeah probably the one I’d like to talk about the most is ResMed. This is a medical devices company that has a global position in a medical device that solves sleep apnoea, which is quite prevalent. Particularly where people are overweight and people living in high altitude areas. The company has now had over 70 quarters of consecutive growth at the revenue line and the earnings line. We’ve held it since $2.00 and it continues to do really well for us. We don’t think it’s expensive; it’s got lots of cash on the balance sheets. It’s quite a safe sturdy company and more importantly, it gives us wonderful exposure to non-Aussie dollar earning streams. And that was by far the biggest contributor, both for the month and since inception for the Fund.

Donna Sawyer: So have you increased your holdings in any stocks over the past quarter?

Rhett Kessler: We have increased our holdings; I suppose I have to draw distinction. Fortunately we’ve been well supported by existing customers and new customers. So we’ve had strong cash inflows, which means that to keep positions in companies that we think are attractively priced, we’ve needed to increase our holdings. Maybe not our percentage holdings but certainly our physical holdings in those companies, so we’ve been ongoing consistent buyers in many of the companies we like. Like Fox (ASX:FOX), ResMed itself, DUET (ASX:DUE), Woolworths and a host of other companies.

We’ve added quite a few new holdings if I may talk about those. We’ve added Tabcorp (ASX:TAH), a probably not well known company called Skellerup (SKL:NZ) which is a New Zealand milk udder, a milking udder lining business – I think it’s a fantastic business. And Z Energy (ASX:ZNZ), which is almost a Caltex lookalike but in the New Zealand market.

Donna Sawyer: DUET Group was one of your only two detractors in August, yet you’ve increased your holdings in the stock. What was the strategy there?

Rhett Kessler: We think it was a wonderful strategy, particularly with the benefit of hindsight. As always happens when noise or gossip starts that the company is going to do a capital raising, its share price tends to fall. We’ve already got a very big holding in DUET and we were able to secure even bigger holding, when they did the capital raising down at $2.00. And it fell from $2.50 down to $2.20, hence the detraction and it was a timing issue. It has since rebounded very comfortably, back to above $2.15. So not only have we made that money back from that month, but we’ve made additional good returns on the new stock that we’ve bought down at $2.00.

Donna Sawyer: What are the key risks you’re considering at the moment?

Rhett Kessler: There’re always a lot of risks, we tend to be paranoid and that probably serves us in good stead. Some of the things we are concerned about obviously, the big flavour of the month is whether the US Government allows itself to step off the abyss. But I don’t know what’s going to happen; I think it’s highly unlikely that they will. Anything’s possible, but highly unlikely. And we like the fact that it creates some nervousness, particularly in this current period of exuberance. But it is a risk that you need to keep thinking of.

More specifically, the biggest risk facing us as predominantly Australian investors, is the fact that labour costs here, continue to be out of kilter with the rest of the world. And we continue to see that play out particularly in the banks, Telstra and any of the big companies where they are driving productivity gains, by reducing their middle management costs, by reducing their staffing. It’s phenomenal that all those companies continue to drive revenue upwards and profitability, in spite of reducing a lot of people, which tells you something about the position prior to letting all those people go. But at every level in the Australian business environment, labour costs are out of kilter.

Donna Sawyer: Finally Rhett, the Fund has been in operation for over five years now, it’s been quite a volatile ride so far. How would you gauge the Fund’s performance?

Rhett Kessler: That’s an interesting question. It does seem strange to think that we opened the Fund three months before Lehman’s went bust, or belly-up and it’s only been just over five years since then. But I think what we can really be proud of, our team can really be proud of is the fact that since inception, we’ve made money for clients every year. And on top of that, because we intertise daily, we’re very proud of the fact that as at the end of September, every client at every entry point has made money with us.

Donna Sawyer: Rhett Kessler thanks for the update on Pengana Capital Australian Equities Fund.

Rhett Kessler: Thank you Donna, as always it was great to be here.