Investment Process
While the manager employs a similar method to other institutional investors in selecting securities to buy and sell, ALF is different to other funds in two principal ways:
- In addition to buying undervalued shares, ALF will also look to sell shares that the manager considers overvalued. These shares are borrowed and sold (shorting), with the proceeds either invested in the investment portfolio or retained as cash.
- While a traditional fund is fully exposed to movements in the market at all times, ALF will be more active in employing various hedging strategies to protect shareholders from adverse market movements.
The value in our investment process is in our ability to identify mispriced securities. This allows us to construct an investment portfolio of undervalued shares that we expect to outperform over time. It also allows us to identify overvalued shares that can be borrowed and sold (short) raising additional funds that can be put to work in our investment portfolio.
If we cannot find undervalued shares to buy then the additional funds will be retained in cash providing a natural hedge for the company's assets if the market falls. As the value of the borrowed shares will naturally move up and down with the value of the company's assets, there is a natural hedge in this funding structure.
Security Selection
The Manager employs a fundamental investment process, based on sound investment ideas taken from the investment universe of listed Australian Securities. Investment ideas come from monitoring economic and industry trends as well as extensive contact with company management and industry sources.
Once identified, investment opportunities are screened to ensure they are of an investment grade. A full qualitative assessment of the proposed investment is completed to establish whether the business is of a suitable quality and attractively priced. Investment ideas are ranked based on their qualitative score and the conviction with the investment case.
Investment Ideas and Opportunities
Investment opportunities emerge from close examination of industry trends. These may include economic, political or legislative changes that impact the structure and competitive environment in which a company operates. Investors in many instances are slow to identify and price these changes.
The best investment ideas present a unique view, are relevant to the value of the business and are not currently reflected in the share price.
Qualitative Review
Once a suitable investment opportunity has been identified, a full review of financial performance will be completed before meeting with management to further develop an understanding of the business and the management philosophy. Where possible, representatives of the Manager will also meet with suppliers, regulators, competitors and customers to gauge the competitive environment.
This due diligence process will allow the Manager to rank the investment opportunity based on the following four qualitative measures:
Business Quality
Management
Valuation
Risk
Short Selling
We employ the same security selection and portfolio construction process as above except we are looking for the opposite qualities in companies we would like to borrow and sell.
The Manager believes the best "shorting" opportunities are found in poorly managed companies with weak fundamentals that can be sold for more than they are worth.
When targeting companies to borrow and sell (short), we look for the following:
- A history of inferior returns
- Management with a poor track record
- Businesses that are highly competitive and struggling to grow
- Securities that are expensive on an a range of valuation measures
The short sale of Securities is regulated by the Corporations Act and the ASX Business Rules.
Portfolio Construction
Investment ideas are "ranked" based on the strength of the investment case and each company's qualitative score. Individual security risk is evaluated separately.
The portfolio weighting of each investment is loosely correlated with the investment ideas ranking. Macroeconomic and sector research will influence the overall weighting of each investment in the final composition of the portfolio.
This process ensures we end up constructing portfolios around our best individual investment ideas, where we have the highest conviction, while retaining a bias in favour of good, well managed companies.
In constructing a portfolio of "short securities" the manager embraces the same process as employed in constructing the investment portfolio. A portfolio of the best individual short ideas is constructed from the investment universe of ASX 200 securities, with a bias toward shorting weaker businesses that we consider overvalued.
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