“We’ve been selling umbrellas for three years of sunshine, and not many people have wanted one,” says Denis Donohue, Head of Investments at Pentalpha Investment Management.
Pentalpha’s sole fund – the $17 million Pentalpha Income For Life Fund – opened for investment on 30 June 2017. The Fund is an Australian equity protected dividend income fund, which invests in a concentrated portfolio (currently 13 stocks) of high-dividend-paying ASX-listed stocks, at what it sees as attractive prices, and uses the exchange-traded options (ETOs) market to implement a “collar” of option protection around individual parcels of shares. It does this by buying put options over each position, and offsetting that cost of protection by writing (selling) call options.
“We effectively cap the downside, and make that cost-effective by giving up some of the upside,” says Donohue. “When we have a serious drawdown in the market – such as we’ve seen since February 20 – the Fund will participate in the first 5% of that drawdown, give or take 1% or so, but then the protection automatically starts to work, and halts the decline in the unit price. That’s because the stock prices of our shareholdings fall below the put ‘strike’ prices that we have – which give us the right to sell the stocks at those higher strike prices,” Donohue says.
The Income For Life Fund targets a 6%-plus dividend yield including franking credits, plus 2%–3% capital growth, in a financial year. “That capital growth target is really to keep inflation at bay, so that the investor’s yield remains 6% in real terms, pre-tax,” says Donohue. For that, Pentalpha charges a fee of 0.92% a year.
Donohue readily admits that he “hasn’t had much to work with” on the marketing front. In calendar 2019, for example, the Income For Life Fund returned 6.7% net of manager fees and costs, while the Accumulation Index gained 23.4%.
“That hasn’t been an easy sell,” says Donohue. “But we’re targeting a client base that has already accumulated their savings; they want to put it to work to get reasonable returns, mainly in the form of income; but they don’t want much volatility, and they certainly don’t want – or can afford – to suffer any catastrophic losses. We can give them all of that.”
So far in March, Donohue says the Fund has lost about 0.5%, compared to a fall of 25% in the broader market. “On a rolling 12-month basis, we expect to be flat for the 12 months to end-March, compared to about a 21% slide for the market,” he says.
Another fund with a similar story – but vastly different methodology – is the $100 million Loftus Peak Global Disruption Fund, which invests in a concentrated portfolio (15 to 35 stocks) of global disrupters, among them (US programmable logic device maker) Xilinx, the top holding; Alphabet, Netflix, Tencent, Alibaba and Amazon.
For the period from 31 December 2019 to today, the Loftus Peak Global Disruption Fund is up 1.4%, says Loftus Peak chief investment officer and founder Alex Pollak, compared to its benchmark, the MSCI All Countries (in A$), which is down by 10.6%. At the end of February, the Fund had, since inception in November 2016, outperformed its benchmark by more than half: a net return of 22.8% a year, versus 14.4% a year. For the month of March so far, Pollak says his fund is down 3.5%, compared to a 9.2% fall for the benchmark index.
Building a portfolio of the great disrupters was not actually done with resilience in a market crash in mind. Pollak says, but that is what his portfolio has delivered.
“We always bought these companies knowing that, whatever price we paid for them, they had great balance sheets. We thought that if the market fell these stocks would fall too, but we expected that their balance-sheet strength – which meant that they don’t require access either to debt or equity capital – would enable them to bounce back quicker than the broader market. What we didn’t expect is that they would also fall by less in a severe correction; but that is what has happened.”
The reaction to the Covid-19 pandemic is “turbo-charging existing trends,” says Pollak – and the Loftus Peak portfolio is benefiting from that.
“A lot of people already preferred Netflix to cable TV, just as a lot of people already worked from home; or already received online groceries; or already did their conference calls online; or already used Microsoft Teams to work. Take Netflix, for example – with everyone at home, it comes into its own.
“Not only is that true, because there is now no longer any sport on US cable TV, most of the reason why people held cable TV subscriptions in the US was for sport. If the sport isn’t there, there’s almost no reason to have it – a handful of subscribers will want it for movies and other things, and to receive their local TV stations. But everyone else is ‘cutting the cord.’
“That big-ticket content is moving away from cable TV and into direct-to-consumer channels such as Netflix – what people are doing in this pandemic is only hastening that move,” says Pollak.
The Loftus Peak Global Disruption Fund charges an annual management fee of 1.2%, with a 15% performance fee charged above a hurdle return with a high watermark.