Investing in Mid-Caps During a Downturn: Webinar with the Australian Investors Association

Recently Shawn Burns, Portfolio Manager of Contango Income Generator (ASX:CIE), spoke to the Australian Investors Association, to discuss the current macro environment, outlining how CIE is positioning its portfolio in the current investment climate and highlights a specific stock that will come out of the current crisis in a stronger position.


Russell Lees (RL): Good afternoon, my name is Russell, and welcome to this week’s webinar, which is focused around investing outside of the top ASX 20 stocks. Before we start, let me cover some important webinar housekeeping.

Today’s webinar would not be possible without the ongoing support of our sponsors. We would like to acknowledge Thinktank, BGC, Magellan and Lowell Resources.

Today’s presenter is from Switzer, Contango, and we also note have been long term supporters of us here at the AIA.

I also need to mention our general disclaimer. Today’s webinar is for educational and general information only. No information provided today is personal advice. Should you wish to explore any of the topics discussed, in relation to your personal position, you should seek financial advice. Today’s presentation will run for approximately 30 to 35 minutes, followed by a 10 minute Q&A session.

We will have enough time to put three to four questions to Shawn. Attendees will be able to table questions during the webinar using the “Ask A Question” feature. We’ll try to get through all of your questions, but we do apologize if your question was unable to be put to Shawn, given the volume of questions we normally get.

I should also mention that all attendees will be emailed after today’s event, a link to the recording of today’s webinar. Now let’s get on with the webinar.

I have the pleasure of introducing Shawn Burns. Shawn is the portfolio manager of the Switzer Dividend Growth Fund and the Contango Income Generator Fund. These funds are ASX listed under the codes, SWTZ, for the Switzer Dividend Income Fund, and CIE, for the Contango Income Generator Fund.

Shawn has 30 years investment markets experience and I reckon that makes him the stalwart of the investment community. And during his 30 years in the investment market, he has had various roles covering stock analysis and portfolio management for several large, international investment managers. Shawn has managed portfolios ranging from several million dollars, right up to a few billion dollars. Shawn’s presentation today is entitled, “Investing in Mid-Caps During A Downturn”. Thank you to Shawn, over to you.

Shawn Burns (SB): Thanks very much Russell, and thanks everyone for your time this afternoon. What I’ll go through here, is I’ll go through our market outlook and then I’ll go through some characteristics of the Contango Income Generator Fund, which is a LIC, a Listed Investment Company, and then at the end, we’ll go through portfolio structure and also a look at a stock and then happy to take your questions at the end.

So that’s our disclaimer, please read that, it’s pretty much what Russell said earlier. As Russell said, I’ve been investing since 1985, I think, I started managing money, so a long time, across many business cycles et cetera, so happy to take your questions, either here or email them through afterwards, if you want anything answered.

Now onto our current market views, so obviously very interesting time in the market at the moment, it’s always interesting, now it’s exceptionally interesting. We’re always thinking about, everyone always mentions a Black Swan event, what exactly that is, I think we’ve got a pretty good example of one here at the moment, it’s something that no one really knows, no one can really forecast it, no one can see where it’s going to come from and also how that runs its course, has a great deal of uncertainty around it. We were watching it very closely as it started it in China, then it looked like it had been contained and then we thought, well, that’s good, it’s gone, and then obviously, it got into Europe, and it’s only now starting to temper its growth rates.

Severe impacts on the global economy, that has come from governments instructing shutdowns and lockdowns, so enforcing economic closure on the economies, and also that the markets have been impacted very quickly. We’ve seen one of the quickest Bear markets of all time, a 20, 30% fall in only a matter of a couple of weeks all around the world, and this is coordinated all around the world.

The interesting thing about this has been the significant global response by governments, and central banks. Since governments introduced these lockdowns, they were thankfully very quick, in coming to the party in trying to counteract the negative impacts of those lockdowns with government stimulus around the world and the central banks did their parts by putting immense amounts of liquidity.

I’ve seen studies that said the amount of government stimulus is the largest since World War II, on a global coordinated basis. So they’ve certainly fired all cannons to try and offset the impact of this slowdown. When we go back to late March, I’ve felt it very hard personally, as an investment professional to work out what the Coronavirus, how to actually measure that and how to get ahead of the curve, and try to think about when will it peak? Is it gonna peak? How far is it gonna go, et cetera. And also combining that with the government stimulus and central banks’ liquidity. So where I ended up after all that, coming to conclusion of, was that I looked at the high yield bond markets as they had the riskiest companies and tried to see whether they were being, how they’re being priced. And whether were finding any support, because it’s important that risky part of the economy, will come together and then drag the rest of the strong companies down.

So I saw that there was a canary in the coal mine and I was watching them, and at the end of the March, it did look pretty diabolical, there for a while, but then it bottomed towards late March, where those high yield securities started to rally on the back of the government support and central bank support. And I thought that’s when we can see a bit of a light at the end to the tunnel. Looking forward the outlook is still uncertain, we’re seeing stability in the high yield markets and that’s run onto equity markets, so we’ve had a very strong rebound from those levels.

There is probably two assumptions underlying or implied into that market rally, going forward and that is that the growth rate of the virus is peaking or has peaked. So growing at a slower rate. So slowly getting under control, around certainly, the key economies in Western Europe, in the US and Northern Asia, and also that governments support and stimulus is ongoing and sees us through that they suddenly decide if there’s a premature pulling of support, we could be in trouble, because certainly the economy’s not strong enough to stand on its own legs at the moment. And also if the infection rate suddenly sky rockets again, then we’ll see equity markets having a bit of a rethink about what the risks are.

Post of all this, what do we see going forward? I think then you’ll see the post-COVID world will be growth-starved and with low interest rates ongoing. When we saw the GFC, as you may remember, I remember there was a lot of liquidity that went into the system and people thought that the inflation and this and that and strong growth et cetera, that’s all cancelled, and I think we’ll probably see much the same here. We’ll see cautious growth outside of that, low interest rates ongoing. So no relief for those people who rely on high interest rates or reasonable interest rates to earn returns on their capital for a living. We see that ongoing into the future. And it was there before COVID, we see that after COVID as going on and probably more reinforced.

So the main policy risks, as I said, that would be withdrawing liquidity support, or government support like JobKeeper, et cetera, that we’ve seen, because it looks like they been actually quite, probably the best policies they’ve put in at this time to support the economy. Withdrawing those would be a big mistake. And the chart down the bottom there, you can see, I’m sure all of you are aware of how fast, I mean the surprising thing is just how fast that fall was, one of the quickest falls ever on the stock market. And then also the rebound we’ve had just recently from here. Happy to take any questions on that at the end.

Now I’m may just talk through the fund I run, the two funds I run, but one of them is the Contango Income Generator Fund. It is a listed investment company, so a LIC. And they’re a different type of investment vehicle, they’re companies, they’re literally companies, so they have a board, they have shares on issue, and this company in particular, has investments, collects dividends from those investments, collects capital gains and pays them out and tries to smooth a dividend out of that. So we’ve been successful in paying a dividend over time.

LICs have been, they are basically retail investment vehicles and they do get knocked around in market volatility, and you see discounts open up to NTAs, which some people see a great opportunities, obviously holders aren’t happy about them, but they do offer opportunities for people looking for a cheap entry into these shares. And specifically for Contango Income Generator, CIE, is its ticker, and I’ve been running this fund since 2015, and the strategy since 2012, so we’ve got a bit of a track record on that. And why we set it up was to provide diversification away from large cap companies. When we saw a look through a lot of the Australian retailers. Australia more than anywhere else, that a lot of retail investors held the big banks, held Telstra, maybe a couple of other stocks, like Woolies, or BHP, et cetera.

That was it, so we thought, well, there’s a lot of concentration risk in that, we had put together a group of stocks outside of the top 20, that will pay out a yield and diversify the risk of that. So we usually look for companies that are moderately growing, fairly stable, have established businesses, has cash flows, pay dividends, and reasonable balance sheets.

Just going forward, this pie chart here shows you the market cap, that’s just by market cap. So the top 20 is that big light blue area, so that’s very unusual on a world basis, to have the top 20 be such a large proportion of the market. If you go to some of the biggest markets like the UK or the US, et cetera, you’ll see a much more balanced outlook, and that brings across concentration risk in portfolios, only a few companies are held, because they’re just so large.

The other two, the dark blue at the top at the top there, and the purple at the bottom, are the remainder of the market, so we just put them broadly into those stocks which don’t pay dividends and the purple ones which pay dividends. So ex-20 that pay dividends is the main focus of the fund, we don’t stay exclusively in there, we do cherry pick a few out of other segments, predominantly, about 80, 90% of the fund is in that purple sector. Ex-20 stocks that pay dividends.

Moving on, this is a bit theoretical portfolio management, sort of 101, here as I was mentioning earlier, those companies which make up a concentrated portfolio like the banks and Telstra, Woolies, et cetera, that is symbolized here by that blue circle, so you’re getting a certain amount of risk for your return. When we put this strategy together, what we wanted to do was say, well, if you blended a bit of this strategy in with your existing holdings, you actually diversify your exposure, so you reduce your risk, and hopefully we can return a similar rate of return over time. So diversification, reducing risk, and hopefully delivering returns through a bunch of stocks outside the top 20.

The features of Contango Income Generator, what does it offer? We pay income quarterly, over the last year or so, it’s been about a cent and we’ve been trying to frank that as well. We’ve been up to 100% franking on that one cent. We’ve made a few changes, probably about a year ago, where we reduced the dividend, but increased the franking ratio. It’s a relatively high yield, and compliments, as I’ve said, just beforehand, compliments existing income portfolios with those large cap exposures. And CIE has got a large income and value tilt, it’s trying to get those companies, which most of the value comes out of dividends and not growth. So we have a skewing towards dividend paying stocks. 10% discount to NTA, that has moved around a lot in this type of market, so sometimes that discount blows out to a much greater level than that.

And ASX code is CIE. I’ll spend a bit of time going through this, so I think that, so you can see the portfolio’s top 10 holdings at the moment, and the sectors represented on the left hand side. You can see that it’s, I’d say that there is a skewing here towards what we would ordinarily think are fairly safe companies, dividend paying companies, companies that have paid dividends for years, and have balance sheets and cash flows that can sustain those dividends. Obviously, what’s happened in the last couple of months, has raised a bit of a question mark over some of those. And a lot of uncertainty actually, over what dividends companies are gonna pay going forward.

On the right hand side, you can see a list of stocks here, mainly, they are are solid dividend paying companies, and we’ve tried to skew those holdings to ones which we think are either going to pay good dividends, or we see significant capital upside in holding the shares. So Aristocrat Leisure at the top there, that is one of the, as we say, one of our growth stocks, we think it’s very strong franchise in what they do, we think they’re a leader in their field. Certainly a lot of their competitors are now way over indebted and struggling, especially, what’s happening in these economic conditions, we think Aristocrat will come out of this, the strong man of the industry and do very well in the foreseeable years going on from that. So, that is a exposure where we’re not expecting a lot in dividends but we’re expecting a lot in capital growth.

As we go down the list, you can see APA Group, that’s number three, is a pipeline operator, that is probably one of the stocks which has been the least affected by the lockdown, its cash flows are still ongoing, its counterparties are BHP, Rio, Origin, AGL, so people who can pay their bills, very useful in this environment. And then the next one down is AusNet which owns an electricity distribution grid, so again, gets guaranteed returns. ASX, very solid company paying a franked dividend. Charter Hall, we see that as one of our growth companies, and then down the list you can see another infrastructure stock, in Spark Infrastructure, another electricity grid. HPI is an interesting stock, that’s a small pub owner, and it’s basically a landlord, and it’s main counterparty is Coles, sorry Woolies I think it is. So it’s very important to have a very strong counterparty on the other side who can pay the rent in this environment, which they have, which is one of the reasons why we hold it, it’s such a high weight in our portfolio.

Back on the left hand side, you see REITs as a large holding because estate is a stable income. Financials, because mainly they carry less debt, pay a lot of franked dividend, and getting franked dividends has been the real challenge over the last few years, and it’s gonna be even more of a challenge with what’s happening with the major banks over the next year. So we put a lot of time in thinking, what is the lowest risk way that we can access franked dividends? And that is, as I’ve said, it has been a challenge and it will continue to be a challenge. The rest is a diversification. So you can see that we don’t, it’s diversified, so if we get a stock wrong, at least it’s limited to the stock, it doesn’t undermine the whole portfolio, we like to have a spread across many sectors, with a skew towards yield and cash flow and good balance sheets, and across many stocks. During these uncertain times, we have increased the number of stocks, and increased the sectors. So we’re carrying up to nearly 50 stocks now, which is the highest it’s ever been, and the reason for that is if something comes out, in these uncertain times, if suddenly there’s a government directive, which targets one of your stocks, it won’t have as big an impact as if you held 10 or 15 percent of the portfolio in one stock.

All right, moving on, we’ll just go onto one of our stocks in our portfolio, this is a relatively new stock, and we probably sat down and probably about 18 months ago started thinking about, we do sit in the value bucket, we sit in the yield bucket, that’s been difficult from a total performance bucket to be in, and that’s worldwide phenomemon, growth has been the area to be in, so we thought, well, instead of having 90, 95% of the portfolio in yield and value, how about we reduce that, introduce a few, do some work on some growth stocks and get a more balanced portfolio, and maybe run that percentage up to 15 to 20, and they can supply growth, capital growth, which we can pay out through the LIC as dividends. And one of these stocks is Appen.

So we like this, we like the balance sheet, we had a good chat with the CEO, we’ve been looking at for quite a while, looking at the financials, and that’s its share chart. What it actually does is extremely interesting, its biggest customers are the big IT companies like Google, et cetera, and what it does, if you go into a search engine, say like Google, and you put in a word, and all these websites come up, that’s the mechanism going through, sort of saying, well, what are you really trying to look at? What do you actually want by putting these words in? What are the most useful websites to you? Appen does the work on that, so what they do is they hire a crowd, a big crowd, like thousands of people, and they get them to answer questionnaires to see and the idea of that is to finesse word search to make it more accurate and more relevant, and relevant is probably the most important. Because things change over time, a word may have a certain association at one point in time, has a different association at another point in time.

So they do that for the large companies, and that’s the large big tech companies, it’s a critical part of what they want to do. Google wants its word search to be excellent, the best, and so, Appen does a lot of work for those businesses. And I think, when we bring it into the portfolio, we’re looking for cash flow, we’re looking for its got no debt, it’s got cash on the balance sheet, successful business, very profitable, and has growth opportunities, and you can see that this is a sustainable business going forward. And is growing strongly. And we pulled in several of these companies in, we would say growth companies, to balance the portfolio out. So we don’t just sit in the yield bucket, and that’s probably been fortuitous in a way because what has happened with a lot of those value type, yield companies, who suddenly have a big question mark over their dividends such as the banks, some of the REITs, they will not be paying dividends or nowhere near as big a dividend as they have in the past. So having more of a balanced portfolio is a healthy thing I think going forward.

Actually, I’ve gone through that pretty quickly there Russell, so maybe we can take a few more questions. I’ve covered a lot of ground, but I’m happy to take questions from any of the people.

RL: All right, thank you very much Shawn, we do have a few questions that have come through from the attendees, our first question is from Peter. How does the mid cap universe compare to the large cap universe in terms of dividend yield?

SB: Well that’s a very good question and it really swings on the four major banks. And it has varied over time, that’s the other thing to keep in mind, it has moved over time. When the banks, the banks want everything in the Australian market, and by the four major banks I mean, Commonwealth Bank, NAB, ANZ, and Westpac, those are such large dividend payers, and such large companies that you often, sometimes we think, oh, we’ve got a reasonable yield, let’s have a look, oh, we’re way behind, because the banks are offering a very high yield. And that swings through the cycle, usually they will be similar, but they can vary a great deal depending on where those four major banks are yielding. So that brings us to today, so that’s very interesting where we are today, when we look at what will the four major banks be yielding. When you look at consensus data, they’re thinking they will be paying 5% dividends, but we just seen ANZ and Westpac defer their dividends, and there’s speculation there won’t be a dividend from ANZ at all. And National Australian Bank pay a very small dividend, 30 cents to the half, where they were paying $1,66 for the full year, last year. So, there’s a big question mark over exactly what the top 20 is gonna pay in dividends. You have a stock like CSL, which is 10% of the market, yielding 1%. So that’s the other.

So I think that’s probably all I’d say on that, the two major influences are the top 20 and the four major banks, a big question mark over where those yields will settle for those guys, especially in this financial year upcoming to over the next 12 months, and CSL, which is the biggest company in Australia now, offering 1% yield. I’d say the ex-20 is probably looking pretty good compared to those right at this moment.

RL: Okay, excellent. This is a question from John, and John asks a question on a couple of mid cap stocks. One is, Bapcor, which is the code, BAP, and Credit Corp, CCP, are these of interest and do you have a comment on these stocks?

SB:  Yes, we’re a holder of Bapcor, it’s not in our top 10, but it’s just outside of our top 10. We’ve spoken to Darryl Abotomey lots of times and the CFO, Greg Fox as well. What do we like about Bapcor? It’s a retailer, so we’re usually quite cautious on retailers, because, especially discretionary retailers, because they’re such fickle businesses, and you get hit with something like now, you suddenly get knocked around quite a bit. We don’t place Bapcor in that category, we place Bapcor in more like in people have to use it, so it’s non-discretionary, and we think they’re pretty good operators. They’ve raised some money a couple of weeks ago, we anticipated that they were going to be good in that, to make sure we don’t get diluted. So we think that out of the, and I’m just trying to think, I think probably Bapcor is the only retailer, if you call that a retailer that we own in the portfolio at this time. Oh, no, we own one more, but we don’t own very many, but Bapcor is one we own and we see them more as more of a non-discretionary type expenditure.

In terms of Credit Corp, that one is a little bit more difficult, especially now I’ve seen they’ve raised money as well. We did anticipate in that raising that we don’t own a lot of Credit Corp, and we have looked at them quite closely, Thomas Beregi, the CEO, we think they’re leaders in their field, we think they are the best operators in their filed, but their field is basically collecting debts and buying debt books and then collecting debts. That is gonna be, you can easily paint scenarios, where that’s going to be quite difficult over the next year or so, we think they’re the best, and if anyone can do it, they can. Though, collecting debts with unemployment going up, and also lockdowns making it very difficult to actually get money, it’s gonna be a challenge for them. We’re probably buyers at the right price of Credit Corp, but we certainly haven’t chased it.

RL: Okay excellent, another question, this is from Carol, and it relates to the dividend on CIE. What is your outlook for dividends in the near, medium, and long term?

SB: Yes, I think, and the dividend, I often preface this by saying that the dividend is a responsibility of the board, so what I think and what I say has got some impact, but the board has final say. Now, from what we can see at the moment, and remember, LICs are very unusual, in that they’re companies and how they pay, they’re not unit trusts, so they can smooth their dividends. I think that, and we’ve been writing out in our reports, that we think we have got our final dividend for this year, it looks like we will be paying a dividend, and it should be a reasonable dividend, and it should be reasonably franked. Into the next financial year, I think we just have to see how that goes in terms of like, if we get any type of stable market or any upward market, a strong market or stable market, I think we’ll be okay, we’ll be paying dividends, if we go through, what we’ve just been through, in late March, sorry late February and March, that could a be a bit more problematic, we don’t want to see that again. But at this stage, I think we can pay our next dividend, and we’ll see how we go in the next financial year.

RL: Perfect, okay. A couple more questions around stocks, are you comfortable holding Sydney Airports?

SB: Sydney Airport, I think that’s one, we do hold it, so we’re comfortable holding it. That’s how that, how quickly that recovers. It’s a prize asset, it’s a first class asset. Obviously going through very tough times with their business down 95% at the moment. It doesn’t have a big operating cost base. It obviously can’t pay a dividend at the moment, with what’s happening. If we get some type of domestic airline routes back up, and some type of network system, just around Australia, or even Australia, New Zealand, that would be a good, a good outcome for Sydney, they could probably wash their face, and they start to pay some cash out. I would say then you have to wait for the international to recover, the share price where it is now, was about $8 in January, so it is a case that you won’t be expecting any dividend this year from it, hopefully it starts to get back on track next year paying dividends, and the domestic route system comes up, and then we start to get, even New Zealand, even travel to New Zealand would be a good thing for Sydney, because a lot of the travel goes through New Zealand, and domestic, that’s probably a viable situation, until it is time for international to grow.

RL: Do you have a strong view on when major international travel will pick up again?

SB:  I think, hopefully, domestic by the end of this year, and then maybe New Zealand, at the end of this year, early next year, and then I think it becomes a country by country. If you listen to Webjet, you listen to Qantas and Sydney Airport, et cetera, they are sort of saying the same type of thing. It will become that this country and that country agree that they’ve done enough and they will open it. So I’d say very slow progress through the calendar next year in 2021.

RL: All right, thanks Shawn, one last question around another stock one. The stock code ALU, Altium. Do you have a view on holding that stock?

SB:  That’s a bit more, we had a look some of the, so this is an ex-20 growth stock, a strong growth stock. We’re looking at that, we found that a bit more complex than Appen, so it’s taking a bit more time to get our heads around. What they do is designer boards, and so I think that it’s a proper business, it’s a very profitable business. I don’t have a strong view on the share price or its growth prospects at the moment, because yeah, we are having a bit of a look at it, it is of interest. We haven’t progressed too far down that, we haven’t come to a final conclusion on Altium.

RL: Okay, one last question from Ross in relation to your portfolio management. What defines, or what are your triggers, when you remove a stock from the portfolio?

SB:I think the good story of removing a stock from the portfolio is if it gets so expensive that you can think, especially if you have a yield focus, if we’re holding the stock just for its yield, and maybe a little bit of growth. The stock price goes up and then it isn’t yielding very much and we sell it out or it gets taken out. So we’ve had a whole series of stocks like Dulux, et cetera get taken out over the years, that’s a positive conclusion.

The other side is if the thesis is broken, then you think, why are we holding this stock, should we still be holding if we see that there’s been a significant change in events, and we decide that we should move on. I think the critical thing right at this point in time is the lockdowns have brought a lot of question marks over certain stocks and you just think, well is this temporary or is this long term? Can the stock survive, or will they have to raise equity, or will we participate in that? And how long does this whole lockdown go on? And how much strain is the business under? The share price has obviously reacted, has that thesis been broken or is it just a temporary issue that it will travel through? This is where we’re spending most of our time at the moment, going through each of our stocks.

RL: Just one last question, Shawn, obviously super funds have had some liquidity, or some funds have had some liquidity issues around the new withdrawal opportunities for members, did you notice any major change regarding mid-cap stocks compared to large-cap stocks, as far as funds selling down to gain liquidity in their funds?

SB: Not yet, we look at it every day, you may see, and that’s gonna be difficult to see, we know a couple of the super funds like Hostplus, et cetera, who have a large proportion of people employed in the hotel industry or the restaurant industry, service industries, now they would be the ones who would be drawing down their super, and would be major users of drawing down their super. Now what stocks do they hold? What stocks do those funds hold? There could be a few bargains coming out of that from our point of view, if they have to sell down their positions. Usually, they can see this coming, they’ll try and avoid any forced sell down as much as they can, I suspect. But we look at it every day, we look at share price moves every day. If something’s falling, we usually give it a couple of days just to see whether they’ll make an announcement, and then come to a conclusion whether we should be buying it or not. If there’s forced sellers out there that’s usually a good time to buy.

RL: Okay excellent, all right, thanks Shawn. A big thank you from the Australian Investors Association, it’s been an honour to have you present at this week’s webinar. For attendees today, thank you for attending. Hopefully it won’t be long until we all see each other again, at one of our regular AIA events. Thank you.

SB: Thank you.