BNC#6 David Fraser – Investor insights from a 25-year-old startup

Renowned investor and Peregrine Capital’s Executive Chairman David Fraser delivered an electrifying keynote at the BNC#6 conference in Hermanus providing profound investment insights and strategies. Unveiling Peregrine Capital’s 25-year journey and investment philosophy, Fraser emphasized disciplined research, flat structures, and equity alignment as cornerstones for consistent returns. His candid revelations on proactive risk management and strategic portfolio adjustments during market downturns captivated the audience, showcasing a visionary approach to investment. Fraser’s bullish stance on South African and Chinese markets, coupled with a focus on small-cap gems and global diversification, provided a roadmap for navigating dynamic market landscapes. His speech was a beacon of innovation, setting a new standard for savvy investing.

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Summary of David Fraser’s keynote address at BNC#6 in Hermanus

During his keynote at the BNC#6 conference, David Fraser illuminated Peregrine Capital’s 25-year journey, emphasizing core principles that underpin their investment success. These principles include disciplined research, flat decision-making structures, and equity ownership by investment decision-makers, fostering alignment and accountability. Fraser highlighted a proactive approach to risk management, showcasing Peregrine’s stop-loss policy and intervention strategies to mitigate losses and capitalize on opportunities.

He underscored Peregrine’s diverse investment approach, ranging from equities to convertible bonds and offshore investments, all driven by a singular focus on generating profitable returns over the medium term. Fraser shared a compelling example of their successful investment in African bank offshore bonds during a market downturn, demonstrating the value of disciplined research and strategic decision-making.

Fraser also delved into the importance of understanding broader market dynamics, such as logistical challenges and competitor landscapes, particularly evident in Perigrine’s analysis of Twingela and the coal export industry. Additionally, he discussed the advantages of employing a hedge fund toolbox, including the ability to go short on shares and use put options for downside protection, as seen during the COVID-induced market volatility.

Overall, Fraser’s speech provided a comprehensive insight into Peregrine Capital’s investment philosophy, emphasizing adaptability, research-driven strategies, and proactive risk management as key drivers of long-term investment success.

Read the full transcript of David Fraser’s keynote address at BNC#6 in Hermanus ___STEADY_PAYWALL___

00:02 Thank you, Bronwyn, and thanks to everyone for staying. I think this is my first BizNews conference, and I think it was BizNews 6. I’ve missed the first five, so I guess you get the graveyard shift, and this is clearly three o’clock in the last day, but thank you all for staying. Unfortunately, it’s not just that bad. I had a presentation, and also had someone to give the presentation. I’ve now got neither of those, so I’ve got a few notes here. And what I think I’m gonna do is just to introduce my talk. It’s just to go through…

00:31 Last year was our 25th year anniversary of starting Peregrine Capital. And I guess when you go through a 25 year anniversary, it’s sometimes time for some reflection. And I think what we did is sort of go back and look why we formed Peregrine Capital and what were the differentiators that we put into Peregrine Capital that make investments, our investment returns, I think, more importantly, more consistent than probably a lot of other people.

01:00 and something that we keep sort of consistently delivering on. My background was that myself and Clive Nates were both investment managers at Liberty Asset Management. Liberty Asset Management in the 90s was a very substantial investment house. It was part of the Liberty Life Group. It managed probably 250 external pension funds money as well. So it was a very substantial asset management organization.

01:28 I think the cornerstone of that business was disciplined research. I think that is still ironically the cornerstone of Peregrine Capital as well. What we liked about Liberty Asset Management was that disciplined research. What we didn’t like about it was obviously the red tape. Great ideas were generated from the analysts, but unfortunately these good ideas went through committee after committee.

01:58 We lost the opportunity, you know, senior people in the organization almost thought it was their mantra to shut down these ideas as opposed to sort of embracing them and looking at them and executing them. So what we try to put together in Perigrine Capital is the disciplined research process as well as having a very flat structure and quick decision making.

02:25 Another thing that’s a cornerstone of our business is that all of our people who manage money and make investment decisions are all shareholders in our business. I think that we understand that when people understand the value of equity, even in their own business, it means that they understand the equity in other people’s business as well. I think we want to have people that value equity, who understand equity, and so having equity in your own business.

02:53 gives us a sort of alignment that we’re looking for out of our staff. We don’t track any benchmarks. It’s open season. We look at anything that will make us money. And obviously over the years, equities has been our bread and butter. But we’ve also had situations where we’ve looked at convertible bonds, offshore bonds, corporate bonds, preference shares, property. So again, with a blank piece of paper and not following a benchmark.

03:21 our only criteria is the position that you’re proposing gonna make us money over the medium term. And I think one of the examples is that we probably made one of our best ever returns out of African bank offshore bonds. When African bank was failing as an equity investment, so it had a number of offshore bonds listed in offshore markets. And obviously these investors continue to panic out of those bonds thinking that African bank

03:51 and the bonds itself are worth nothing. And certainly some of these bonds traded as low as 20 or 30 cents in the rand. And we were very active buyers of those, of those bonds. And over the time we were almost made a hundred percent hole on the majority of those bonds. So again, you know, what we’re looking for is any instruments that will get us an equity type return. Um, another interesting part of our business is that, um,

04:18 you know, investing is a contact sport. At the end of the day, we make bad decisions and unfortunately we often make bad decisions. And I think what we try to guard against is having losses, bigger losses in our portfolio. So what we do is we’ve put in place a stop loss policy and if a position gets drawn down by 10%, there is an intervention. And what we ask the analysts to do is to sit down and effectively,

04:46 go through this position and explain to us why it’s underperformed, what he thinks the reasons are for the underperformance, whether his initial thesis has changed, as well as a recommendation on what to do with that. I think that does, again, we talk about people having sort of anchoring or blind spots. We then take that decision away from the analyst. He presents the rest of the team and the rest of the team actually makes the decision. And again,

05:14 that decision can either be to cut the position because the thesis has changed. Alternatively, it can be just to hold the position, or in some instances, even to double up on the position. If there’s nothing wrong with the position and it’s just been, for example, some selling pressure from a significant shareholder trying to get out, often we’ll then double up on the position. There’s an opportunity with exactly the same thesis to buy something at a 10% lower price, and sometimes we in fact do that.

05:45 I think a disciplined research process is absolutely paramount to investing these days. I think, again, it’s not just on the company, particularly in South Africa. You have to understand the greater environment, whether it’s the logistical environment, the power environment, its competitors, and what’s happening around the business. I think when we looked at Twingela, we probably spent two-thirds of our…

06:14 Tungela is a coal export company. We probably spent two thirds of our time analyzing transnet, in particular the export coal line. What was gonna happen? What are the risks there? Could they move the coal? We knew they were in some trouble, and again, we knew they had to get the coal down that line. So again, by spending a lot of our research effort into the stuff that’s relevant, I think is something that perhaps differentiates us. And once again,

06:43 Having a hedge fund toolbox just gives us far more tools than than the traditional fund manager. I can remember Liberty going to go and see companies that you think were potentially a buy and you know going to them and hearing the story perhaps wasn’t that fantastic, realizing it wasn’t a buy and then sort of shut it went down. Without business now if we’re in that position we say well okay well clearly isn’t a buy but potentially it’s a short.

07:12 maybe it’s a sell. And again, having that ability to go in short shares is something that is absolutely valuable. It just means that whatever research you’re getting, you’re getting the best out of it. You have an ability to make, to take positions no matter what sort of research you’re getting at the time. Again, one other thing about hedge funds, I think that generally we always look at our downside protection. I think it’s a situation where we often buy out the money puts that…

07:40 just sort of dissolve and never really get exercised and again come off our returns. But the ability to have puts in the portfolio does mean that when we do get market drawdowns, you’ve got the ability to bat off the front foot. I think none more so was in the beginning of COVID. We sat down and watched the weekend of the Italian spike in COVID. And certainly we’ve got a lot of actuaries in our business and…

08:09 The messages were flying around that weekend. We got into work at six o’clock. We had a meeting. We realized this thing had no way of being contained and was gonna run very significantly out in the next two or three months. We went immediately in and took very substantial put options on the S&P 500. And again, in the next week or so, we saw that drawdown on that index. Knowing that we were protected, we sat down and targeted a number of quality companies that we were just waiting to buy,

08:39 weren’t at our price level yet. So as these companies came towards us, we had the ability to engage the market and buy these companies, put them into our portfolio, knowing that we had to put protection in place. In other words, we were batting off the front foot, not batting off the back foot. If you fully invested and you’re having a drawdown, it’s really difficult to think clearly and to think efficiently. But when you know you’ve got that protection in place,

09:06 far easier to engage the market and buy the shares that you’d be waiting to buy for many years in some cases. As far as our positioning at the moment in SA is concerned, I think similar to SA, we’re actually quite bullish on the SA market. In our business, price is everything. What is priced into our market right now? We think very little. We think certainly not a positive election.

09:37 If the ANC had a coalition with the EFF, would we see market downside? Yeah, we probably would, but probably, you know, maybe five or six percent. We don’t think that the base case, first of all, we don’t think that’s the base case. And second, well, we think a bad scenario is somewhat priced in. I think we’ve got certainly local long-running institutions that have sat in the sidelines for the last six months. We know the foreigners are totally absent from our market.

10:06 And I think as Magnus said yesterday, when he eventually phones his friend from the States or from the UK and he says, yes, we are bullish South Africa, quite frankly, it’s too late. The shares would have moved probably up to 20%. At the end of the day, the liquidity is not there anymore. You’ve got to position yourself for these situations and you’ve got to be ready to take advantage of them when they come. So we really do think the downside is pretty well priced into South Africa and we’re pretty bullish on South African shares at the moment.

10:35 I think again, similar to Sire, we’re not often aligned, but we certainly are at this point in time. We have roughly 10, or probably about 8.5, 9% in China at the moment. Again, we believe that China has been battered. There’s been massive selling of China. Nobody wants to know about China. And we still believe that those tech companies in China are certainly amongst the best in the world. Lots of good IP, growing markets.

11:04 Obviously we’re dealing with a communist country and we are reminded of that now and again, but when you’re buying 10 cent on probably 11 or 12 Ford PE, it’s a very different situation to maybe the 20s or 30s it was a number of years ago. So once again, it’s in the price. We believe 10 cent will grow, certainly double digits for the next few years, and we think that’s a nice place to be right now. Again, I’m sure Pete’s not here, but we’ve also taken a little…

11:33 a little bit more of a constructive view in small caps in South Africa. You know, we’ve just got to the stage right now where three or four PEs for generally pretty quality companies is really just too cheap. So we have been actively buying quite a few small cap companies. And again, the selectivity around that is just around management teams who we believe we can work with. I think Pete put it eloquently.

12:02 who understand capital allocation, who understand share buybacks. You know, there are some management teams out there who have a very different agenda to share all the value, unfortunately. And it just doesn’t help you to waste your time to try and convince these people as to what they should be doing. A lot of companies get it, a lot of companies don’t get it. But if you select a company that does understand shareholder value, understands about share buybacks, understands about capital allocation,

12:32 And again, when a company is saying, should I buy another company or should I just buy my own shares back, that’s the sort of framework that we want to instill in companies that we can work with. So I’m quite constructive on SA Small Caps as well. Ironically on the bond side, we hold UK government bonds. We’ve never held them before, so that’s a new position. We took some US government bonds, but we sold out of them towards the end of last year into that rally.

13:01 Again, selectively looking at some specific opportunities. We’ve got quite a decent portfolio of US shares, some European shares as well. And right now, equity content is almost exactly split between offshore and South Africa. And if anything, the South African equity content has crept up over the last month or two.”

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