Peregrine Capital 25th Birthday – How SA’s oldest hedge fund pioneer generates those 100x returns

This interview explores the 25-year success story of Peregrine Capital with its co-founder and executive chairman, David Fraser, and CEO, Jacques Conradie. They share insights into their investment philosophy and strategies, emphasising the importance of backing strong franchises and conducting thorough fundamental research. They also highlight the need for disciplined selling and avoiding emotional attachments to investments. There’s also valuable advice to aspiring investors, encouraging lifelong learning and the importance of understanding management teams as it can lead to rewarding opportunities to buy – or short-selling prospects.

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Edited transcript of the interview with David Fraser and Jacques Conradie

Alec Hogg: Now for me, this is a very interesting discussion that we’re about to have because 25 years ago, this month (July) was the launch of Peregrine Capital. And it was about a few months thereafter that I got to meet the company’s executive chairman David Fraser. I’ve watched his career and the growth in Peregrine Capital with great interest. If you’d invested at the start, each R1m is today worth R130m. We’re going to be finding out about the 25th anniversary, the Peregrine success story, the hedge fund success story and Jacques Conradie, the CEO, who’s been with the company now for 15 years. The two guys who made it all happen are with us in studio. David, looking back at those very early days, hedge funds were certainly not really appreciated. Nothing like today where pretty much every financial advisor has to know about hedge funds, if not recommend clients invest in them. It’s been a long journey, but your launch, In July 1998, many of us forget that was just before the Emerging Market crisis. Not exactly great timing.

David Fraser: No, it absolutely wasn’t. I think the first month of operation, the JSE was down over 20%. But being prudent investors, we hadn’t invested everything on day one. We scaled into the market. So ironically, despite the fact it was a bit of a torrid start, we actually made money in our first month and could pay our fees. So we were quite lucky. And I think, you know, given we were… Disciplined investors. And obviously the rebound post that was quite nice. So we had a really good start which was nice ironically despite the headlines. Only proprietary money at that stage also gave us the headspace that we could in fact start investing for the medium term and weren’t going to be judged over a month or a quarter. Again, at that point in time, we were only running Peregrine own money to start with. They raised R50m from their initial IPO and gave us R33m of that R50m to manage. That was a real leap of faith. And we didn’t feel the pressure that we needed to produce returns in day one or day two. They certainly gave us a runway and a nice space to say, we back you, make good investment decisions over the medium term. And I think that’s been one of the initial philosophies that we would. carried forward.

Read more: 10 000% and counting over 25 years: The remarkable Peregrine Capital story

Alec Hogg: You say ‘we’ – it was you and Clive Nates. He is now well known as the driver behind Lincoln City, my second favorite club in the UK, as it should be for all South Africans. How long did you and Clive work together?

David Fraser: Clive and I worked Liberty Asset Management for about three and a half years. I worked under Clive when I was there. We both shared a real passion for bottom-up fundamental investing. I think we both got quite frustrated around the red tape we were getting from an institutional asset management environment. There was a lot of reporting back to clients, a lot of admin, a lot of marketing and very little getting out there and kicking the tyres of companies.

Certainly both of us felt that if we could take good discipline investing and marry that with a flat decision making structure and less meetings and less client-facing time, we could probably come up with a winning formula. Clive knew Sean Melnick (Peregrine Group’s founder and CEO) – they used to play squash together. Sean was an ex Liberty asset management employee as well. and he presented us with an opportunity which we grabbed with both arms.

Alec Hogg: Liberty – you, Clive Nates, Sean Melnick, (Discovery’s founders) Adrian Gore and Barry Swartzberg…. wonder what would have happened to Liberty if they’d managed to hold on to all of you guys. But let’s bring in your CEO, Jacques Conradie. We spoke six months ago, Jacques, And you were telling us your story about how you came to work with David. But what is interesting is that you’re an actuary, he’s a chartered accountant, and the two of you are also portfolio managers for all the funds. How does that work? Because I guess at some point in time, somebody has to manage things.

Jacques Conradie: So Alec, we try to keep our lives somewhat simple. We have many fewer funds than a typical long-only asset manager. I think it goes to David’s earlier point. One of the key decisions we’ve made is to make sure that the business stays 100% focused on performance. Many companies think they can do many things well. We think it’s hard for humans to do many things well – we think it’s easier if you pick one thing. And our one thing we’ve picked is performance. That’s kind of the North Star. So everything has to be: how does that impact on our ability to deliver for clients? And for those reasons, we’ve decided to keep the business simple, not have 10 or 20 funds. We’ve really got the High Growth and the Pure Hedge funds. We’ve got one or two mandates that run off a formula slightly scaled up or down versus them, but that’s formulaic allocation. So it’s not that much for us to apply our minds to. We’ve got these two funds and we try to do the best we can for them. I think also having a culture where, as David said, not having meetings, making sure your key fund managers don’t get distracted from the investment process. Of course we do meet clients, but we spend 80%, 90% of our time just picking stocks and looking at the market and reading. That’s how we need to ensure that we can keep this going in the future.

Alec Hogg: So, David, you’re not planning on buying an English football club?

David Fraser: No, that’s something Clive has taken on. I think it’s amazing. He has embarked on a new career. I believe it presents its own set of challenges – he’s always been a fervent soccer fan. I truly commend him and think he’s brought remarkable value to the club. But that’s not for me, thanks.

Alec Hogg: Well, Warren Buffett famously said that if you do what you love, you never have to work a day in your life. It seems like you two are doing what you love.

David Fraser: Absolutely. What’s fascinating about our business and our careers is the unpredictability of each day. We are confronted with information in a real-time setting and have to digest and interpret it faster and more efficiently than most. So, we never really know what the day will bring, what trading updates we will get, whether they will be below or above expectations. I find this environment incredibly stimulating. I believe that a real passion for investing is a prerequisite for anyone we hire. This job is more than just an 8-to-5 schedule, it is somewhat all-encompassing. But when it’s your passion, it doesn’t feel like work, it’s more like… fun.

Jacques Conradie: People tend to perform at their best when they genuinely enjoy their work, almost as if they’re doing it for the thrill, regardless of whether they’re getting paid or not. And that’s precisely why we’ve been somewhat media shy for most of our history. We love investing, we enjoy reading annual reports and engaging with company management teams. We also understand that communicating with clients is crucial as it helps them understand our process and how we generate profits. So, a balance is needed, but we really enjoy the investing part.

Alec Hogg: What about the dynamics between the two of you?

David Fraser: Well, our backgrounds are quite different. Jacques is an actuary from Cape Town and I’m a Johannesburg native with a CA certification. However, we share a common goal, which is to provide our clients with the highest possible return. We often remind ourselves that sometimes investing is a kind of contact sport, disagreements are inevitable. We always strive for the truth. Our working relationship is strong. We don’t always agree on everything, but our disagreements often lead to better ideas. The essence of our work is to question each other’s ideas, that’s what makes us better investors in the long run. We don’t claim to know everything; the market has a way of humbling you every day. It’s crucial to have smart people who are encouraged to question and critically examine our ideas. We pride ourselves on our flat structure, which enables every team member to contribute. It’s crucial in our business, and quite rare in other sectors.

Jacques Conradie: Human nature is about wanting to be nice to people and to say things that please them. That’s how we are encouraged to deal with each other. But that doesn’t work in investments. It has to be about the truth and getting to the right answer. You don’t have to be nice or try to please the other person. You’re the one that’s actually got to find the flaws in their arguments. So it’s actually the opposite of, to some extent, being nice. Now, obviously, when we find the right answer, we’re aligned, we go for something, but you have to have the relationship where you can almost speak truth, and also where the other portfolio managers and analysts and the team can do that to us, and that’s really what we try to foster.

Alec Hogg: It’s a remarkable business model if you get it right because it’s highly scalable.

David Fraser: Certainly, liquidity can pose a challenge, but you’re right. Our business is scalable. We’ve been careful to concentrate on hedge funds and not branch out to long-only money. Liquidity may limit us, but we have plenty of room to grow beyond our current asset base.

Jacques Conradie: We don’t believe our business can expand indefinitely; we operate in South Africa. We do have offshore positions, but we’re aware of where our competitive advantage lies, and that’s in picking South African stocks. We want to maintain a broad universe of South African stocks. Currently, there are probably 120 to 130 companies in South Africa that can be considered for significant positions. However, if we grow too large, we’d be restricted to the Top 40, which would make our job much harder as it would reduce our options.

Alec Hogg: So you look at 120 to 130 stocks, not just buying to hold, you can also sell them, take a position one way or the other on each one of those companies.

Jacques Conradie: That’s correct. In a traditional fund, the best you can do is not own underperforming stocks, which is a relative win. But it’s even better if our clients actually make money. Therefore, our job involves identifying companies that are going to underperform and are expected to decline. This approach to investing uses all the tools at our disposal, including selling stocks short and borrowing them. We don’t necessarily use all these tools all the time, but they are available when we need them, offering our investors the full spectrum of investment opportunities that we can find.

Alec Hogg: Your history is filled with striking examples, such as African Bank, where you bought offshore bonds when everyone else was seeking refuge after the company’s collapse, or Capitec, which you purchased at R40 a share, now almost R2000 – and many others. But the most impressive was Thungela. I’m curious: when you see a large company shedding a division, like Anglo-American did with its coal unit, does that pique your interest? Does it inspire you to start analyzing?

Jacques Conradie: It certainly excites us far more than it probably should, Alec. Those are the situations we relish, where we have to be alert and scrutinize everything closely. Not every situation will turn out to be a golden opportunity, but it’s definitely a compelling reason to delve in. We tend to keep our investigations confidential because we prefer to be the ones doing the legwork. Even if our competitors are aware of the potential opportunity, many won’t take the time to thoroughly explore it. You have to be willing to put in the effort, knowing that maybe only one out of five will yield significant returns. It’s not a guarantee, you see. You must have the tenacity to go through all the documents, do the necessary work, and be ready to act. We set target prices for purchases and sometimes, the market doesn’t meet them. In such cases, you have to accept that despite the effort, it didn’t pan out. But it’s all about persistence, and eventually, one or two will hit, and when they do, they hit big.

David Fraser: The more we did the more we just realized what a Fat Pitch it was. Thungela was well capitalized by Angl. It was given an 18-month underpin on the coal price. Whichever way we sliced and diced it, we couldn’t see any downside on roughly what it was going to come onto the market at. And we could only see any sort of upside should the coal price start moving up. So for us, it was one of those one-way options. And as Jacques says, we mathematically had a buying program in place before Thungela was unbundled to say at what percentage we would own at certain price levels. Because at the end of the day, we knew we wanted to own this, there was a kind of an opportunity where people were getting something that quite frankly, a lot of them didn’t want, and they were just gonna be indiscriminate sellers of the share.

Alec Hogg: Your two hedge funds, and one in particular, have an impressive record – one never losing money in 25 years, never recording a negative year. I examined the S&P 500’s performance since your funds launched and found seven years when it went into the red. How do you explain your consistent positive performance during these periods?

David Fraser: You’re presumably referring to our Pure Hedge Fund, which caps its equity content exposure at 20%. We manage two major products: the Performance Fund and the Pure Hedge Fund. The latter is designed for lower volatility with only a fifth of its capital exposed to equity markets. The core of our business is about stock picking: we aim to pick the best ideas and short the worst ones. With some leverage, this fund has managed to generate good returns, especially during tough years. On the other hand, our high-growth fund, which doesn’t have an equity content cap, has only recorded losses in two years, one of which was in 2008. Depending on clients’ risk profiles, they would pick either of these two products.

Jacques Conradie: The 25-year run with no down year shows that we aren’t dependent on a single theme or factor. It also demonstrates that the alpha we’re generating is uncorrelated. If it were, we would have had one or two bad years.

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Alec Hogg: How has your investment approach evolved over the years? What have you learned that has led you to adjust your strategies?

David Fraser: There are a couple of things. Initially, I used to stay up late watching markets on CNBC, but over time, once I became confident in our fund’s positions, I became less focused on daily market movements and more interested in medium-term trends. That’s one significant change in my mindset over the years. Also, having a great team with a shared objective and a passion for markets has been instrumental.

Jacques Conradie: The core of our investment philosophy is akin to that of Buffett: we are value investors aiming to buy things for less than their worth and short things for more than their worth. The challenge is determining the worth and deciding when to buy or sell. Over time, markets become more efficient, so you have to work harder to generate the same returns. We continue to learn from our mistakes and refine our processes, ensuring we don’t repeat the same errors. By doing this, we refine the nuances of our approach, but the core principle of buying things below their worth remains consistent.

Alec Hogg: And, to conclude with a little “paying it forward,” what advice would you give to your younger selves or to someone coming out of university now with a business science degree or a CFA, like you or Jacques, who says, “I want to go into investments”? What would your advice be, David?

David Fraser: Well, I believe it’s essential to back strong franchises. Conduct thorough fundamental research and gain a deep understanding of the management teams you’re investing in. In recent years, we’ve noticed a trend where some management teams seem more self-centric rather than shareholder-centric, which is concerning. Therefore, it is crucial to invest in companies where management prioritizes their shareholders, or at least shareholders being a key stakeholder. Aspiring investors should also be prepared to put in the hard work of conducting comprehensive fundamental research. I can’t emphasize enough that fundamental research remains a vital passion of mine, and I wish I could share this passion with the younger generation. In South Africa, the quality of fundamental research may have declined somewhat over the past decade or so, but those who excel in this area can still find wonderful opportunities in the market.

Jacques Conradie: Also, lifelong learning is one of our company’s passions and it aligns with our business goals. The abundance of resources available today makes it a golden age for learners. Books, live streams of events like the Berkshire Hathaway AGM, and insightful podcasts like Invest Like the Best offer direct access to knowledge. So, for those with a passion for this field, I encourage you to read, listen, watch, and explore. And if it is, truly your calling, teach yourself and find the right environment to thrive in.

David Fraser: And buy and sell at the right time. Remember, investing involves both buying and selling. Having the discipline to sell when an investment reaches fair value is vital; falling in love with an investment can be detrimental. Selling at the right time is crucial. We try to sell before reaching fair value and tend to be a bit early, but over time, this approach has proven beneficial. Discipline is key, and avoiding emotional attachments to investments is essential.

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Jacques Conradie: Regarding management teams, engaging with those who understand the value of their shareholders and prioritize their interests is a fantastic experience. On the other hand, dealing with management teams driven by self-interest and poor capital allocation can present short-selling opportunities.

Alec Hogg: So understanding management’s focus and alignment with shareholders can be a powerful advantage for investors? Conversely, identifying companies with management more concerned about personal empire-building and neglecting sound capital allocation can provide valuable short positions?

Jacques Conradie: Correct. Absolutely. Being astute in evaluating and engaging with management teams can make a significant difference in investment success. Understanding their motives and priorities can be the key to identifying promising investment opportunities or short positions.

(Note: The transcript has been edited for clarity and conciseness while preserving the speakers’ key points and insights.)

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