- Please share with our readers a bit of background to FK Capital Management, including details about the key personnel in your team.
FK Capital’s leadership teams’ differentiated perspectives, professional experiences and industry connections together create a unique synergy that drives FK Capital’s investment approach and ongoing outperformance.
Over a lifetime of analysing the dynamic technology and consumer sectors, Jorge Finkler recognised a compelling opportunity ahead and, in December 2011, joined Ruben Kupferman, who had developed a large AUM base and maintained an esteemed private-banking career in Mexico. Together, they created FK Capital Management Ltd. in 2012. In 2014, Jorge and Ruben teamed up with Eduardo Finkler (Jorge’s brother), who has brought an invaluable long-term, private-equity style approach to evaluating companies.
- What was the motivation of launching a fund focused on the information technology and consumer discretionary sector?
The Firm is led by younger professionals who bring fresh outlooks and an inherent familiarity with the preferences of the Millennial generation, who are driving key secular trends in technology and consumer behaviours that are constantly evolving.
Consequently, these sectors produce many winning businesses that successfully harness innovation and trends, along with losing businesses that harbour broken growth models. Across this highly dynamic crop of opportunities, only firms with experienced leadership, proven research methodologies and in-depth due diligence processes – like FK Capital – can unlock their potential.
- Please walk our readers through the portfolio construction process of the fund, from the decision to create a highly concentrated portfolio focusing on the tech and consumer discretionary sector, to identifying the companies offering the best opportunities to earn long-term alpha for investors.
Usually we start with the following filters to get to a smaller universe of investment ideas: we look for companies with a market cap higher than US$200 million, predominantly Information Technology and Consumer Discretionary sectors, worldwide but with particular focus on the U.S. and Asia.
An important factor of our analysis relies on the fact that we try to have a first-hand evaluation of the products and services that are provided by the companies where we are invested (richer assessment than screens), we constantly look for companies harnessing promising trends driven by millennial generation and secular growth.
After we have found a name that appears to be suitable for our portfolio, we apply a deep qualitative research methodology to ideas, we think that every investor could see the same multiples or cash flows on a screen but we consider that great investment ideas are found by being able to identify strong business models; e.g., long-term vision, end-consumer satisfaction, progressive cultures, outstanding management teams (may involve calls and/or in-person meetings) and more importantly considering various intangibles that reflect wide moats/competitive advantages that cannot be easily found just by looking at a financial statement.
For us, of special importance is to see that the companies have the ability to reinvest their cash flow in projects with high ROIC, as we think this is a key attribute of successful compounders.
For short positions we look for companies with weakening technologies and products, overvalued securities, poor management out of sync with ongoing innovations and trends.
Once invested, our investment committee conducts further due diligence and monitoring by looking at future earnings outlooks, cash flows, competitive ecosystem, company edge, sustainability of market share/position, size of market and relationship with stakeholders and we are constantly monitoring news and corporate events.
Finally, we do a gross, net and beta analysis, confirm catalyst that will accelerate earnings growth potential (long) or drive underperformance below market expectations (short).
Our portfolio is comprised of approximately 12 to 25 long and 10 to 20 short names, and we have an ongoing risk management.
- What is the current level of investor interest for the fund, and how does the fund’s concentrated portfolio fit within an institutional investor’s portfolio relative to other asset classes in terms of return generation or downside protection?
- Since the inception of the FK Capital Fund back in 2012, what are the biggest challenges which have been faced by the team, in terms of fund raising, portfolio implementation, as well as active risk management?
- The tech sector has been a key return driver for the global equity market over the past decades, yet we have seen how volatile the sector could be from the dot-com bubble burst in the early 2000s. Considering the concentrated and focused exposure of the fund portfolio, how would the team manage its drawdown risk during periods of market distress?
- The information technology sector is well-known for the frequently and rapidly changing trends, and a tech company which is well-positioned to profit off the current trend may immediately fall out of favour once the trend shifts. How does the team identify the signs of upcoming changes, and what measures would be taken to ensure that the fund portfolio remains relevant throughout these changes?
- The recent fiasco surrounding Huawei, as well as the growing concerns over potential Chinese government espionage through the Chinese tech giants have posed as headwinds against the country’s tech sector. How has the fund portfolio been affected by these issues, and what is the team’s view on how they could affect the growth of China’s tech sector over the long term?
- What is the team’s view on the growth of information technology and consumer discretionary sectors in other emerging economies, such as India, Latin America and Southeast Asia?
- Please provide some insights on potential key opportunities and challenges which may arise within the information technology or consumer discretionary sectors in near future, as well as how the FK Capital Fund is positioned to take advantage of them.
FK Capital Management Ltd. delivers a distinct value-oriented long/short equity strategy centred on achieving long-term capital growth and avoiding large drawdowns. Based in the Bahamas, the Firm combines an independent view of value investing, a commitment to following game-changing trends and forward-thinking brands poised to capture next-generation consumption patterns driven by Millennials and Gen Z. FK Capital integrates growth into its value investment strategy, with each holding supported by a catalyst that will accelerate long-term earnings. As a long-biased fund that’s poised to capitalise on key demographic and cultural shifts, the fund has significant exposure to global Information Technology and Consumer Discretionary opportunities – where disruption is occurring.
The portfolio managers are strategically based in the Bahamas, isolating the team from conventional investment thinking. FK Capital regards long-term growth as vital to its strategy and shuns the pitfalls associated with simply seeking cheap market multiples to achieve value. The team is distinguished by its patience and unwavering focus on long-term growth opportunities, allowing them to invest with conviction through short-term volatility and, ultimately, actualise on its investment theses.
We have had a considerable number of investors interested in our strategy and we think that the reason is that our results speak for themselves, since strategy inception in 2012 our stock-picking and long-term focus, has delivered a net cumulative return of 118.44%1 substantially outperforming our benchmarks (S&P 500; Eurekahedge Long Short Equity Index; and MSCI ACWI Index [MXWD]). In addition, we have achieved a net Compound Annual Growth Rate (CAGR) of 11.81%1.
We think that a good example of how our portfolio fits good and adds value to an institutional investor portfolio is our year 2018, where individual contributions to the Long portfolio aside, what really added value for the Fund was our Short book, which generated a 15% return for the year and mitigated the underperformance on the Long side. While our Short portfolio has always been vital to our investment strategy, the fruits of this strategy and its positive impact on Fund performance became truly evident with fourth quarter 2018 declines in the U.S. market where many of our shorts are based. We were able to deliver a +6.5% return in December while the markets experienced their worst December since 1931.
One of our biggest challenges since inception has been the shift from active to passive investment which adversely affected those holdings that are commonly excluded from most of the biggest US ETFs. In some periods the index driven capital flight, took away significant flows from those stocks that made up an important part of our holdings.
Also, in this period managing the short book has been very challenging, we have been right in a lot of our short thesis where we have had strong conviction but the high degree of market liquidity and the persisting bull market trend has resulted in their price appreciation.
Although this price movements sometimes take their toll in the Fund’s short term valuation, they do not affect the intrinsic value of the underlying investments that over time have proven to be sound investment decisions.
We are long term investors with an eye on mitigating downward market swings. We will always prefer to hold-on to our long-term investment thesis and strategy in order to stay invested in assets that will compound the capital of our shareholders in the medium-to-long term.
Inasmuch as we firmly believe that having patience and conviction to weather short-term market storms rewards long-term investors, and that these qualities are integral to our investment philosophy, so too is the ability to be objective and continually challenge our investment theses to ensure the Fund represents our best ideas at any given time. We recognise the need to re-evaluate our viewpoint and shift our position to stay ahead of evolving market trends.
We believe that periods of extreme volatility are set to continue and that the market milieu demands that we be nimble to both quickly seize opportunities and abandon ideas that no longer appear viable. We are living – and investing – in “adapt or perish” times.
We consider that we have the familiarity with the shifting social, cultural and economic trends, we have a finger on the pulse of the way that the Millennial and Gen Z generations are shaping how companies approach their markets. This valuable lens allows us to capitalise on progressive names and opportunities and short laggards. We take a first-hand approach and conducts robust research on each of the opportunities in which we invest.
As young professionals, we are connected to Millennials bringing fresh outlooks and an inherent familiarity with the preferences of the Millennial generation, who are driving key secular trends in technology and consumer behaviour.
We endeavour to maintain first-hand experience with the products and services provided by the companies we invest in, which strengthens our understanding of the market and adds a vital dimension to our decision-making process.
We seek tier-one brands, excellent management teams and customer satisfaction, we are always focused on finding the best opportunities, we strive to fully understand management performance, end-consumer fulfilment levels and, ultimately, whether the companies we invest in are harnessing innovations and capitalising on key trends.
In 2018, our Long portfolio detracted 18% from Fund performance primarily as a result of its investments in China-based companies. GDP growth in China has far surpassed that of all other major world economies over the last decade and as 2018 opened, we remained optimistic that geopolitical issues would not take their toll on single names that otherwise showed great promise. But as the year progressed, the U.S.-China trade dispute loomed large, and then escalated. Negotiations between the world’s largest trading partners were marked by strong rhetoric and much political ballyhooing, some of it over Twitter. This led to broad selloffs of Chinese companies including those held in the Fund.
Unfortunately, these companies did not rebound over our holding period and the decision we faced was to dig in our heels and risk further price declines or adapt to changing market conditions by replacing some of those underperforming names with ones we felt had stronger performance potential.
Over the long term we are of the opinion that some holdings were unfairly battered by the news flow, and we are confident the drastic price movements are the result of an overreaction by the market. Many investors sold those names to reduce their exposure to China on negative trade war news, tarring good companies with the same brush. In fact, we believe the case for investing in these companies remains unchanged: they possess important competitive advantages in markets with significant barriers to entry. As industry leaders with revenues derived largely from domestic sources, we believe they will be relatively immune to the effects of any imposed tariffs in the long term.
In terms of the emerging markets we are basically concentrated in Asia Pacific, specifically in China. We think that there are great companies with powerful technological advances and with a stronger dominance than its US peers creating very important competitive advantages and barriers to entry. A good example is Tencent, whose dominance in the Chinese internet market is even stronger than Facebook’s in the U.S.
We think that the fact that the Chinese government is so long-term oriented to growth provides a favourable environment for the businesses and is taking them in the right track, a good example is the Made in China 2025 initiative where the main goal is to migrate from being the country that manufactures cheap and low-quality products, to a country focused on the high-tech field.
We see Software as an important opportunity in the technology side, we think that in a lot of fields in the economy Software has transformed market dynamics. We find very attractive the degree of operating leverage that goes embedded in these businesses and their recurrent revenue streams generated by subscription-based services with a very sticky nature and customer retention rates above a 100% in a lot of them.
Regarding the challenges for the technology sector we think that recent regulation initiatives mainly in social media companies, could play an important role in their market dynamics in the mid to long term.
In the consumer discretionary side, we think that the companies that will keep growing are those with a long-term vision, end-consumer satisfaction, and progressive cultures. We have identified new consumer behaviour trends and industry dynamics. In the past, mass media marketing directed consumer behaviour by eliminating almost completely the costs associated with ultimate buying decisions. Billions of dollars were spent on marketing programs aimed at increasing sales volumes while protecting profit margins. Today’s consumers however, do not relay on mass media advertising as much as in the past; the internet and social networks provide more efficient and reliable product information for buyers through reviews, comments and other content resulting in a better-informed client.
In addition, consumers are turning more conscious and are able to do their own product research becoming more selective and discriminating when deciding on what to buy. As a result, in many fields consumers are turning to products made by smaller companies that offer better choices, consequently eroding the moats that characterised large corporations in the past.
Inside the consumer discretionary sector, we think there are a lot of companies with important challenges as they are still trading at high valuations and such a trend has been reversing as the market has started to recognise the consumer tendency change. Another reason for non-sustainable high valuations is the practice of certain companies to borrow money at low interest rates to pay dividends instead of investing those inflows in business expansion or research and development.