Cyan Newsletter – 31 March 2020

The Cyan C3G Fund fell approximately 20% in March 2020.  No doubt this news is disappointing for our many investors, if not entirely unexpected. This was ahead of the All Ords and well ahead of comparable smaller companies’ indices such as the S&P/ASX Emerging Companies Accumulation Index which dived 30.8% in the month.

However, the market is moving so quickly and the volatility has been so extreme – like nothing we have ever experienced before – that the relative performance can literally change 5% or more in a couple of hours. Since the second week of March, when the virus panic really took hold, the average intraday change between the All Ords’ high and low has been 6.8%.  On Friday, 13th March the index ran an extraordinary 13.2% in the 4hrs of afternoon trading giving new scope to what used to be known as the Friday ‘Claret Run’.

These are moves one might ordinarily expect over the course of a month or a year, never in a couple of hours. But that is the world we find ourselves in currently.  We will not say that it’s been an easy time to invest.

Our investment philosophy during this crisis has been fourfold:

1. Divest the businesses that appear directly exposed or overly leveraged to the virus fall-out;
2. Hold those businesses through the volatility that may be experiencing short-term challenges but have solid balance sheets, defensive recurring revenue streams or dominant market shares that will see them through the present challenges;
3. Add holdings in companies we have researched and liked for a long time but had previously found too expensive and taking positions in companies that are now likely to benefit from the current crisis;
4. Keep ample cash available for upcoming opportunities.

As such over the past month we have:

1. Sold our positions in AMA Group, Atomos, Audinate, Carbon Revolution, Oventus, McPhersons, Murray River Organics and Webjet;
2. Added to our positions in Alcidion, Kelly Partners, Quickstep and Vita Group;
3. Made initial investments in JB HiFi, Jumbo Interactive and Service Stream;
4. Adopted a cash balance at month’s end of approximately 40%.

Outlook

So what are our current observations and how do we believe we can benefit moving forward?

Spending habits have changed markedly due to government regulations, changes in lifestyle, incomes and priorities. Whilst only temporary (we use this very loosely as it could mean anywhere from 1-6 months) danger sectors such as travel, entertainment, apparel, hospitality, gaming, catering, real estate and automotive are going to be seriously impacted and unfortunately we expect many businesses may not survive – certainly not without needing to raise significant additional capital.

Conversely consumer electronics is thriving (there has been a huge run on monitors, printers, laptops, electronic gaming, freezers, coffee machines), telecommunications is booming and obviously for those that have been in crowds at the local Woolworths or Aldi, food is, naturally, people’s number one priority. That, and toilet paper.

Given the massive fall in overall consumer spending, and the rise in unemployment, we are actively avoiding any lending or financing businesses, including any temptation to make a re-investment into our longer-term holding in Afterpay that we divested last year. We cannot see any scenario in which bad debts do not blow out markedly. Whilst this may not be apparent for a number of months, we believe the fallout for this industry sector, across the board, will be grim.

Additionally, the recent speed and widespread extent of the virus in the US is causing us to consider carefully any businesses with meaningful exposures to that region. Again, there appear many dark clouds over this region.

We have the Fund positioned well away from any of the ‘danger sectors’. As shown in the table below of our larger fund holdings, we have exposure to sectors likely to benefit in the current environment (education, technology, telecommunication) or are defensive (accounting and insurance) and at around 40%, we hold a significant amount of cash.

But of course in a fast moving market we expect we’ll need to be nimble to take advantage of the many price movements and opportunities.

Importantly, in the coming weeks and months we are likely to see an abundance of market capital raisings in order to support these struggling sectors. Indeed the ASX is presently considering increasing the maximum placement size from 15 to 25% of a company’s total share capital. Of course much of this will be survival capital but for those that do ride out the storm, the returns over the next couple of years are likely to be significant.

At times like this when the market is on its knees, the attributes of the asymmetrical payoff of a long-only investment (where the maximum loss is 100% but the maximum gain is theoretically unlimited) should not be underestimated.  We will not get everything right of course, but there will be an abundance of opportunity to get some investments very right.

We’re increasingly confident the government, and the Australian population in general, are navigating this crisis prudently. We addition-ally support the measures the government is putting in place to protect struggling businesses and the unemployed and believe the domestic economy will fare better than many others and can already see some light at the end of the tunnel.

Lastly, we would like to extend our best wishes to our many investors and readers, many of which, we know personally. Unlike prior market crashes, the current crisis is touching everyone, not just those with an exposure to an ASX investment. We know we are all concerned about the health, careers and lifestyles, and the physical and mental well-being of relatives, friends, partners, and loved ones, both here and abroad and we hope everyone is holding up well in these challenging times.

As always, we are contactable in person and encourage you to do so if you have any questions for us.