Marcus Burns: A toasty small cap for the long-term

A reckoning is overdue for stock markets, warns Marcus Burns, co-founder and portfolio manager of Spheria Asset Management. To explain this view, he points to the distortionary effect of the massive pandemic-driven fiscal and monetary stimulus efforts of governments and central banks around the world.

The bond-buying sprees of the Reserve Bank of Australia and other developed market central banks have undoubtedly steadied the ship, economically speaking. But they have also “short-circuited” the normal market cycle, partially resetting what was a very late-stage market before the pandemic struck last February.

“We don’t really have a discount rate right now and people are investing like it’s negative, like cash is worth nothing. But cash and earnings today should be worth more than cash and earnings tomorrow,” he says.

The big clean-out of companies that many were predicting in the early stages of the pandemic never eventuated – at least not yet. But Burns believes it’s only a matter of time and that this is the burning issue investors must get their heads around over the next five to 10 years.

Marcus Burns

Portfolio Manager

Spheria

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I recently spoke with Burns as part of Livewire Markets’ new Top-Rated Funds series. This features Australia’s 100 top-rated funds, according to Lonsec, Morningstar and Zenith.

Meet Marcus Burns: A style-agnostic "maths nerd" (his words)

A self-proclaimed “mathematical thinker,” – which Burns credits as the main reason he was drawn to the industry – this is reflected in his stock selection process. It’s nothing particularly fancy but seems a down-to-earth, fundamentals led approach focusing on finding cash-flow generating companies with healthy balance sheets and foreseeable upside to their stock price.

“It doesn’t mean we’re a value manager; it means we’re looking for stocks that have upside, whether they’re growth or traditional value-style stocks,” Burns says.

So, apart from a mathematical bent – and presumably an interest in finance, having majored in economics at the University of Sydney – what attracted him to funds management? He wasn’t born into it like many of his industry colleagues. “My father was an architect and basically viewed stock investing as a form of gambling, so that’s how I initially thought about it when I was younger, too,” says Burns.

But something clicked for him about 25 years ago, after reading a book by “some guy called Warren Buffett.”

“Remember, back then Buffett wasn’t as well-known as he is now – and I thought, ‘wow, this is the first time the stock market has ever made sense to me,’” says Burns.

From this point, he became slightly obsessed.

“Investing is a bit like repeated puzzle-solving, but every time you do it, the pieces look a bit different. There’s always a sense of achievement when you’re investing, especially if you have a really good team around you,” he says.

So, what motivates him?

“Winning. I know many people might say the same thing, but I really want to win, I want the team to win and I like having a growth mindset.

“I think if we can have that culture then eventually, we’ll have to win because we’ll keep chipping away until we’re a bit better than everyone else and, perhaps more importantly, better than our former selves.”

The philosophy of Burns and his team was shaped by years of reading and seeking to better understand how some of the most successful money managers differentiate themselves from the market.

“A big part of this game is about making fewer mistakes, as much as it is about picking winners,” he says.

 By the numbers

• 55.9% - The fund's 12-month return (as of 31 April), beating the Small Ords by 16%
• 20-65 - The number of companies typically held in the portfolio
• $25,000 - Minimum investment amount for the retail fund

Managed Fund

Spheria Australian Smaller Companies Fund

Australian Shares

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An unsexy, low-percentage game

“That doesn’t sound very sexy – don’t make mistakes – but it’s at least 50% of doing better than the market: take away those big losers, shift that return curve over to the right and obviously you’re going to find some better businesses if you apply the metrics.

He sums his process up neatly as: Stop the losers, find some great stocks, don’t take crazy risks to get there and over time, that’s going to eke out better returns.

“This is a low-percentage game. If we’re 1 or 2% better than the market and our peers over many years, then over time that will compound into a massive number.”

As with so many of the best investors, the experience of market adversity has been a key driver of Burns’ success. And though Australia’s experience of the global financial crisis was somewhat muted – thanks to a combination of luck, geographical location and the quirks of geoscience that gave us iron ore – Burns had a closer view of the action, working for a London-based hedge fund manager between 2005 and 2008.

As the crisis unfolded, Burns and his team at GLG Partners (now Man GLG) took the view that any holding without cash flow was out: “And those remaining stocks massively outperformed the selloff,” he says.

So when he and Spheria co-founders Matthew Booker and Adam Lund set up their own firm, making it hurricane-proof was a priority. They did this by building portfolios of stocks that weren't reliant on large capital raises or huge PE discounts for their success.

Spheria's approach revolves around the ability to understand and value cash flow, which became the bedrock of the fund manager's small- and micro-cap funds.

When will money mean something again?

Pondering the above question – and what effect this snap-back to reality will mean for markets, particularly share price valuations, is currently top-of-mind for Burns and his team.

“How will this central bank and government intervention play out in wealth, money and stock markets? And how do we preserve and grow client money in that environment? That’s what’s occupying a lot of my thinking right now,” he says.

“I think inflation is going to come back, but I don’t even know that it’s necessarily going to be called inflation; I think everyone’s missing the point.

“The monetary value of paper is declining. You can hedge that by being in real assets such as property, gold or possibly even fine art – though I wouldn’t recommend that, it’s not something I understand – and by investing in good businesses.”

So what does this mean?

How does this decline in the value of money affect his fund’s positioning? “We start to think about whether companies have been priced for when inflation comes back; we think about whether businesses can still grow in that enviro; or if they’re very capital-intensive, whether their cost of doing business will rise.”

Circling back to Burns’ earlier point about investor thinking having temporarily severed ties with reality – in this context, the cost of capital – it makes sense that he believes we’re at the Euphoria stage of the market cycle.

“People are borrowing money to buy expensive stocks that have no earnings. The rate of margin lending is at its highest level ever in America right now, and I’m guessing here in Australia we’re not far behind,” he says.

In a market that is now driven by the fear of missing out, “people are buying into stocks purely because they look around at home many of their friends are making money in the markets and they want a piece of it too,”

The mention of Bitcoin here was almost inevitable. Reaching for his phone, Burns scrolls through a long list of the different types of cryptocurrency – there’s now more than 4,000 of them, spread across three core categories of alt-coins, tokens and stable coins. 

Burns refers with wide-eyed incredulity to several friends who own large stakes in crypto, refusing to sell down their reserves due to something akin to religious fervour.

Perhaps with a nod to the overwhelming “herd mentality” that drives such thinking, individualism underpins one of his most valuable pieces of investment advice.

“Do your own thinking. Own your mistakes and back your conviction,” he says.

And continuing the quasi-religious behavioural theme, Burns calls out an old concept as the biggest investing myth he’s ever heard.

“The efficient market hypothesis has been exhorted as gospel, but it’s just completely false,” he says.

Investing with a tiger cub

Given that Burns has spent a lot of time reading the classics of the investment world and looking at other managers in building his own process, I asked him who he would invest with if he had to choose a third-party fund manager.

Burns singles out US-based hedge fund Lone Pine Capital, a US$36 billion fund manager headed up by Stephen Mandel. The fund is one of the “Tiger cubs” spun out by billionaire Julian Robertson’s two-decade-old firm Tiger Management.

“I really like his high conviction management style, with around $27 billion invested across just 40 stocks – big punchy positions in really great businesses,” Burns says.
“He just goes hard, buys quality names and holds them for long periods of time. They will usually be good cashflow producers, have good valuations and I think their returns will be great over a long period of time.”

Another Steve crops up when Burns is asked who he would have dinner with if given the choice of anyone: “Steve Jobs, because he saw so much innovation in technology and he was part of driving so much of it.”

The view ahead

Burns warns that when the pendulum swings, the cost of capital will again mean something and the market will very quickly reprice listed assets.

“Whether it’s through inflation and rates rising, or whether people start demanding to be paid something on their cash, that will cause the cost of actually giving companies capital to rise and will cause bad businesses to fail,” Burns says.

“And we haven’t really seen that. We’ve just put the defibrillator on, gushed more adrenaline into the veins and kept it all alive.

“Allowing the bad companies to die is healthy, and we haven’t had a cycle for a long time, which I think is dangerous.”

In spite of – or perhaps because of – the above, Spheria’s flagship investment strategy, Spheria Australian Smaller Companies Fund, performed very strongly through the pandemic.

While the local small-cap universe is up an impressive 40% in the 12-months to the end of April, Burns’s fund added 16% to this, gaining just under 56% over this period.

A toasty stock pick

And finally, when asked to name one of his favourite companies right now, Burns returns to a well-grounded firm that is very relatable to local investors.

“I would back Breville (ASX: BRG) on a really long-term basis,” he says.
“It’s not particularly cheap right now, but I think it is when considered on a long-term basis.”

“It’s got an incredible record of innovating, most of its earnings are generated overseas and management has proven it can innovate against other big players like DeLonghi and other competitors. It also holds the high-end of the market.”

Perhaps the biggest appeal, which is something other small-cap fundies have also highlighted, is the staggering size of Breville’s total addressable market.

“With revenue of around $1 billion, their business is a great cash flow generator with a tremendous return on capital and the management team is really thinking very strategically about building the business for the next five or 10 years,” Burns says.

“If you said ‘Buy one stock, shut your eyes and come back in five or 10 years,’ that’d be the one.”

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