Why having a private markets mindset can drive outsized returns in public markets

This interview was recorded on Wednesday 30 October 2024.

There’s taking an active approach and then there’s the idea of taking a private equity approach to investing in any asset. For HMC Capital Partners, this means taking the view of influencing genuine change in a business as an investor. It’s the approach it follows in the HMC Capital Partners Fund, which can invest in private or publicly listed assets and currently holds a highly concentrated portfolio of seven investments.

According to Victoria Hardie, managing director for HMC Capital Partners, this extends beyond identifying “diamonds in the rough” - or undervalued companies experiencing a misstep. Hardie and her team want to add value for investors and other shareholders through active participation with a company.

“One of the gates is to identify that we can influence the outcome because if we don’t feel that we are going to be able to get enough influence and drive that change with the broader management, then we simply won’t get involved in that situation,” Hardie says.

She describes it as a partnership approach, referencing one of the portfolio’s investments in Baby Bunting (ASX: BBN) where HMC Capital Partners were able to share expertise in retailing, real estate and strategies around locations for stores.

In this episode of The Pitch, Hardie discusses taking a private equity approach to investing, how she identifies opportunities and her exit strategy. She also discusses HMC Capital’s (ASX: HMC) involvement with the proposed Sigma Healthcare and Chemist Warehouse merger.

Edited transcript

The Capital Partners Fund takes a really active approach to managing the portfolio. How do you approach this and what value are you looking to add for investors?

If you think about the spectrum of equity investors, at one end of the spectrum, you've got passive investors that follow the index and are hoping that the market goes up. At the very other end of the spectrum is the Capital Partners Fund. So, it's an extremely active approach.

It's not just picking stocks and hoping for the best. We are picking undervalued stocks and then we're really rolling up our sleeves, getting involved in those situations and driving value for the benefit of our fund investors and other shareholders in that situation.

When I talk about adding value, it's the full spectrum of major M&A, just small asset sales portfolio reviews, looking at their capital structure and their capital allocation. Even going so far as changing boards and management teams to deliver on the promise that we see in a business because we are investing in quality companies, but they just haven't fully realised their potential.

You've delivered really strong growth in the fund since its inception two years ago. How's the fund been able to do this?

We’ve delivered a little bit over 28% annualised return in over two years. Most of that has been from taking what we call a private equity style approach in the listed equity space.

Our seed investment was in Sigma Healthcare (ASX: SIG). A lot of people would be aware of the proposed merger with Chemist Warehouse, and so we were very intimately involved in helping Sigma negotiate and structure that transaction with Chemist Warehouse that's delivered incredible returns, not only for our fund investors but also other Sigma shareholders. It's really rolling up our sleeves, getting involved, acting like an owner, and really being aligned with other shareholders and trying to drive that value above and beyond an index-type return. So, it's really a private equity style, mid-teens-plus type returns.

Why do you believe a proactive approach to investment in this space is critical compared to other active investors?

I think we all know that there's been a trend towards index and passive style investing in the markets, and so I think there is a role to play for active investors with that ownership mindset to really hold boards to account and drive that value that we are looking to achieve.

We are completely aligned with other shareholders. We're just looking for value. We don't have any other objectives. Bringing all of our capabilities as HMC, not only the investment team that's working on the fund, but our broad networks across all of our strategies and bringing that expertise into a specific situation can really drive outsize returns.

If we look at some of the other opportunities that we're invested in, Baby Bunting is a more recent one, where we have a lot of expertise internally, not only in retailing but also in real estate and strategies around where the best places for retail stores are. And we bring all of that in a partnership approach with the Baby Bunting team.

You mentioned Sigma and Chemist Warehouse as an opportunity earlier on. At any given point, are there enough opportunities to consider and how do you go about finding them?

There aren't hundreds of opportunities. By definition, it's a small set of opportunities, and so our fund will always be concentrated into eight to 10 positions at any one time.

We go through a screening process where we're looking for quality companies that are trading at a discount to their fundamental value diamonds in the rough. We like to say that might've had a misstep, whether it's a strategy execution issue, a management issue, or maybe they're facing cyclical factors. Maybe there's a conglomerate issue where the sum of the parts is not trading at full value because the market's not able to price each piece appropriately, and we identify how we might go about unlocking that value.

But most importantly, one of the gates is to identify that we can actually influence the outcome, because if we don't feel that we are going to be able to get enough influence and drive that change with the broader management, then we simply won't get involved in that situation.

The strategy seems to favour companies that have a strong asset backing, but as you mentioned, are experiencing a misstep. Why do you focus on these companies and what benefits does the broader HMC Capital network offer to this process?

The reason we focus on businesses with real asset backing is to provide some downside protection. As I mentioned earlier, it's a concentrated portfolio.

We can't afford to have any of these businesses go to zero. We need some downside protection, and that real asset backing provides that buffer on the downside and theoretically asymmetric return profile.

The fact that these businesses might've had a misstep from our perspective, provides us with a buying opportunity we can get set in these situations at a discount or at a good price. Buying well is half the battle in making a good investment. 

That also provides us with the window of opportunity to bring our capabilities, whether that's our deal-making capabilities as former investment bankers, or our broad network across our boards, not only on HMC but also our listed REITs. There's a lot of capability and relationships that we can bring in any one situation to unlock that value, and it's a pretty unique strategy and capability in the market.

You mentioned half the challenge is identifying the companies, which means the other half is knowing when to exit. Can you take us through your exit strategy?

One of the benefits of our strategy is because we're investing in listed equities, there's a market there every day. If a stock has hit or is approaching our target price, we have the opportunity to take advantage of that liquidity and sell into the market, unlike a traditional private equity strategy where you might be waiting for a buyer to pay you for 100% control of a business or an IPO window to open where you can list a stock and exit that way. 

So, we can take advantage of that flexibility, and we have the discipline of price targets for each of our positions where once we feel like we've delivered as much return as possible in a situation, we can then take advantage of those liquidity moments and exit and realise value for our unit holders.

Is there an example of when you've exited a position?

Because the fund's only been up and running for about two years, and some of these situations take a little while to play out, there's only one situation where we have decided to sell down some of our positions, and that's in Sigma Healthcare.

We've sold down from our peak of 19%, we're sold down to around 10%. We're still holding a very significant position in Sigma. But from a risk management perspective, we did elect to sell down some of that position because the fund was getting very overweight Sigma due to its strong performance.

Exposure to a portfolio of alternative assets targeting growth and income

HMC Capital Partners Fund I (Fund), is an Australian-domiciled unlisted fund providing exposure to a high-conviction investment strategy seeking to generate superior risk-adjusted returns. Find out more here.