My notes from the Aurora Investor Event (9 Oct 2024)
Interesting nuggets about their research process, investment philosophy, and a deep dive into Lloyds Banking (as well as some other companies like Barratt)
I attended the annual investor evening held by Aurora Investment Trust, one of the funds that I follow closely in terms of holdings and their monthly reports. They describe themselves as a value style investor which is very similar to my style and so I wanted to hear more about their research and investment process to see if there was a way to augment my own process.
I am tempted to put some capital in their funds. They focus on larger caps compared to what I do, so there is very little overlap in holdings if I decided to diversify a bit by buying into their listed investment trust.
Below are part of my notes on the event. I actually wrote down seven pages (that’s how informative it was!) but here is my recollection of the highlights and interesting bits.
Disclaimer: I do not vouch for the accuracy of the below; I tried to catch everything said accurately, but I am not a professional scribe. So take the below as my view on what was said, rather than actually what was said. Likely, there will be some minor errors, and potentially major ones.
Intro to Aurora, General Comments
Aurora’s investment style: Warren Buffett named of course, but more importantly is Phil Fisher. His book, Common Stocks and Uncommon Profits, was named.
One of the key initiatives they plan to do is to increase marketing activities. They are aware of the lack of investor interest and discount to NAV, but say this is general to the Investment Trust market overall. But planning to do more marketing to get more investors in.
Current Portfolio: there is a +120% upside compared to Intrinsic Value. Not mentioned if this is based on their NAV, the current share price. Cash in the portfolio is given no upside in the calculation above. So clearly they believe they have the right holdings to deliver strong returns in the years ahead.
Key movements in portfolio, last 12 months
Added to existing holdings in Lloyds Banking, Churchill China.
Trimmed Netflix (summer 2024) and Easyjet.
New positions included Hargreaves Lansdown (and now exit!) and a still-secret new holding (less than 3% of portfolio at the moment).
Exits include Hotel Chocolat and Hargreaves Lansdown (both takeovers).
Barratt Developments was one of the key decliners in the last year. “Mystifies me” was used as the reaction to the decline in the share price, and “there is value there” was used to describe the current price.
Investment Process, Philosophy, Edge
We don’t buy anything unless we see a potential 100% upside. Also, aiming for a 15% annual rate of return, so looking for companies that can also reliably grow profits 15% yearly.
They commonly track companies and sectors for many years before buying. Hotel Chocolat and Hargreaves Lansdown cited as examples of this. In HC case, they considered during the IPO, but passed (did not go into detail why).
When they evaluate management, one of the things they look at is where on the risk spectrum do they sit. Are they minimum risk, or maximum risk? Aurora didn’t go into detail on what part of the spectrum they prefer; but in the case of Lloyds it seems like they would prefer the minimum risk end of the spectrum? Helps with their goal to prevent a complete zero in any of their investments.
Safety is their number one priority, given they run a concentrated portfolio. So nothing should go to zero. A key part of their post-investment process is a monitoring programme for every company they own. So they only invest in businesses that they can set up a robust, external monitoring programme of the company’s trading and operational performance.
Top 5 positions account for >50% of portfolio, seems like this is something they are comfortable with. Average number of holdings is about 15. Has never been more than 20 positions. But they don’t have strict limits on this; if there are plenty of “early” holdings where they might be 3%-ish, then that’s alright too…
They have considered non-UK investments in the past, but this monitoring criteria holds them back. Harder when the whole team is UK based, to monitor a US company’s trading, interview industry players, customers/suppliers, etc. But they are open to US investments (and other countries), one example is Netflix.
They see “sitting on cash” as an edge they have; indexes and ETFs can’t do that. There is a degree of discipline to sit on cash, to not give into the pressure to invest, if there is nothing to buy.
One weakness they had in their past (and quite far back from implication, like the 2000s) was not running their winners. This sounds like something they do better now. And they have the right setup, as they are not constrained by maximum sizing rules, as they hold concentrated portfolios by default.
There was a couple of minutes spent on Fermi Estimation when describing their investment approach. I got lost here a bit, but I gathered that they take a collaborative approach internally, and average out multiple viewpoints on each criteria (eg competitive advantage of a company). And that via Fermi Estimation, you then get to a very good approximation of the truth, even if each person’s view is rough.
They are now making less and less new investments every year. Averaging about one new investment a year. Reason why is that the investment bar has gotten higher as they refine their criteria/checklist. Keep refining and adding more filters to that checklist.
The type of business models they look for:
Strong pricing power. Which usually leads to good ROCE, they are aiming for 15%+ yearly
Safe capital structures. So they look carefully at covenants, pensions, etc.
Serves a growing market.
Transparent. Externally, via their Monitoring Programme. The key levers of the company’s success need to be easily monitored from an external perspective.
Honest, competent, and aligned management.
They have strong price discipline. Many of the companies they research and track, may never hit their price targets to buy. Want to pay no more than half the price of their calculated Intrinsic Value. Also needs a 15% return a year hurdle.
Sizing of positions. They use the Kelly Criterion. Edge over Odds. As they get more sure of the payoff, they increase their holdings.
They have this “A” rating system for companies that they research. A double-A company is one with Good Business and Good Management. They talked about triple-A companies too, but I didn’t catch what the last A stood for.
They had looked at Rolls Royce at one point, but it didn’t pass their Transparency test. How do you mystery shop a jet engine? And no-one in the industry was willing to tell them how much they paid for an engine, how much it costs. Too opaque an industry for their liking.
Monitoring Programme
They spent quite a bit of time discussing this. They try to measure all key aspects of the company that they can, externally.
For every company in the portfolio, there is an assigned analyst in the investment team to run the monitoring programme. At least 80% of each analyst’s time is spent on monitoring programmes vs other work.
Every holding they have, they construct a future roadmap of the key things they expect. So they can quickly see if a company is getting off roadmap from their expected thesis.
A key success is early warnings of problems; want to spot these before the market, in case they need to exit. Critical, given their concentrated holdings, and need to avoid zeros.
Watchlist / Candidate Universe
This numbers in the 100-110, the number of companies they are researching and tracking, but not invested in.
They add companies to their Universe not when they’re cheap, but when they meet the A criteria above. Because their research is so methodical, takes time to complete. So if you only start researching a company when its cheap, it probably might not be cheap once you finish researching.
On the Candidate Universe, when it becomes attractive in price, then they are ready to act in a big way.
They divide up their Candidate Universe into 6 boxes, but here is where I couldn’t quite follow. Something about As, AAs, and AAAs as one of the parameters.
Deep Dive presentation into Lloyds
Three major reasons in their investment thesis here:
Low cost of funding
Economies of scale
Moat of high regulation
My view: nothing unique here, these are well known in the market…
The Big4 banks have cost of funding approximately 100bps lower than the Specialist and Challenger banks. This is due to their vast amount of current account deposits. Big competitive advantage when it comes to competing on loan rates, especially in the mortgage sector, hence the Big4 dominate.
Regulatory moat is high. Went into detail about how the big banks can use an IRB (Internal Ratings Based) model to determine their regulatory capital needed for mortgages. Compared to other other banks, who have to use an SA model (Standard Assessment). Potentially halves the amount of capital required by Lloyds Banking, compared to someone like Metro Bank.
New 3.1 regulation coming into the banking sector. Will close the IRB/SA advantage, but it will still be quite a big gap. Metro Bank, for example, still decided to exit mortgages despite this gap closing.
The market still thinks banks are risky, because they look back at 2008. However, in Lloyds case, they have much less risk now. What caused their downfall was riskier loans. Now their book is much more mortgages (safer by implication) as well as safer underwriting standards.
Aurora believes that in the base case / conservative scenario, Lloyds Banking should be able to deliver shareholder returns (dividends + buybacks) in the ~14% CAGR over the next few years. So even if the valuation doesn’t re-rate at all, it still hits their investment criteria.
Strike Rate / Ratio
They had a slide showing their win/loss rate over all their investments (think this is from start of the fund?).
Looking at a Position basis (each company is one position), the win/loss ratio is 75% / 25%.
Looking at a Value basis (£ invested), the win/loss ratio is 90% / 10%
Not quite sure if this was just Aurora, all of Phoenix. They say they think this is higher than industry norms.
Housebuilders, Barratt Developments
They have quite a bit of expertise in-house on housebuilders. Knowledge built up since the 1990s?
Aurora’s style of investment is to really understand the key drivers of revenue and profit. In the case of housebuilders, it is the amount they pay for the land. Barratt Developments (a holding) was used as an example. Land is bought 3-4 years before the houses built on them are sold. Buying land is a bit of an art - you have to estimate how much you need in 3-4 years, the other input prices (eg construction costs), and the price of the house you can sell. In the last 2-3 years, buyers have been working under gloomy assumptions; soaring inflation, slowing house sales, higher interest rates, etc. So by implication, all land buying teams have been more cautious, so prices paid for land should be low.
We know Barratt Developments are an astute buyer of land. Because we have extensive networks in the industry, we talk to them, including the big land sellers.
This stacks the probability that in the next few years, they should see good margins on houses sold, as the land input cost was at a good price.
They did mention Vistry briefly, the implication there that they had also looked at them, but considered Barratt Developments a superior pick. I gathered between the lines that the implication here was also that Vistry might be one of the players in the market who overpay for land.
Cutting losers
They don’t operate a stop-loss system. It all depends on their monitoring programme, whether they spot a company going off roadmap. And whether the company still has the “As” they rate. Also they exit quickly if management integrity is ever in question.
They are willing to take huge paper losses on holdings, if the roadmap remains on track. High conviction.
Frasers and AO.com
After the presentation, there were stations where you could talk to analysts and staff working in the monitoring programmes of specific companies. I had a good discussion on AO.com and Frasers.
At this point, I had downed my notebook, turned off my brain, and had a beer, so my mental recollection is fuzzy.
On Frasers, they believe the market is wrongly perceiving some of the weaknesses here. Strong cashflow was pointed out as a key thesis for their investment. Also that they have very competent senior management, despite what the public thinks is a one-man show from Mike Ashley. They are also positive on the investment portfolio of stakes being built up in different listed retail equities, but didn’t elaborate further.
On AO.com, the thesis is their strong dominance/market share. Hard for anyone to replicate this now in the UK. They have pricing power with suppliers. Other players who do large appliances (eg John Lewis) are distracted / not investing, so the gulf in customer experience is growing between AO.com and those “legacy” players. Management are also highly rated; example given that they are humble enough to u-turn on mistakes. For example, Europe - exited, rather than try to make it work, despite a huge write-off.
Conclusion
Overall, it was a very informative event to attend. And free as well, even if you’re not an investor in the fund! This is going to be an annual event, so I highly recommend watching out for this event this time next year.
If you’re invested in one of the companies they are too, then the post-presentation drinks will be really useful. Where you can engage with the specific analyst(s) assigned to one of the companies, to get a good view or debate.