How does Magellan position a 'best ideas' fund for a crisis?

Magellan has relaxed the constraints on its High Conviction fund in order to provide more flexibility during the pandemic, including moving to 25% in cash.

The global equity High Conviction fund, which is high conviction and only held between eight to 12 best ideas, had been opened up to allow up to 50% in cash and included high-quality mid-cap businesses.

Even by high conviction standards, this level of stocks was unusually low as others tended to have around 20 to 25 stocks.

Deputy portfolio manager Chris Wheldon, who manages the fund with Hamish Douglass, said: “We’ve relaxed some of the constraints to provide a bit more flexibility in the strategy. First of all, we can take cash up to 50% of this portfolio. Likewise, we can be a little bit more offensive in this portfolio compared to some of our other ones and we’ve opened up the universe to include very high-quality mid-cap businesses for the high conviction strategy. We’ve also embedded an active currency hedging program”.

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Cash was 25% in March and April, a “meaningful increase” from the 5% weighting it held at the end of February.

As to what would encourage Wheldon to utilise this cash, he said he would have to see a dramatic reduction in macro risk or find a high-quality, durable business which was attractively priced.

“We’d have to feel like there’s a dramatic reduction in the risk associated with the macro backdrop, or we’d feel that prevailing prices offered a more attractive investment profile. Until one of those two things happen or both of those things potentially happen, I expect we’ll retain that defensive posture that we’ve got at the moment,” he said.

“We’re searching for those incredibly high-quality durable businesses, operating in attractive and growing industries. We’ll be very insistent as always on a big margin of safety and trying to acquire those businesses at a very undervalued price.

“Our view is that prevailing prices for most equities don’t appear that attractive at the moment. Prices for most equities don’t seem to allow for a lot of potentially bad news or bad outcomes. So you marry those ideas of a very uncertain macro environment with prevailing price levels, and it just seems to us that risks here at the moment seems skewed to the downside.”

Regarding the hedging strategy, at the end of February, the portfolio was about 54% hedged and this dropped to 26% at the end of March as the team felt it was “appropriate” to add that additional layer of downside protection.

Equity holdings

Wheldon said the portfolio remained the same during January and February but shifted to a more defensive position in March. This saw it exit a position in Yum Brands and luxury good manufacturer LVMH and trimming those positions which had a high degree of economic sensitivity.

“Yum Brands was really around some short-term question marks around their balance sheet and funding profile. And LVMH was just recognising that in this environment that just didn’t have the same attractive investment profile,” he said.

Instead, it added exposure to Chinese technology company Tencent, a stock held in several other Magellan funds. This meant there was 35% of the portfolio in four businesses; Microsoft, SAP, Alibaba and Tencent, plus 6% in Starbucks.

“We expect all four of those businesses to be incredibly resilient during this initial shutdown period, but also in the recessionary period that we expect will follow. And pleasingly, that view has been supported by the first quarter results from these companies so far,” Wheldon said.

“You’ve got 70% of the portfolio in five very high-quality businesses and businesses with good resiliency to an economic downturn and in cash. It’s a very high quality and defensive core to the portfolio.”

It had a smaller 30% weighting to Alphabet, Facebook, Visa and Estee Lauder.

“We recognise these businesses are more cyclical and they’re going to have some challenging short-term headwinds ahead of them. Importantly, though, we recognise the quality of these businesses and the industries in which they operate will recover and will grow over time,” he said.

“They might have a bumpy couple of quarters or years potentially ahead of them, but we think they remain incredibly well positioned for the long term.”