Fund Insights: Charles Heenan – Kennox Asset Management
Today Andrew talks to Charles Heenan – Investment Director of Kennox Asset Management. With over 30 years’ experience in global stock markets and a distinct value* approach to global investing, Charles spoke to Andrew about the origins of the fund, his investment style and his views on the global economy in general.
ANH: Why don’t you give us the 30,000 ft view – what are you seeing?
CH: Thanks, Andrew. The global economy has been through an extraordinary period recently – the world experienced a huge financial crisis in 2008/9, which created existential questions about the financial system. We cut interest rates to levels never seen before – and kept them there for a decade. We faced a pandemic and imposed unprecedented lockdowns. Some parts of the markets have had an exceptionally strong run on a tight consensus, especially technology shares and the US. What to make of this all? Where are the next opportunities? What’s overcrowded and overpriced? What’s dangerous and what’s harmless? Does all this debt matter? Why has inflation returned? What happens when the government tries to solve all our problems?
These are the types of questions all investors should be asking.
That’s the backdrop we live in, and Kennox focuses on finding a way to navigate the issues, the threats and the opportunities, and translate that into a sensible and attractive portfolio. That is to achieve our core aim: to protect and grow our clients’ wealth, in that order.
There are a few things we look to to navigate these issues – our beliefs are:
- Markets overshoot and great opportunities can arise in selectively taking positions against consensus
- Decrease risk by focusing on well-capitalised businesses with established track-records
- As long-term investors, our turnover is commensurate with 5-10 year holding periods
ANH: What is the size of the fund and what is its expected growth over the next few years?
CH: The fund is £70m at present. Growth of AUM isn’t the primary focus of Kennox; that is to find investors who believe what we believe and who are looking for something sensible but a bit different. Great success for us, and by the way also the most enjoyment, will come from expanding our little network of clients who like and believe in what we do.
I remember when I mentioned Shell to you at an Advisory Panel, your eyes lit up – you got it, you understood the opportunity. These are the types of people we’d like to have with us.
ANH: You launched Kennox – a “long-term only” global equity fund in 2007 (a very difficult time) – could you provide some information about yourselves and your career paths leading up to the launch of Kennox?
CH: In the early 1990’s, a couple of years out of university, I got hooked on financial analysis and investment decision making (two key aspects of investing), working for a small brokerage and consultant in Montreal, Canada.
After figuring out what part of the investment industry I was interested in – taking responsibility for the decisions, i.e. Fund Management – I ended up in Scotland and worked for eight years with Angus Tulloch and team which was an amazing experience. At one point I realised I was running my own money differently to how I was running money for my clients, and I wasn’t happy with that.
Additionally, we were owned by a big bank. Control was way way over my head and far away, again not an ideal situation.
To be as pure as possible, I left to set up Kennox. That was 15 years ago. To be in charge of your own destiny and to do what you believe is an incredible gift.
Having previously trained as an actuary, Geoff joined me shortly after. It’s been a great partnership as we share the same vision.
ANH: How much attention do you to pay to the macro-economic climate? Max Ward, formerly of the Independent Trust and our Advisory Panel, was primarily focussed on buying good companies and not easily side-tracked by the everyday noise caused by 24/7 economic news.
CH: First and foremost, we are stock pickers. This means we enjoy digging into the strategies and competitive positioning of companies all around the world and comparing that to the financial results that the companies report.
As an ex-accountant yourself, Andrew, you’ll appreciate that, while it has subjectivities and its own way of thinking, accounting and financial statements are the best framework to understand companies’ financial health. They are a powerful tool – if you know how to use them.
As per the introduction, the backdrop matters. Ignoring it is dangerous – you wouldn’t intentionally ignore any significant risk to your investment, would you?
We take account of all risks to your businesses, whether they be macro or micro. Put these risks into perspective and balance them. Next, build in a margin of safety. At that point, blend to make as sensible a portfolio as you can.
ANH: Given the current market conditions, how has your view changed on the Sustainable Earnings of the companies that you invest in?
CH: Our companies’ earnings are starting to come into their own – many have faced headwinds that are clearing up, industry-wide supply has shrunk and competition has lessened, and profitability outlook is improving.
We always try to understand our companies by assessing their long-term earnings power – via their past track record, by their concrete competitive advantages, by their strategic positioning and by changes in the economy and consumer’s needs and wants.
ANH: What are your key investment strategies? You have enjoyed a good 3 years (25%) – in arguably difficult trading conditions. How have you done this, and do you think you can keep it up?
CH: The market’s mood notably changed in November 2021. Since then, the fund is up 20%.
We’re especially pleased to be able to make money in more difficult markets – that is a key objective for us, as big investors in the fund as well as the managers.
The investment strategy is designed to do well in choppy waters as well as when the sailing is smooth.
Absolutely, we believe this will continue for a while – it would be very rare to have such as seismic shift, such as the change of regime since November 2021, and it to flip back again. That’s not the way markets work.
We have only one investment strategy – Kennox is focused, built to do only this, and do it as well as we possibly can.
ANH: How much capital do you have in the fund – what was the percentage at the start and the percentage now? (We like fund managers who have skin in the game!)
CH: Because it is how I believe in running money, I have 100% of my equity exposure in the fund – and that’s pretty much all my financial wealth as well. I believe in this!
ANH: You run a fairly concentrated portfolio of equities. Can you tell me briefly about your top 10 holdings (representing about 52% of the fund) and again– briefly -something about the other 48%?
CH: We think being selective is a good thing. What we are looking for is rare: we are comfortable waiting for it, and backing it. That’s what conviction is about. We had 27 holdings at end March 2023.
To give a flavour of our portfolio holdings and positioning (from our monthly commentary):
Kennox is a stock-picker first and foremost. This is represented in the portfolio by holdings such as M6 Metropole, Sky NZ, Stella International, Texwinca, or Canon Marketing Japan. Each are well-run niche companies that fly under most investors’ radars.
The portfolio also features concentrations in areas where prospects are especially compelling. One example currently is the energy majors. The global economy remains entirely dependent on fossil fuels but has significantly underinvested in the safe provision of these valuable energy sources.
Current low valuations for the leaders in this area (such as Shell) represent an exceptional opportunity. Another concentration for the portfolio is gold miners. In a time where global debt has ballooned and where governments throw increasing amounts of money at any problem, having exposure to a financial asset not linked to monetary distortions, in the form of long-life gold reserves like Newmont’s, is uniquely attractive.
Overall, the portfolio continues to consist of diverse sector leaders trading at attractive valuations, where past headwinds are turning into tailwinds, characterised by low levels of leverage.
ANH: Do you think the UK is being overlooked by investors due to its current unfavourable situation, or do you believe there are still investment opportunities worth considering?
CH: UK is well out of favour and definitely a rich hunting ground at present. But be selective, buy high quality – and we may need to be patient. Like many and maybe more so than some, the UK has challenges as well as opportunity.
We’re always looking at areas where the market has overshot and is excessively pessimistic. That’s where the real bargains are.
ANH: Some of our clients are interested in investing in companies that prioritize addressing climate change. What is your stance ESG policies? I see that some of your main holdings are in the energy/oil and gas industry, how would you explain investing in them to ESG enthusiasts?
CH: Start with the big picture. Is the whole industry investible or not? We will invest only in companies that bring overall benefit to society. Aligned to the 17 UN Sustainable Development Goals, if we assess that a company or an industry causes significant net harm to society at large, we will not invest at any price. This assessment is viewed as the widest balance of all its activities and interactions with stakeholders, including employees, customers, suppliers, the environment, and other aspects of society at large. For example, under this framework we will not invest in gambling, tobacco, pornography or armament companies.
Kennox must be willing to take contrarian positions. Kennox is willing to take a stance against views in the marketplace if we assess that consensus to be misguided. For instance, if we assess that a company or industry provides a service that is suboptimal on one measure in the view of the market, but overall necessary to the smooth functioning of our society at large, Kennox will judge this industry to be investible. The case for fossil fuels falls into this space at present – exclusion on ethical grounds is inconsistent with absolute dependence today.
Any assessment is complex and subjective. In essence, our assessment is to consider the strategic issues that a responsible and sensible company director faces to ensure the sustainability of the business franchise, as measured over decades, not quarters. By its nature this is a complex, often qualitative assessment, and always involves trade-offs and the balance of a wide range of interests. In this area, Kennox’s view is that pragmatism is worth more than idealism.
Once we assess an industry to be investible, it is important that our investee companies should be responsible and progressive, especially in the difficult areas (i.e. fossil fuels). Once Kennox assesses an industry to be investible, Kennox will seek out the leaders and engage with them to improve as much as possible, encouraging them to be progressive.
ESG should be fully integrated into the investment process.
Our investment team is fully responsible for both the Kennox ESG policy and its implementation – there is no better way to ensure that ESG is fully integrated in all aspects of our investment discussion and decision-making.
ANH: How do you find time to find good global companies with such a small team? (Compared with JP Morgan Global or BlackRock, for example!)
CH: In some areas, smaller is better – but it’s imperative to (1) know exactly what you’re looking for, and (2) know exactly how to find it, i.e. a robust process. We built the investment philosophy and process from scratch to be fully and perfectly integrated.
Some missions are better achieved by the crack unit, not the battalion – the “Guns of Navarone approach”.
ANH: More than 20% of your portfolio is in the Energy sector – can you explain your rationale for this weighting.
CH: Sometimes all the factors line up – essential, underinvested, unloved and inexpensive. Expanding on that:
Fossil fuels currently represent 80% of global energy supplies. These fuels are deeply embedded in all aspects of the current energy complex. This energy complex is composed of different facets such as transport, manufacturing, heating, electricity, agriculture and there are no immediately available substitutes for any individual facet of this energy complex, much less all concurrently.
Due to ESG pressures on top of a classic investment cycle (where low prices lead to low investment), fossil fuel supply looks to be significantly underinvested – and has been so since 2015.
The world is returning to peak demand, but investments are a fraction of peaks.
Signs of this underinvestment are popping up across the system, not least in the form of higher energy prices (and this was the case even before the Ukraine war). This predicament for the global economy – of dependence on fossil fuels but underinvestment in them – inevitably leads to higher prices for longer periods of time. With this backdrop, sector-leading energy majors remain exceptional investments.
ANH: What is your criteria for (a) buying stocks and (b) selling stocks? What is your portfolio churn every year – that is buying and selling?
CH: We buy only the highest quality companies and only when they are available on excellent valuations. We achieve this by thinking only in the long term.
This opportunity comes up most often in the form of short-term headwinds. The extrapolating mind of the market views any headwind as an ominous and permanent risk. This gives a price drop. This price movement transforms into a genuine opportunity only when we assess that the headwind is temporary and the long-term risk profile has not changed – or perhaps has even improved, as survivors face decreased competition. Kennox refers to this as the J-curve, where temporary headwinds turn to tailwinds as the industry eventually cuts backs supply and/or demand recovers.
Our assessment of a company’s Sustainable Earnings will drive the price targets at which we will make buy and sell decisions. We look to invest in quality businesses when they are trading at less than 12x our Sustainable Earnings estimate, will be trimming a position as the valuation moves above 15x SE, and will look to exit a position when valuation moves to 20x our Sustainable Earnings estimate.
Because we believe in being long term stewards of our companies, because we buy high quality, because we are selective, our turnover is low, commensurate with 5-10 year holding periods (turnover averages under 15% pa).
ANH: What is your outlook for 2023?
CH: Inflation is back for the first time in something like 4 decades; debt is high across the board; we’ve seen a return of banking crisis in the US of all places; assets, especially those in the US, are not cheap. These are challenges that an investor can’t ignore.
But the outlook for what we do and the portfolio is as good as we have seen it. Having had a “quiet” five years up until 2021, our patience is starting to pay off. We’d be surprised if we switched smoothly and seamlessly back to the status quo of the late 2010’s – the world has changed too much for that.
ANH: Where did the name Kennox come from?
CH: The founding directors were sitting in the chairman’s house in the west of Scotland, choosing a name for the new business – and what better than named after a lovely spot in Scotland?
* Value investing: An investment strategy that involves picking stocks that appear to be trading for less than their intrinsic value