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Alternative Market Briefing

Spotting red flags in equity investments, a lesson learned

Wednesday, May 19, 2021

Mark Walker
B. G., Opalesque Geneva for New Managers:

London-based Tollymore Investment Partners is a private partnership that invests in a small number of publicly listed businesses. After returning 224% net in the last five years, the manager has learned a thing or two about potential red flags in investments and how to deal with them.

Tollymore compounds partners' capital over the long term by investing in a concentrated portfolio of undervalued high-quality businesses. The firm's philosophy is patience and independent thought. It partners with investors who think like business owners rather than traders.

Tollymore's long-only global equity strategy, which manages $25m, has annualised 26.7% (net) since May 2016, after returning 77% in 2020. As of April, it is up 3.3% YTD.

The founder and managing partner, Mark Walker, previously worked at Seven Pillars Capital Management, RWC, and Goldman Sachs.

The firm was created "as an effort to create value for long-term minded individuals, family offices, endowments and foundations," Walker said in an earlier Opalesque TV interview. "It is an attempt to create value for those investors with very long-term, potentially perpetual investment problems that they are trying to solve."

Red flags

"Just as I believe that multiple small insights can compound to form a defensible business, so too can multiple small fractures compound to unravel a company's investment merits," Walker says in a Q1 communication to investors seen by Opalesque.

He goes on to list several red flags he should have been aware of in a 2017 investment in Wonderful Sky, a financial PR services business based in Hong Kong, and reflects in the following post mortem: "As the potential value of the company dwindled, upside remained largely unchanged: a classic value trap. I was far too slow to incorporate new information into my appraisal of the company's equity prospects. I collected red flag after red flag, painfully contorting the narrative to justify our continued, and in some instances, increased, ownership. It should have been quite clear to a reasonable observer that business quality had been misanalysed and was deteriorating. Despite espousing the value of intellectual honesty, our ownership of Wonderful Sky was awfully dishonest. I was seduced by extreme cheapness: the company's bizarre capital structure meant that even modest equity declines had extreme implications for business value, resulting in negative enterprise value in the order of hundreds of millions of Hong Kong dollars. In the giddiness of finding this valuation 'anomaly' I lost sight of the core principles of Tollymore's investment philosophy."

Walker has been swifter in recent times to exit investments failing to demonstrate positive fundamental business progress. He offers the following lessons learned from Wonderful Sky, his only significant dollar error, and other investment mistakes:

1. be less willing to give the benefit of the doubt to management when aggregate economics are not at least directionally supporting unit economics;

2. do not pay to average into businesses with temporary problems, funded by businesses earning the right to be larger portions of the portfolio;

3. be careful when fragmented supply consolidates, and the impact that might have on the utility of aggregation;

4. do not get too close to management, a relationship which may muddy the objective assessment of business prospects; and not be hamstrung by the label of long-term investor - cutting losses is consistent with maximizing long-term value of a group of companies.

Related articles:

04.Jun.2020 Opalesque Exclusive: Long term investor, Tollymore, generates 20% returns p.a. since inception
19.Mar.2020 Other Voices: Taking a long-term investment view is the only way to navigate this period
20.Feb.2020 Opalesque TV: Where patient capital is a clear behavioural edge

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Small Managers - Big Alpha - Episode 2

With larger quantities of capital chasing the same alpha strategies and continuing to erode alpha, savvy investors are turning to smaller and/or emerging managers as they look for alternative sources of return. Opalesque presents a carefully screened panel of investment managers worth taking a look at.

- Robert Zuccaro, Target QR Strategies
- Mukhtader Mohammed, Arbritrium Capital Partners
- Craig Reeves, Prestige Capital Management
- Mark O. Witten, Portal Asset Management

When: Tuesday, June 22th at 10:30 am ET
Free registration:

You can access the replay of Small Managers - Big Alpha Episode 1 under the same link.

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