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Alternative Market Briefing

Fundamentals a winning approach for Texan hedge fund LRT

Wednesday, December 22, 2021

amb
Lukasz (Lucas) Tomicki
B. G., Opalesque Geneva:

For some fund managers, the last several months have felt like sailing upwind as fundamentals seem to have been left aside.

"Market momentum, investor flows, and positioning have determined returns for many stocks over the past few months much more than the financial results reported by individual companies. The current market environment remains frustrating for investors such as us who believe that stock prices follow company fundamentals over the long term," LRT Capital Management says in a November investor letter.

Fundamental analysis measures a security's intrinsic value by examining related economic and financial factors to determine its real or "fair market" value. It differs from technical analysis which instead studies the historical price trends of the stock.

LRT Capital Management, LLC is a fundamental investment hedge fund manager based in Austin, TX with current AuM of about $130m. Its flagship, the LRT Economic Moat Strategy, invests in a concentrated portfolio of companies with competitive advantages, purchased at attractive valuations, and held for the long term.

LRT's founder Lukasz R. Tomicki will be presenting at the Small Managers - Big Alpha Episode 6 webinar on January 11th, 2022.

Markets in the twilight zone

George Soros, one of the world's most successful financial speculators, posited a theory he calls "reflexivity" where a feedback loop exists in which investors' perceptions affect economic fundamentals, which in turn changes investor perception. "…Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more people lose faith, but the prevailing trend is sustained by inertia."

LRT believes that the market has reached the twilight period, especially with respect to high growth technology companies that are going to "change the world".

"The rise of growth-at-any-price investing, #neversell, meme stocks and the overall total disconnect between fundamentals and stock prices is just one of the many signs. Investors and traders alike are buying stocks based purely on momentum, without regard to the fundamentals of the companies and in some cases without even knowing what the companies do."

LRT Economic Moat Strategy

The strategy invests only in companies with (1) durable competitive advantages, i.e. "moats", (2) the ability to grow and reinvest capital, and (3) management teams that can allocate capital effectively. All three are sources of perpetual inefficiency and mispricing, says the manager.

To find investment candidates, LRT performs primary source research and detailed analysis of the nature of competition in the industries the investment candidates operate in. The portfolio construction is completed via a proprietary allocation algorithm developed by Tomicki. Since January 2021, the strategy has been using market index hedges to reduce volatility with typical net exposure between 60-100%, and beta adjusted net exposure between 40-65%.

"What differentiates LRT Capital is our proprietary and systematic portfolio construction process," Tomicki explains to Opalesque. "We have developed proprietary tools for portfolio allocation, risk management, and hedging. So while our portfolio is fairly concentrated (40 names, about 45% in the top 10 names), it is incredibly diversified and hedged with respect to market risk. For example, historically, we have had a beta with respect to the S&P of only between 0.4 and 0.6, while generating close to double the long-term return of the S&P500 (net of fees). It is the combination of a fundamental and qualitative security selection process, with the systematic and quantitative risk management / portfolio construction process that makes LRT's investment strategy unique amongst hedge funds."

Tomicki, CFA, has more than a decade of investment experience. Before founding LRT in 2012, he established and sold LobbyAssist a US-based technology company that developed tracking software for state campaign finance and legislation.

The strategy has outperformed the S&P 500, the Russell 2000, and all relevant hedge fund indexes by a wide margin since inception in October 2012; it has annualised 26.5% compared to 13.4% for the S&P 500. It is up 22.4% YTD after returning -3% in November, according to documentation seen by Opalesque.

When is a moat a moat?

Conceptualized and named by Warren Buffett, one of the world's most successful investors, an economic moat is a distinct advantage a company has over its competitors which allows it to protect its market share and profitability. It is often an advantage that is difficult to mimic or duplicate (brand identity, patents) and thus creates an effective barrier against competition from other firms.

The manager at LRT focuses on moats because they provide a more tangible valuation: "Quantitatively focused investment strategies are being arbitraged away very quickly due to advances in computing power, machine learning techniques and new data sources. Quantitative information is priced very efficiently by the markets… but qualitative insights are not!

"Qualitative processes are hard to replicate and arbitrage. There is no Bloomberg screening tool for switching costs or network effects. The presence of a moat makes the valuation of a business more certain and improves risk management. Moats force you to take a long-term view an advantage when other market participants are obsessed with quarterly results."

One of LRT's holdings (1.5% of long exposure) with moat and growth opportunity is Dollar General, a discount retailer with the largest brick-and-mortar presence in the U.S. by store count. Another small holding is Axon Enterprises, a law-enforcement-centric company seeking to revolutionise the way police work is conducted.


Related:
Nov. 2019 Opalesque TV: The Economic Moat Strategy: Investing with conviction to outperform in times of volatility and uncertainty


Webinar:

Small Managers - BIG ALPHA Episode 6

We are proud to present you the next episode of this groundbreaking webinar series with the following carefully screened panel of investment managers:

• Andy Chakraborty, Duo Reges Capital Management
• Lukasz Tomicki, LRT Capital Management
Steven Grey, Grey Value Management
• Scott Phillips, Lavaca Capital

When: Tuesday, January 11th at 10:30 am ET - 3:30 pm UK time - 4:30 pm CET

Free registration: www.opalesque.com/webinar/

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