Livewire | Decade of excellence: 10 years of outstanding performance for L1 Capital’s Long Short Fund

This article was first published by Chris Conway in Livewire Markets on 12 November, 2024.

In September, the L1 Capital Long Short Strategy (ASX: LSF) passed its 10-year mark since launching. It has been a decade of success, with the monthly class of the unit trust fund delivering a return of 18.7% p.a. – 10.7% p.a. ahead of the 8.0% p.a. delivered by the S&P ASX 200 Accumulation Index to 31 October 2024.

And while those numbers tell a story, there is so much more to the journey than just the raw figures.

Humble beginnings and hard work

L1 Capital founders and Co-Chief Investment officers, Mark Landau and Raphael Lamm, only ever wanted to be focused on markets. They only ever wanted to be picking stocks and driving great returns for investors.

Mark Landau and Raphael Lamm in the early days of L1 Capital.

When building a funds management business however, particularly in the early days, you have to be so much more than a fund manager – IT manager, HR manager, marketing manager, and so on… but more on that later.

The LSF was born out of the desire to pursue a wider range of opportunities than allowed by the benchmark-aware, long-only Australian Equities Fund launched in 2007, when they founded L1 Capital.

“We realised that there are a lot of great opportunities that we were missing out on due to our investment mandate being so narrow”.

While that evolution sounds simple enough, setting up a fund takes an immense amount of work, with Landau adding that it required “a lot of experience and mistakes to work out how to get the parameters right for a fund. You’ve got to make sure you get the right balance between being able to deliver performance and diversification, handling correlations across the portfolio, and isolating your insights to remove the unwanted risk”.

Downside protection and incredible growth

After 10 years, the LSF Strategy now has north of $4.6 billion of funds under management. While Landau and Lamm had no concept of how big it would become, they knew how they wanted to invest their own money. They thought that would likely resonate with investors, particularly those not overly enamoured with the relative return concept.

“We could see that if you could deliver strong positive returns and have a genuine ability to preserve capital in down markets, there would be virtually unlimited demand from high net worth and family offices.

Resonate it has, with the focus on capital preservation manifesting as significantly less underperformance in down markets for the strategy.

In the 122 months since the LSF Strategy’s inception, the ASX200 has fallen in 46 months, with an average decline of 3.1% per month. During those same months, the LSF Strategy declined only 0.4% per month (on average).

“Passive has become the dominant investment choice for most people. It’s a way of getting access to the market and paying virtually nothing in fees, but you get a hundred percent on the downside if the market falls. I think downside protection is an underappreciated aspect of the Fund,” says Landau.

Current views on markets

At a macro level, Lamm cites the ability of global central banks to prove they have inflation under control as the biggest risk factor facing markets.

“The markets are working under the assumption that they’re going to be largely successful.

“To the extent that’s not the case, you can see higher bond yields and that’s going to put pressure on global economies, but also on equity valuations,” says Lamm, adding that while we’re probably past the worst of it, “getting to target and staying at target is going to be exceptionally hard”.

Regarding valuations, Landau and Lamm see markets as expensive compared to history, both in Australia and globally.

“Prospective index returns for the next few years look like they’ll be lower than what investors have become accustomed to over the last decade,” says Lamm.

He notes that Australian banks look particularly expensive, while high-growth and high-PE stocks are also very expensive compared to the past.

“We’ve seen lots of really good companies, with good management teams, good balance sheets, good medium-term prospects,” adds Lamm.

He cites UK supermarket chain Tesco (LON: TSCO) as a standout, adding that it is enjoying better trends than Australian peers, but is trading on a PE ratio of 13x, versus PE’s in the 20’s for the Aussie equivalents.

JD Sports (LON: JD) is another UK retailer on the radar. Lamm labels it a “global category killer opportunity” and Landau adds that it is “likely to grow earnings at least 10% per annum for the foreseeable future, and trades on a PE of 8x.”

“A typical Aussie discretionary retailer, that’s not growing as fast, would be on two or three times that multiple”.

Staying in the UK, the team likes NatWest Group (LON: NWG), which is “trading around 7x earnings, with double-digit earnings growth, solid dividends, and a very focused strategy,” says Lamm.

“Commonwealth Bank, on consensus numbers, has low single-digit earnings growth and NatWest is growing at more than 10% per annum,” adds Landau.

Another area of opportunity is gold, with Lamm seeing “lots of companies with really strong medium-term earnings growth on very low multiples” both in Australia and offshore.

“The gold sector has been a bad actor for shareholders over the past decade, and that’s really taken away a lot of interest”.

The L1 Capital approach and lessons from the past

The current views on markets are informed by previous successes and lessons learned from a few missteps, as well as a determination not to get caught up in the latest investment fads.

Of the latter, Lamm notes it’s particularly important not to get swept up when there has been a long period of sustained strong performance – like there is now.

Thinking differently, willingness to take an opposing view, and not being wedded to any particular investment style have also served L1 Capital well.

Landau notes that a lot of fund managers effectively pick growth or value.

“Whereas if you just focus on one, you risk buying a value trap if you’re just focused on value. And for quality, you could buy the most exciting growth business – there’s plenty of companies on 100, 200 or 300 times earnings that are great businesses, they’ve got great management, but I can’t possibly justify why I’d pay that sort of price,” says Landau.

The combination of those factors saw the L1 Capital team take advantage of the mass market dislocation through the Covid period, which Lamm and Landau highlight as one of their greatest successes.

They highlight investments in Qantas Airways (ASX: QAN) and aerospace company Safran (EPA: SAF) at the peak of Covid negativity as examples, where “people were trading [Qantas] like they were never going to fly again,” says Lamm.

Another example, on the short side, was Peloton Interactive (NASDAQ: PTON).

“Everyone thought that they would be doing gym at home for the rest of their lives and everyone already bought their machine”.

“The stock was trading assuming much higher than normal sales and much higher than normal margins and then trading at a much higher than normal multiple”.

“You put all those things together, and overvaluation was extreme”, says Lamm, with Landau adding that the share price fell from around US$120 to just $10 in the space of 12 months.

Another winner closer to home has been AGL Energy (ASX: AGL), which the team bought and sold multiple times over the journey – highlighting their willingness not to be wedded to a view and to change course when new evidence presents.

“We originally bought AGL at around $10 a share and held it all the way through to about $25 and then we went short and held it till it was around $7, and then went long again and held it until it was well into the double digits.”

Another winner, which colleague James Hawkins spoke about at Livewire Live this year, has been BlueScope Steel (ASX: BSL).

“The company really was in trouble and there was a massive turnaround proposed by management that the market didn’t buy into.

Despite the successes, there have been challenges along the way. As fruitful as the Covid period ultimately proved to be for the L1 Capital Long Short Strategy, it required a level of effort that pushed the team to the limit.

“It was a really challenging and stressful period, and I can’t tell you how many times we went to bed at two o’clock in the morning and did it all again the next day, and then again the next day,” says Landau.

As for investment challenges, Landau cites former ASX-listing Boral as a misstep, saying poor management, bad acquisitions, and accounting irregularities in the US all amounted to “one disaster after another”.

But the silver lining was that it was a great lesson “in terms of how important management is; having management that is sensible with shareholder funds and also allocates capital in a sensible way,” says Landau.

A more recent example has been not being invested in the “Magnificent Seven” stocks in the US. While Landau notes that it hasn’t “cost us any money…with the benefit of hindsight, it’s pretty obvious that over the last decade, Microsoft, Meta, Google and these companies are fantastic businesses.

“They’ve got great outlooks, they’re very dominant, they’ve got great balance sheets. It really ticks the boxes of our process, but we could never quite get there valuation wise… and that was a really bad error of omission,” says Landau.

Honing their craft

That willingness to be objective markers really stands out when talking to Landau and Lamm. While rightfully proud of the business they have built and what they have been able to deliver for their investors, they are always hunting for how to improve their edge – it is an unending pursuit.

But they have also developed the wherewithal to know where they can move the needle and where they can’t, a skill which they have honed over the journey.

Landau adds that it’s “important to be realistic about where you’ve got edge and trying to focus your investments purely in those areas”.

In a nod to the rest of the L1 Capital team, which has grown considerably over the years, Lamm notes it is critical to “always do the work yourself or within your own team”.

The final word

Mark Landau and Raphael Lamm – the 2024 vintage

With success comes reward. For Lamm and Landau, one of the biggest rewards has been what they wanted all along.

While they had to balance running the business and running a fund in the early years, success has enabled them to focus less on the former and more on the latter.

“There was no desire for Rafi and me to be IT people or HR people,” says Landau.

Given their track record, that’s likely music to the ears of LSF investors.