Manager Monday: Kenmare Capital Partners
In this Manager Monday on Kenmare Capital Partners, we'll look at position sizing returns through two different portfolio regimes.
Do you have conviction in your stock picks? This question usually refers to how concentrated you make your portfolio. As the logic goes, if you believe your names will outperform, more capital should be deployed to those positions. Over time, managers can shift their positions sizes around to demonstrate conviction and one of the most important features of active management: sizing ability. In this post, we’ll examining how Kenmare Capital Partners, a smaller manager (under $200MM reported assets) that has been filing since June of 2005, has displayed conviction over two disparate regimes. The simulated performance of their public filings reveal the dynamics of position sizing.
All of the following data and analysis is based on publicly filed positions via 13Fs. This means that shorts, non-equities, and many non-U.S. names may be excluded depending on the nature of the manager and their filings.
Kenmare’s assets have fluctuated since 2005. They have an average of ~$200MM in AUM, and currently stand at $145MM according to the latest filings. They’ve always been a fairly concentrated manager, shifting downward in their number of positions over time, specifically in 2007 and 2012, to their current count of 15 positions.
While they’ve always been concentrated as compared to other managers of their size, examining the concentration levels of their top 20, 10, and 5 positions reveals two distinct periods in their portfolio. As the number of names decreased, their largest positions increasingly represent the majority of the portfolio. However, it’s the top 5 names that tells an interesting story.
From March of 2012 through August of 2014, we see their top five names spike to 81% of the portfolio. After August of 2014, the top five names became less concentrated, bouncing between 53% and 65% of the portfolio. Exposure through position sizing shows the same story.
Two Time Periods:
Analyzing separately these two more and less concentrated regimes, we can better evaluate their portfolio management skill. On a ROIC basis, the largest positions outperformed the other buckets during the more concentrated period with a clear upward trend for size buckets larger than 3.5%.
In comparison, during the second, less concentrated regime, from September 2014 to April 2016, there’s much less of this trend, even if those largest buckets did generate positive returns.
We can further understand how they’ve performed by looking to their batting averages and their win/loss ratios. A hedge fund’s batting average is how often a manager is correct that their stock picks will outperform, where the win/loss ratio goes hand in hand with capital deployment, and measures how much a manager earns when their right against how much they lose when they’re wrong.
The more concentrated period shows batting averages above 70% in all buckets over 3.5%, while the less concentrated period shows right above 50% for buckets 5.0% and higher. In the more concentrated period, more of their names outperformed, while they broke even in stock selection during the less concentrated regime.
More Concentrated Batting Averages:
Less Concentrated Batting Averages:
Win/loss ratios show that the high concentration period posted stellar results in buckets 7.5%-10% and >10% (38X and 3.6x respectively). The less concentrated period interestingly has a decreasing trend at the higher buckets. Kenmare shifted capital downwards, but in the >10% bucket, the average detractor is hurting more than the average contributor is adding. Comparing these two regimes, Kenmare generated higher returns when they had more conviction.
Digging into those top three buckets, we find that the reason for the decline in performance is the outsized detraction from large names. The portfolio still retained a solid 68% batting average and 65% capital deployment, but CLH, LTRPA, BEN, and MTW all hurt at average position sizes of 6% or greater.
Of the detractors above, four of the six are still in the portfolio, and of the top three detractors, two of them have been in the portfolio for over a year, CLH and BEN. Not cutting these positions while maintaining a large position size causes the win/loss ratios to decline in those larger buckets.
Compare this to the previous period, where detractors hurt less and were removed from the portfolio. Those positions still listed as in the portfolio at August 2014 rarely detracted while in the portfolio, or eventually became a contributor.
As the portfolio became more equally weighted, the larger positions detracted more heavily in the second period, creating headwinds for the outperformance through position sizing. There was slight outperformance prior to March 2012, but from then the positions generated >40% pp of outperformance.
However, after resetting the axis to September 2014 the outperformance is only about 4 pp.
While they’re still generating alpha through position sizing, allowing those larger positions to drag has hindered their ability to redeploy that capital to higher conviction names.
Kenmare Capital Partners has historically posted solid batting averages and capital deployment ratios, but comparing the two periods of differing concentration demonstrates the potential negative effects of deploying capital in lower conviction names. Kenmare has a great record picking names and deploying capital, but in more recent months, hasn’t cut performance-hindering securities. Position sizing is an essential tool for any portfolio manager, but as the concentration of a portfolio changes, a manager must always consider the conviction and potential return each of his or her positions. Ultimately, long-term managers with concentrated portfolios view their performance over a much scale than their peers. Considering their previous history in picking concentrated names, we wouldn’t be surprised to see some of these recent picks turning around and becoming contributors in the future.
The Liquidity Deception
How hedge fund liquidity has plummeted under the industry’s most watchful eyes.
Today, few investors realize that, by some measures, liquidity in the equity markets is below pre-Lehman default levels. For active managers, the moderate decline in trading volumes at the exchanges masks an even greater concern. Liquidity, for active managers in particular, has receded to record lows, and is set to decline even further. The problem is that traditional liquidity measures don’t take the herding behavior of active managers into account.
Crowdedness and crowd selling is now a real risk to investors, and liquidity, or lack of such, is a primary ingredient in this risk factor. This study unpacks trends in liquidity that every money manager should understand—ignoring them could be a costly mistake.
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