Christopher Johnson: Hello, my name is Christopher Johnson and today I'm joined in the studio by Mark Ellis, the CIO and Founder of Nutshell Asset Management.
Mark, thank you so much for joining me.
Mark Ellis: Thank you, Chris, for having me.
Johnson: Lord Michael Spencer, who is backing Nutshell Asset Management, recently reunited his feud with Terry Smith by betting £10,000 that Nutshell would outperform Fundsmith by the end of 2024. How confident are you that Nutshell will be the victor in this?
Ellis: I really like Fundsmith and I think it's a good idea to have a benchmark with one of your leading peers. I've actually, before I launched Nutshell, recommended Fundsmith to family and friends. But after 13 years, I think the process and the style is a little bit dated and also his size is obviously a disadvantage. So, I think we've got a better product and a better process.
Johnson: In regards to the whole bet between the two men, is this really the right way of expressing competition with a rival, do you think?
Ellis: The bet is Michael's idea. It didn't come from Team Nutshell. However, we really embrace competition. We think competition is healthy. We think that at the end of the day a charity could be rewarded with £10,000, which is a good thing. And it's great to have Michael as a backer of the fund and a big advocate of our process. His team have gone through our process and our strategy for many years since 2019. So, it's great to have him on board.
Johnson: I'd like to move on to how you're using AI and quant tools to help manage the fund. How do you introduce these two forms to improve performance per se?
Ellis: Well, my background has always been quant based. I went back to university in 2002 and got my dissertation. I got a distinction in finance, a masters in finance, and I was the first student to get my dissertation published. And I got it published in the Journal of Asset Management. And it was entitled Momentum and the FTSE 350. So back then in 2003-2004, that was the foundation of the strategy. And I found when you combine momentum with fundamental factors, the market often underappreciated the performance going forward.
So, in 2016, I left my job at the hedge fund and focused entirely on creating a model, a quant-based model, which reduces the investable universe from around 10,000 stocks to around 500 stocks. Hopefully, these quant tools and this model, which I've created, I mean, I can put any ticker into the model. It gives me a score, zero to 100 on how calibrated a particular stock is to the factors we like. And this then gives us a short list of stocks where we really want to focus. Hopefully, it makes them – I mean, like Warren Buffett, he likes companies which are manager proof. Hopefully, this model, which I've built, will make them as PM proof as possible, what we actually focus on. And like everything, models are not kind, they're not completely without their flaws. So, we then push these through a qualitative checklist and then some more manager discretion before we create a portfolio of around 30 stocks.
Johnson: So, in 2023, the Nutshell Growth Fund's annual return rate reached over 26%. So, what has driven the fund's success?
Ellis: I think in Q4 2022, we were very aware that this was a great opportunity to go long. I wrote a paper, a small, short thought piece on fear and panic as a driver of future returns. And it was clear that sentiment was so poor in Q4 2022, that it was a good opportunity there. In fact, most of the opportunity was in the tech space. Our weighting to tech went up to around 55% in December, which is the highest it's ever been. And we came out – and the portfolio, so we had 55% in tech, 10% in communication services, and yet the portfolio was only on a P/E of 18. So that was a great place to start 2023. And also, the beta was about 1.1, which is high for us. We generally keep it around 1. So even without NVIDIA, we didn't have that in the portfolio. We managed to get 26.5%. Novo Nordisk was our biggest position. I think that added about 3.5% to the returns. But we had a really diversified set of drivers. In fact, I think 13 companies added more than 1% to the portfolio in that year.
Johnson: And why didn't you invest in NVIDIA at that time?
Ellis: We had it historically. We typically don't like semiconductors because of the seasonality. However, if their growth profile and some of their other elements and valuation is compelling, then it can slip into the portfolio. Probably one of the lower rankings in the portfolio. At that time, we thought it was quite rich and quite volatile. But having said that, after the blowout numbers earlier this year, the growth and some of the other factors have pushed it into the portfolio. So, we actually own it now.
Johnson: According to Morningstar data, you have recently bought over 700,000 shares in China Overseas Property Holdings. What has driven this decision? And also, can this business still do well when China's property sector is in a real deep crisis at the moment?
Ellis: We adjust down the kind of scores from China because of the geopolitical risk, the current recessionary environment in the property sector. Some of the accounting numbers are a little bit less lower quality. So, because of these factors, we reduce the scores coming out of China. But even with those negative biases, companies like China Overseas Property have managed to get into the portfolio. We cap the size of exposure to China. And these positions have only come into the portfolio over the last few months based on valuation, really. I mean, as we all know, the sentiment towards China is really about as low as it gets. And my background as a relative value trader means, usually when sentiment and fear is this high, it's usually a great place to start looking. This particular company, even though it's in the property sector, it's managed to grow its earnings per share by around 25% per annum. Even last year, it grew its net income by 23%. It's currently on a P/E of around 7.5% this year, and I think it's being dragged down by the general poor sentiment in the property market in China. A lot of international investors have been fleeing and selling their positions in this stock. I mean, these are PMs who were happy to buy it on 30 to 50 times earnings a few years ago and now selling it on a P/E of 7. So, we think there is a decent risk-reward there. There is risk there, which is why it's only 1.5% position size in the portfolio.
Johnson: And finally, I was very intrigued by Boohoo Group. So, it is your smallest holding at 0.22%, so tiny. Is it time to just sell out of the fast fashion brand completely?
Ellis: I think that the time to sell out was about three years ago. But yeah, it's an interesting story. We're big advocates of continuing to learn, and Boohoo – the blessing with Boohoo was we tightened up our exit process on the back of this holding. We originally vetoed the position because of its poor ESG, and then when it made steps to improve its ESG, we kind of let it get into the portfolio. But we had a different exit strategy at the time. And now it's a legacy position where I think it's like a free option. It's 0.2% of the portfolio. Mike Ashley is now gaining a position in the stock. I think he owns 22% of Boohoo now. So, there might be some kind of recovery play there. But I keep it because I like to get reminded that it's a big learning process, and some of the mistakes of the past for holding it too long.
Johnson: Mark, thank you so much for joining me.
Ellis: Thank you very much for having me, Chris.
Johnson: This is Christopher Johnson for Morningstar U.K
