Where to from here? Tips to dodge the noise Spatium Capital June 2022 Over the years, Spatium Capital has written about and been interviewed on many topics - the Russian invasion of Ukraine, the Omicron strain, the Delta strain, lockdowns, the rise of ESG investing, Donald Trump, the yield curve inversion…the list goes on. Whilst the famous saying goes, 'there's only two certainties in life; death & taxes', we would argue there's a third overlooked certainty; perpetual worry in the financial markets. Whilst empirical evidence has highlighted time and time again that markets do rise over the long term, and that short-term dislocations are often (not always, however) the best time to invest or start a business within a given market, the ever-present knot exists within each of us - "what if we are wrong, and everything goes to ruin?" Central Banks have played a considerable role in wrapping economies in 'cotton wool' since the Global Financial Crisis (GFC) and more recently throughout the COVID pandemic - perhaps they've even appeased many knots in stomachs. As we once commented, central bank policy has evolved considerably over the last few decades to develop and implement new monetary policies that are reflective of the shifts in modern society. Evidently, the support for these policies can be seen in the outcomes. The most recent monetary responses have led to, as an economist might say, minimising 'deadweight-loss'. That being, when supply and demand are unbalanced, a deadweight loss is a cost to society. Prime examples of this were the central bank interventions during the GFC which protected many of the world's largest interconnected investment and retail banks (and their balance sheets) from triggering a domino effect of collapses and subsequent job losses. The recent COVID-19 era also saw both fiscal and monetary policy pump trillions of dollars into the system with the view to protect businesses and people's livelihoods from collapsing under the financial strain of being forced to stay home. Arguably, both of these central bank responses minimised the amount of deadweight loss in the system, despite 'true' capitalists asserting that by intervening in the natural flow of capitalism, central banks had only deferred these problems to a yet-unlived future. A problem which we appear to now be living through. S&P 500 annual returns since 2000 - an annual return of 7.1% over the 21 years. Is it then fair to criticise central bankers for fuelling the current monetary environment, given that when they were tasked with deciding how to respond to COVID-19 (which at the time was an unknown-unknown) their most recent precedent was the GFC? Despite the material differences between both the GFC and COVID-19, both had the potential to collapse the financial system on which we all so heavily rely. So, perhaps the response was warranted. However, the current discourse seems to be arguing that central bankers have allowed 'loose' monetary policy to continue long past its due date, thus leaving society with the threat of persistent inflation, continual demand exceeding supply, and interest rate rise that may cripple those who overexposed themselves to a cheap-debt market. With the above being said, defending or recusing central bankers is not our focus nor within the bounds of where we believe we add value. Rather, we have found that as the months have become years, the one guarantee we are almost prepared to give is that when new "unknown unknowns" enter the macro news cycle, you can almost always expect an overreaction. At its inception, the unknown-unknown nature of the pandemic was so unpredictable that it was unlikely to be solved using logic or predictive algorithms. If we consider a less destructive situation, logic or predictive algorithms have a great deal of difficulty trying to predict how many meals a restaurant may serve on any given night, or what time patrons will arrive. This is because the number of variables and potential decision-tree options associated with this task is so diverse that it is almost impossible to be correct. Bringing this logic back to finance, consider how an algorithm might forecast retail, wholesale, and institutional investors' response to a black swan event such as the pandemic. If we thought dinner choices had a lot of variables, investor decision-making might just break the algorithm. Taking it a step further, now introduce the most recent geopolitical challenge, and add an Australian federal election. Central bankers may be forgiven for leaning towards the accommodative stance taken. The beauty about unknown-unknowns is that they personify disruption and despite best efforts or claims made by 'experts', none will see them coming. So, if the third certainty in life is that there will always be a perpetual worry in the financial markets, (you just need to pick the topic you want to read/worry about - as we've shown with our take on Central Banks) we have learned and encourage our readers to consider some general principles to reduce said worry: Investing generally should be a boring, time-consuming, and not an exciting endeavour, which generally should be engaged in over a lengthy time horizon; Diversification amongst industries and across asset classes is often your best friend - this has become much easier to achieve with the availability of ETF products across many thematic and asset classes; Pick products that match your level of risk tolerance and stage of life; Blindly following herds (not just in financial markets) is not advisable; and Last but not least, don't check your portfolio each day or each hour - short-term variance is all part of the long-term reward. Author: Nicholas Quinn

Funds operated by this manager: Spatium Small Companies Fund

Like kites, do portfolios rise against or with the wind? Spatium Capital March 2022 For the runners, cyclists or outdoor sportspeople within our readership, a handful of circumstances will almost always result in a proverbial groan: headwinds. That gust of wind that makes turning that corner on the bike or spending the next half of a game with a wind impediment less enjoyable, is unfortunately a part of exercising amongst the elements. Headwinds, as it were, have become known as such a physical inconvenience that they are also a common analogy for when situations in life are met with obstacles that inhibit progress. The counter to a headwind therefore is a tailwind, where benefits and/or privileges fuel our progress, bypassing or simply overcoming the obstacles (or headwinds) that come our way.  If we then take this concept and apply it to a fund manager's portfolio, how many would attribute their performance success to an investing skill or purely an outcome of a bull market? Put another way, did the manager overcome genuine obstacles (a headwind) to achieve success, or were they the beneficiary of a rising market (a tailwind)? Recent research published by social scientists Dr Gilovich and Dr Davidai in 2016 suggests that people are more likely to both recall and overweight their headwinds more poignantly than those of their tailwinds. Their theory claims that when people benefit from a tailwind, the satisfaction is adapted to quickly and is relatively short-lived, whilst a headwind's dissatisfaction is 'consumed' over a longer-period. Using the sporting analogy at the top of the above paragraph, many can relate to the internal monologue that goes on when a headwind is faced; often, longing for the tailwind. Usually, this monologue does not end until the tailwind is experienced. At which point, a brief sense of relief is felt and the team or individual go about adjusting to the new advantage. Almost without a second thought! This tendency to recount information in a way that confirms one's view (confirmation bias) that they had more obstacles than benefits has been coined by Gilovich and Davidai as the headwind-tailwind asymmetry. It is suggested that because a headwind is an obstacle that needs to be addressed, whether that be in a career, sport, relationship or an investment context, there is a greater propensity for these events to be etched into our memories. Their very existence can in fact precede critical junctures and choices in our lives. Conversely, a tailwind is a privilege that often goes unseen by its very nature of not necessitating significant effort or attention. It's harder to recount a privileged education, upbringing, career opportunities or investment successes when they were already occurring without requiring effort. At Spatium, we pride ourselves on having outperformed the benchmark (a headwind) without having a beta in excess of the benchmark, or resorting to leverage or gearing within the fund (an easy 'tailwind' during a rising market environment). Conversely, when the market winds inevitably change, Spatium has had a long-term average of losing only half as much as the benchmark. When assessing managers, portfolios, or even individual companies, one must be critical: "has this business overcome genuine headwinds, and has the strength, knowledge and processes to do so again in the future" or, "has this business simply benefitted from structural tailwinds", such as declining interest rates, or similar paradigm shifts, those of which may be unlikely to be repeated at the same amplitude (or in the case of rising interest rates, potentially work as a headwind) into the future. In aggregate, one should enjoy just as many tailwinds as headwinds over the years, with the key focus being maximising ones advantage during tailwind periods, and remaining convicted to persevering through intermittent headwinds. Author: Jesse Moores, Director

Funds operated by this manager: Spatium Small Companies Fund

The upcoming earnings season - like drinking from a fire hose Spatium Capital January 2022 Twice a year, the earnings of various ASX-listed companies are reported. First, in February, providing a snapshot as at the end of December, and then again in August, following the Australian end of financial year on June 30th. Many see this as an opportunity to receive a health check on the current results and future trajectory of these listed companies.  Despite the best attempts of forecasters, the unpredictable nature of how the market will respond to a company's earnings leaves many working feverishly to calibrate their respective positions, especially when anomalies are rife.  For example, it is not uncommon for a company's stock price to increase when the market expects a greater decline in revenue than what is reported. Conversely, if a company does not achieve expected revenue targets (even if these revenues are positive), then it can result in a decline in the company's ticker price as forecasters adjust their valuations. It seems that recently, earnings season has become further complicated through the introduction of new and 'undefined' metrics that impact:  the 'top-line', the company's ability to drive increases or preserve its revenue stream within the marketplace;  the 'middle-line', the company's ability to effectively manage their costs, improve current processes to become more (cost) efficient, and manage its overall financial wellbeing (including debt obligations, etc) and; the famous 'bottom-line', the residual between how much money a company can bring in, and what it costs them to get there. The 'bottom-line' may not always paint a clean picture, given 'up-and-coming' businesses often reinvest heavily in market share acquisition strategies (such as marketing, or developing new products). This subsequently drives up 'middle-line' costs with the hope of gaining future 'top-line' benefits. Without itemizing each variable that sits within the top to bottom line segments, we trust the point has been made - earnings season is complex. More so now, it seems, with new environmental, social and governance (ESG) metric expectations. Many businesses are now facing significant shareholder pressure to factor in ESG metrics. Whilst driving up middle line costs now, ESG so far appears to have significant customer and employee retention benefits, as well as being the public 'right thing to do'. The cynic may challenge whether these programs are truly driven by ESG good or future 'top-line' benefit. Whereas the optimist might assert that whilst either motive could be true, greater ESG benefit cannot be a bad thing, irrespective of the method(s) used to get there.  This discussion calls into question the purpose of a company (generally speaking, to operate in self-interest) vs. the operation of a government (establishing the rules that do not allow this self-interest to operate unfettered). It is the classic economics example of 'who pays for the light bulbs in streetlamps?' The cynic argues that through the creation of jobs and payment of various taxes, it is the company who pays for streetlamp bulbs. The optimist, true to character, would just be happy they don't have to walk home in the dark. If earnings season wasn't already complex enough, the wider adoption of these new metrics can feel like trying to drink water from a fire hose. Like anything that is new, there will inevitably be kinks that need to be ironed out and parameters that need redefining. Perhaps the nirvana for these new metrics and their wide-scale adoption comes through regular policy and regulation revisions that encourage and guide companies to do what is considered socially better. Or maybe the onus is on the companies to willingly take on these new expectations from the community and thereby lobby the policymakers to formalise these shifts.  Is only doing the right thing because you were told to do it enough in our customer-aware world? Either way, we suspect this debate is far from over and we watch with great intrigue how this may continue to impact future earnings seasons. In conclusion, earnings season and finding the next best company is fraught with hurdles that are likely not made much easier with the level of information available.  We'd argue that this is only going to become increasingly complex in an environment where pundits and analysts are doing their best to quantify and price-in a rise in interest rates, ongoing supply chain constraints and inflationary pressures that are seemingly going unchecked.  Relying on strictly linear forms of measurement or analysis is likely to negate an investing edge and conversely, too much information is likely to saturate one's bandwidth with little clarity on how to use it. We'd argue that the best way to navigate earnings season, or any other disruptive market cycle, is to not only remain convicted to one's tried and tested investment thesis, but also keep half an ear to the ground for emerging trends to consider how these might need to be examined

Funds operated by this manager: Spatium Small Companies Fund