Marcel Maschmeyer:

"I'm a hardcore fan of active investing"

Marcel Maschmeyer has been described by the media as Europe’s “most renowned fund manager”, having achieved a 5-year return of 95.8% on his Paladin ONE fund and beating the 51 other funds in his peer group. Although he continues to manage Germany-based Paladin Asset Management, he is now backing an additional fund management venture, Guernsey-based Sarnia Asset Management. Marcel is a co-founder and major shareholder of Sarnia Asset Management, and despite holding no day-to-day role at the company, he is intimately involved with its investment strategy and upcoming fund launches.

James Faulkner, Sarnia’s Digital Content Manager, caught up with 32-year-old Marcel to find out what makes him tick – and why he’s evangelical when it comes to active fund management and European equities, two areas that the St. Peter Port-based company will focus on.

James: Before we speak about Sarnia Asset Management, let’s talk about Paladin Asset Management, the company you have managed and built in Germany over the past seven years. The Paladin ONE fund is one of the best-performing funds in Germany since its inception back in 2015. In terms of absolute return, it ranks #1 in its CityWire Selector peer group, even though it takes on less risk than many other funds (figures as of 31 December 2021). Give us an insight into what drives your existing fund’s success. What’s the magic formula?

Marcel: There is no magic formula, but there are three things we consistently do that seem that help. The first one is our focus on perception phases. In our view, equity stories go through three distinct phases: Market Ignorance, Discovery, and Execution. In the first phase – Market Ignorance – either a stock is not well understood, or something might have gone wrong in the delivery of the strategy. At that stage, the discount to a stock’s fair value can be significant. This offers the opportunity to make a better-informed decision than the market via deep research. In the second phase – Discovery – a stock arrives at an inflection point in its development, drawing market attention again and starting to re-rate. The valuation gap to fair value starts to close. In the last phase – Execution – the equity story is well understood, which results in a low discount to fair value. However, this execution phase involves entrepreneurial risks, that are often underestimated. Things may go wrong, things may take longer. From a risk/reward perspective, it is not the right time to be invested. Conversely, phase one can present investors with an opportunity, but in the absence of a clear trigger or catalyst the supposed discount could persist indefinitely. We aim to invest when the value of a stock is fundamentally well secured and when our analysis suggests that a clear potential catalyst for a re-rating of the stock exists.

There’s often something happening under the surface that the management of a company is working on and occasionally it becomes visible. And given the way that we go about looking at companies, we often see these types of things going on. And if we see something interesting happening, combined with a valuation that gives us a stable base whereby we feel that even if this weren’t to materialise, we wouldn’t lose much money – those are the types of investment we really like because they’re asymmetric in terms of the risk/reward profile. That also means we don’t buy and hold things forever and our investment periods tend to be 6-18 months on average. This is shorter than most other so-called value investors. But it also means that, should a company’s stock fall out of favour, we have the option of coming back at a discount.

The second major ingredient is risk management. For us, risk management is first and foremost about picking companies that aren’t in industries that are massively influenced by external factors. So that means we aren’t fans of anything that’s particularly sensitive to the economic cycle, or anything that’s commodity price dependent. Those types of companies are hostages to outside factors over which they have very little or no influence. We don’t like that, because it doesn’t offer the level of predictability that we’re after. After this initial filter, we look very deeply at a company that has piqued our interest. We try to understand not so much the one fair value by calculating the DCF (discounted cash flow) down to the very last decimal, but rather the range of possible outcomes if certain things materialise. This way we get an understanding of the factors that influence the company and what could lead to its success, once again to understand one of those perception phases that might be about to materialise, but also to understand the downside.

Usually, we form our thesis in a day or two, and we can write a one-pager to say this looks interesting because of X, Y and Z. Everything that happens afterwards is mostly checking to make sure we haven’t missed anything. We can sometimes spend six weeks digging into a new company before we feel comfortable enough to make any kind of initial investment: going through the annual reports, reading prospectuses, building our models, looking at competitors and suppliers and things like that. In a world where there is often too much information, it pays to soak up as much of it as possible. A concentrated portfolio means we can allow ourselves to do this kind of deep digging to understand and mitigate risks and that leads to what thus far has been an astonishingly high hit rate. This is highlighted by the fact that of the 16 stocks that contributed more than 1% to Paladin ONE’s overall performance in 2020, for example, 14 were positive and only two contributed negatively. Yes, we make mistakes, of course we do, but it happens much less often than it should if we were merely tossing a coin.

And the third thing is that once we understand the specific business risks of the companies we’ve invested in, we then try to diversify our portfolio. We run a concentrated portfolio so it’s usually 25 companies or less, and it’s really important that each individual business risk is diversified away by the other companies. For example, during the pandemic, our exposure to international travel was offset to some extent by the fact that we had online pharmacy investments in the portfolio. My colleague always says the less we lose on the way down the less we have to recoup on the way back up – remember that recouping a 50% loss requires a 100% gain!

James: Given that you’re already a highly successful fund manager and the owner of Paladin Asset Management in Germany, what prompted you to back the idea of starting from scratch with Sarnia Asset Management in Guernsey?

Marcel: Even though Paladin is a profitable business, I couldn’t sell it, even if I wanted to. This is true for any niche or one-product fund manager. If the business works because of you, then you cannot exit in any way, shape or form. Nobody will buy it for any reasonable amount, because if they were to do so, soon after my lock-in I would probably take my money and start investing privately, and a couple of friends or long-term investors would call me up and say, “hey, can you invest my money too?” And before I know it, I’m setting up another fund. Being a fund manager at Paladin is a job for life.

I am passionate about fund management and wanted to create a business that can do things that Paladin was not set up for. We are building Sarnia Asset Management as a business that can, in the long-run, work independently of any particular individuals. The company will be built around many managers and become a platform. The more managers we have, the more attractive the platform is for investors. The more investors we have, the more attractive managers we can find. The scalability of Sarnia Asset Management will be entirely different. Of course, everybody looks for scalability, everybody looks for a fund that you can grow to $50 billion. But the paradox is that barely anyone with $50 billion in a single fund continues to make outstanding returns for investors. I’m sure that in a world of free money and high leverage the likes of Millennium and so on can do reasonably well. But if you’re just buying and selling stocks and hoping to pick well, once you have too much money things kind of converge to the average. At Sarnia Asset Management, we will have a different kind of scalability. We’re not banking on one strategy to carry the firm: over time we will set up ten, twenty, fifty different strategies, all of which work in their respective niche and benefit each other. So this is scalability of a different kind – a kind that is not to the detriment of investors but is beneficial for all parties involved.

It’s really important to know what it takes to establish a new fund manager and to know how it’s done. I think the fact that we’ve done it successfully before lowers the bar significantly for us to be able to do it again, because now we know what it takes – and what to watch out for.

James: Why was the new firm set up in Guernsey? What attracted you to the Channel Islands?

Marcel: Stability and a high degree of predictability. Guernsey offers long-term political stability, financial markets form a primary pillar of the local economy, and it’s geographically really close to Europe. Also, Guernsey is an English-speaking and highly connected financial centre, and the company will be able to address a large portion of the world’s wealth from there. Guernsey provides Sarnia and its clients a locale that is likely to be stable for decades to come and doesn’t burden us with some of the excessive regulatory burdens that are imposed elsewhere, or with the kind of politically motivated changes that could completely scare away both businesses and clients in other jurisdictions.

In short, we see it as very fertile ground on which to grow this company.

(To learn more about Guernsey’s attractions as a place to do business, read our article: British Switzerland by the sea: why Guernsey’s future is brighter than ever)

James: Your portfolio at Paladin is German centric but invests in companies from across Europe. How does one get abreast of companies from countries with different languages and cultures?

Marcel: My mother tongue is German, but I speak several languages, having spent four years of my life in school in France, then more than ten years in the UK. My brother lives in Los Angeles along with some other family members, so it’s always been a very international mindset. As a young student I was fortunate enough to get that exposure where I was classmates with 22 other nationalities, which broadens your horizons to being able to understand the commonalities and the differences between different cultures.

The next major point is we can draw on our huge network of contacts from across Europe and further afield. This is particularly important when it comes to understanding local markets, especially when you’re talking about smaller companies, as not knowing the right brokers, for example, can be a quick way of slipping up. Building a support network and ecosystem like this takes considerable time and experience.

James: The European equity markets have had a bad press over recent years, especially given the fact that they have been overshadowed by the performance of the US. Tell us about the attractions of the European equity markets and why investors would be wrong to overlook them.

Marcel: Let’s call it growth at a reasonable price. In terms of the two markets and how they’re valued versus how they might be valued in future, I think it just leaves European equities in a much more attractive risk/reward profile, as the European peers of similar quality, on average, are simply cheaper. As such, they tend to offer a little bit less risk on the downside, and more upside if valuations were to converge the other way.

So that’s the macro backdrop, as it were. But within that you still have heterogeneity, because not as many people are scouring the European market for these undervalued high-growth companies. MiFID II made research almost non-existent for some European smaller companies, so you can add so much value by looking at these companies in great detail. Nobody’s going out there and doing this kind of research anymore. I’m just glad the market is as inefficient as it has been.

James: Can you foresee any catalysts on the horizon that might change international investors’ perceptions of Europe as an investment destination for public equity?

Marcel: I think we’re seeing something right now, which is that Europe hasn’t committed to raising interest rates whereas the US has. If that were to continue, those that are currently focusing their investing on the US would be likely to begin to look elsewhere to escape that headwind. As for how long that divergence might continue, that requires a prediction that I am unable to make. However, as things stand now, the cards are stacked in favour of European Equities.

James: At Paladin you work very closely with Matthias Kurzrock, with whom you’ve shared tremendous success in recent years. Tell us about the relationship between yourself and Matthias and how you complement each other. You are both shareholders of Sarnia Asset Management, but neither one of you has a day-to-day role at the company. What do you bring to the table?

Marcel: Matthias is meticulous and very risk averse. And those are two strengths of our approach that we will bring to anything that we do, including Sarnia. But how does being meticulous and risk averse match up with outperforming peers and indices? At Paladin we’ve delivered an average annual net return of more than 13% per year for the past seven years and the foundation of that performance is the incessant focus on the downside risks before we get into any investment.

In terms of how we work together, it’s the ability to take the other side of an argument that’s especially crucial. If we’re in a room full of optimists, I guarantee you that Matthias and I will be the pessimists and will challenge absolutely everything. The same works the other way around: if everybody is telling us that something is doomed to fail, we’re likely to evaluate the other side of that argument. It’s that culture of deliberating every day – without ever fighting – to try to find out what’s right and not who’s right. That’s probably our biggest asset as a team.

As for the culture at Sarnia we will certainly carry across that strong debating ethos. We also believe in small independent teams making their own decisions. I don’t think it makes sense to create a bunch of headstrong advisory boards and committees, which is in a sense just another example of that cardinal investment sin of overdiversification. If fifteen people all need to agree on what’s a good investment, that kind of environment is only ever going to lead to an average performance. What’s needed are smaller teams of individuals with conviction and skin in the game to make these decisions. They can then debate with others who are in similar positions but potentially have a different view – but just to get that extra sense of perspective, not in order to overrule anybody.

This respect and appreciation for one another’s talents is crucial. I’ve known Matthias for many years, and I also have very longstanding friendships with other team members. Trust is a luxury, and we have that in droves with the team at Sarnia. It’s also important to bear in mind that we are here for the long haul: we’re in the prime of our investing careers and we do this because it’s our passion as well as our job. We plan on doing this for a long time to come – certainly decades!

But beyond that it’s also much of the same in terms of our investment approach. It’s that meticulous approach to risk management; it’s that deep understanding of perception phases and going the extra mile to really get under the bonnet of a company to find out what makes it tick. This is how we operate at Paladin, and it will also be our bread and butter at Sarnia.

James: How would you describe your investment philosophy? Are you dogmatic or pragmatic? Is stock selection a science or an art form, in your view?

Marcel: Art. Stock markets, businesses and valuations – it’s all down to interpretation. There are so many data points out of which you must build your own conviction: confronted with the same data set, people all come to slightly different conclusions. On top of that the world is constantly changing, which means that – and this is where I do become dogmatic – you have to stay humble and keep questioning your assumptions. So I’m dogmatic in the sense that you have to maintain that group of people around you who will constantly challenge you to keep you on your toes.

James: Which investors are you most influenced by and why?

Marcel: Seth Klarman. He’s style agnostic and he tends to go into places where few others dare to tread. He focuses on niches or areas where he can build up a certain level of expertise or conviction where he feels other people aren’t really looking. So he’s contrarian but not just for the sake of being contrarian. The other great thing about Klarman is that he really appreciates scalability and its limits. He’s one of the few people out there who sends money back to his investors if he feels he can’t put it to good work. As an active investor, I think it’s important to stay focused on returns, rather than to simply grow the assets under management to earn bigger management fees. That means being asset managers not asset gatherers.

James: How has the coronavirus crisis impacted your attitude towards investing?

Marcel: First and foremost, it’s reinforced our emphasis on sound risk management and sound diversification. Our ethos of having deep understanding of our portfolio companies and their specific risks and then diversifying those risks has really helped us through covid. We were invested in areas that we thought were really stable like wholesale food retail, tourism and air travel. All these sectors had previously experienced isolated downturns locally, but (with the exception of air travel after 9/11) none of these industries had seen a collective global downturn. Those three industries only made up 7% of the portfolio, which meant we could get out and we could get out pretty quickly based on the fact that we knew what the company-specific risks were. Back in January 2020, we confronted TUI Group, the multinational travel and tourism company, with the question: how does your P&L look if you have a year with zero revenue? They of course laughed us out the building. We all know what happened next. I don’t think it was zero, but it was pretty damn close. They had no contingency plans for such an extreme event because they’d never seen anything like it. But in the world around us we were already wondering what if these lockdowns in China were to make their way over to other countries.

Beyond that, we did actually have a “put” on the market because this was the first time ever since 2008 where we realised there was actually something big happening in the world and we didn’t know where it was going to lead. That insurance served us very well on the way down, but we stayed hedged for quite some time which led to us giving up some of the profit on the way back up. But the point of the put wasn’t to generate alpha, it was to carefully manage risk; and in that sense we were vindicated. But all successful investors know that whatever the circumstances, you can’t bet the farm on one possible outcome. That’s the insurance that our put afforded us.

As for the long-term implications, I think the world is slowly coming to the realisation that covid is morphing into something akin to seasonal flu in terms of its perceived risk to humanity and is no longer likely to dominate our hearts and minds going forward. That has predictably led to something of a renaissance for some of these sectors that had been hit really hard by covid, like the travel and tourism stocks. But up to this point, this seems to be pretty confined to the bigger more obvious large cap plays. What’s interesting is that there isn’t, up until now at least, the same kind of enthusiasm for some of the smaller companies that stand to benefit from the recovery in these parts of the economy. This strikes us as a possible opportunity for those willing to look further afield than the more obvious names.

Another major implication, which is especially pertinent when it comes to Sarnia, is that the greater reliance on technology during the pandemic has levelled the playing field when it comes to a boutique manager going toe to toe with the big boys. I think we are heading into a time where niche managers can really come into their own and generate alpha for their clients through being nimbler and more innovative than their larger peers. What’s more, niche managers also look to be better business propositions as they harness the online channels that can help to narrow the gap in terms of marketing and distribution. Sarnia has a lot of digital content knowhow onboard and will make use of the opportunities we currently face.

James: Being an active investor almost appears a little contrarian these days given the massive shift to passive investing and the rise of algorithmic trading etc. What does the future hold for active investing?

Marcel: As you illustrated in your recent article about active investing, I think that the rise of passive is more of an opportunity than a threat to the active space. With the passive space primarily allocating money based on size, this has very little to do with the actual fundamentals of the underlying investments. The analogy I’d use is a flock of sheep where the number of sheep continuously grows but nobody’s herding them. But once they move, they all move, and when you see lots of sheep moving in one direction you may think they’re onto something. But they’re not. I’m not sure that’s strictly true for sheep but it sure is the case with markets. As an active investor, however small, you play a role in pointing the sheep in the right direction; and if you find things that people have overlooked and the passive herd eventually come storming your way, that’s a very good place to be. Personally, I really enjoy being on Team Shepherd as opposed to Team Sheep.

When you combine this with the fact that MiFID has severely restricted the amount of research available on smaller companies, you have all the ingredients you need as an active investor to find some very interesting investment opportunities.

James: Thank you for all these insights!

Marcel: It’s a truly great time to launch an active manager. I am excited about the products and services that Sarnia Asset Management will offer. Stay tuned for more!

For further information about Sarnia Asset Management, please contact our CEO Swen Lorenz via [email protected] and we will get back to you within 24 hours (and usually much quicker than that).

Disclaimer: This blog is intended for informational purposes only. This blog is not intended to invite, induce or encourage any persons to engage in any investment activities and is not a solicitation or an offer to buy or sell any stock, investment product or other financial instruments. If in doubt, please seek financial advice from an independent financial adviser. Sarnia Asset Management is licensed by the Guernsey Financial Services Commission (GFSC). Past performance is not an indication of future returns. Investments carry risk, including the risk that you will not recover the sum that you invested.

By James Faulkner

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