December 2021 - Luke's Fund Performance Update

The ASX 200 Accumulated Index was up 2.7% for the month of December, and Luke's Fund achieved a return of -2.2% over the same period, bringing the Fund’s current returns for FY2022 to 12.4%, compared to the ASX 200 Accumulated Index return for year to date of 3.8%.

The breakdown of our holding’s contribution to performance over the past month is outlined in Figure 1 below:

Figure 1 – Contribution Breakdown

The top contributors over the month was:

1. Talga Group, which rallied on positive news in the natural graphite space, including a signed offtake agreement secured by Syrah Resources.

2. Dusk group, which announced the acquisition of Eroma Group, which was well received by the market.

The top detractors over the month were:

1. Betashares Blockchain Leaders ETF, primarily due to a flawed arbitrage trade.

2. Novonix, following a sell off on high growth / high Beta companies.

Portfolio Breakdown

The breakdown of the portfolio is outlined in Figure 2 below. The portfolio is predominately exposed to a Goldilocks / Reflationary macro environment, which does not reflect the most probable outcomes for 2022, which is likely to experience periods of inflation and/or deflation. To be clear, inflation is defined as an environment when growth rate is decreasing, and inflation rate is increasing. Deflation is defined as an environment when growth rate AND inflation rate are decreasing. So, deflation, in my definition does not mean inflation will fall to zero, but is falling (i.e. inflation falling form 8% to 65 is a deflationary environment).

Figure 2 – Portfolio Macro Segment Pie Chart

Our aim is to reduce our goldilocks / reflation holdings down to a 30-40% position size in the coming month. We will also move some of our cash to US dollars, REITS, low beta holdings, and long term US Treasuries as a deflation hedge. We are currently searching for high quality REITS, with long term leases, low debt, focused on the industrial sector, to improve our inflation/deflation hedging, given quality real estate performs well in both regimes.

TRADING ACTIVITY

We made the following portfolio changes over December:

1. Sold out entirely of high beta assests, or assets underperforming, including Novonix, Clean space Holdings, Janison Education Group, and Betashares Blockchain Innovators.

2. We trimmed Talga group, Dusk group, Squoia Financial Group, Camplify Holdings, Cogsgate, Calidus Resources, and Cettire.

We held 34% cash at the end of December.

COMPANY NEWS & REPORTS

Notable news from our holdings included:

Dusk group

Duck Group announced the acquisition of Eroma Group, for $28 million. Eroma is Australia’s leading supplier fragrance oils, packaging, waxes, and other home fragrance inputs. Eroma, is a 95% online business. The acquisition price was 5x FY21 EBIT multiple. The acquisition comprises $15 million cash, and $13 million script payment.

Talga Group

Talga announced ab extension and scope expansion of its MOU with Mitsui and released impressive drill results, which indicate indicative resources will be increased substantially over time.

KEY LEARNINGS FROM THIS MONTH

During December, as discussed in our Global Fund Update, we have flagged that our macro risk management strategy was, well, non-existent as at the end of November. December & January will be a period where we will focus on adjusting the portfolio make-up to reflect the most likely macro regimes indicated by 42 Macro quantitative analysis for 2022.

We did make some significant errors in the December, having developed what we thought was an effective arbitrage trade using the CRYP ETF. We back tested against the US equivalent BITQ ETF (which the CRYP is based upon), and the trade worked very effectively. What we did not factor into this opportunity, was the reality that the market makers had discretion on the value the CRYP ETF would trade day-to-day, meaning the day-to-day CRYP ETF price does not necessarily reflect the underlying asset values in the ETF on a day-to-day basis. Compounding this error, we did not have a macro risk management strategy in place at that particular time. Had we had this strategy in place, the trades would never have been implemented. On the bright side, we have learned some valuable lessons, which we hope to build upon.

We expect the next 6 months to be very challenging for small cap investors, and despite our recent portfolio changes, we remain exposed to inflationary / deflationary macro regime risk. We’ll continue to reduce our reflation exposure, and increase our deflation hedge where we can.

If you have any opinions on the companies we hold, or what like to know more, we would love to hear your feedback.

Regards,

Sean