VGI performance ‘unacceptable’ for contrite Rob Luciano

The hedge fund manager said he had made some missteps including selling out of music streaming giant Spotify at the wrong time.

VGI Partners Rob Luciano. Picture: Jane Dempster/The Australian

A remorseful Rob Luciano has described the performance of his VGI Partners during a disastrous March quarter as “unacceptable” and said the hedge fund had made three critical errors that saw profits plunge and performance fees slashed.

An introspective Luciano was grilled by analysts on Tuesday. The star Sydney hedge fund manager was asked if he and his team had lost focus in recent months, accused of being too “opaque” for financial advisers to understand and even whether VGI had spent too much on time and money on charitable donations.

Luciano could hardly argue, given he was delivering results for the first six months of 2020 that saw VGI’s performance fees spiral from $32.9m a year earlier to only about $100,000, and funds under management drop $700m in the March quarter alone to $2.9bn.

He did not try to hide his contrition over what he admitted had been a “cathartic” experience that saw VGI enter March in a strong position, only for Luciano’s team to completely misread the consequent market comeback, fuelled by central bank spending to try to negate the effects of COVID-19 around the world.

“We misread the macro and we misread the market signal,” the VGI executive chairman said of a performance record that saw VGI funds lose money for the 12 months. This compared with its unlisted master fund delivering a compound annual return of 13 per cent after fees since 2009.

“The events that have taken place over the course of this year, not only have they been tremendously humbling but they have been cathartic in nature … and certainly personally it has been a time for a lot of reflection and time for a lot of soul searching.”

Luciano had made his name in the rough and tumble hedge fund world by executing moves such as taking a high-profile short position in Corporate Travel Management. It helped it achieve big returns and market darling status after the main VGI vehicle floated on the ASX in June 2019 — an IPO that attracted big names such as billionaires David Hains, Michael Heine and the Smorgon family as shareholders.

But April to June this year had been rough, and Luciano laid the blame on three critical errors that unwound much of VGI’s previous good work that had seen it end March in a relatively strong position.

Error No. 1 was sticking with US dollars too long and not previously taking advantage of a relatively weak Australian dollar, only to see the former climb back in value as commodity prices firmed.

The second mistake, Luciano lamented, was undertaking some more short-selling just as the market began rallying in late March.

A third error was even more galling. VGI had for several years been a shareholder in the Swedish music and audio streaming company Spotify, listed on the New York Stock Exchange. But believing that spending-wary consumers would cut back on their audio subscriptions as more people worked at home — many Spotify listeners use the service travelling to work — VGI sold up.

“That stock position after we sold it went up nearly 120 per cent,” Luciano sighed.

“So any one of those errors, if you take one out we would have had a positive return. If you take two of those errors we would have had a mid-teens return, and without any of those errors we would have been up 25-30 per cent.”

The margins are fine between glory and defeat, and Luciano admitted his team had thought the economic and financial marketplace environment was going to be weaker for a much longer period.

It also led to more soul-searching by Luciano over other past errors in which VGI had “bluffed” itself into selling out too early.

“We bought a position in Apple at $US80, $US90 a share. We got bluffed out of it at $US100, $US120 a share, which I’m sure is making some people shift in their seats at the moment. We bought a position in Twitter at very low prices and got bluffed out. And more recently we made the classic error with Spotify.”

In the shorter term though, Luciano had been too bearish for too long, and it has had him questioning some of VGI’s methodologies. While they didn’t require an overhaul, there would be tinkering, he said, while citing the thinking of legendary investor Charlie Munger of Berkshire Hathaway.

“If you have an investment thesis or a large investment in something, you need to try to disprove the idea, try to prove it wrong and be unemotional about it and be objective about it. If you can’t disprove, it is proven to be in a good investment and it stays in the portfolio for another day, another week or another year.

“But when you look for self-confirming evidence and let your biases creep in and your arrogance creep in, and perhaps even more so arrogance when coupled with ignorance is deadly investments, then that becomes a problem. So with any organisation and any process you need to constantly improve.”

That will manifest itself in “red-teaming”, where plans and assumptions are challenged in-house. Luciano trotted out some of his investment team to admit they are now working more closely together.

But he still believes current stock prices are being inflated by the money flowing from central banks around the world and there are firms and industries “masquerading” as success stories.

“You could have a weak industry structure or a weak business model and you can very quickly pretend that you have an e-commerce capability and all of a sudden your business model is no longer flawed and no longer has issues,” he said.

VGI’s performance in July and August has been better, the master fund returning 5.1 per cent and the offshore fund 6.5 per cent.

Luciano says his “watch list” of prospective companies to buy into or short is growing, though admitted some of the good performance was down to the market rising quickly. But the tide will surely turn eventually, he seemed to stress. It is only a matter of time.