Happy Birthday: 1 Year of the Keynote - Spin-Off Fund
Reflections on the first year
Published onReading time 6 minutes
The Keynote – Spin-Off Fund is celebrating its first anniversary. With a performance of +29.7% (in EUR since launch on 21 July 2023), the fund built on the successful spin-off selection of the past twelve and a half years and, according to Morningstar, ranks among the top 1% of its peer group over one year. The Keynote team navigated the fund independently of macroeconomic uncertainties and an equity rally driven by only a few stocks, achieving a clear outperformance relative to the broad equity markets and the peer group. A disciplined, research-driven investment process within a focused portfolio away from the mainstream suggests high absolute and risk-adjusted returns will continue in an otherwise benchmark-oriented world going forward.
The Keynote - Spin-Off Fund was launched on 21 July 2023 and celebrated its first anniversary on 22 July 2024. This period was characterised by two market phases:
- From the end of July to the end of October 2023, the equity markets corrected. The narrative of an impending recession at the start of 2023, which shaped the view of almost all economists, strategists, investors and CEOs, appeared to be confirmed in the summer and autumn.
- From November 2023, the equity markets embarked on a strong upward run, driven by the complete reversal of the macroeconomic and market-policy consensus and by investment themes such as Artificial Intelligence (AI) and GLP-1 (weight-loss medications).
However, the equity market rally was driven by a small number of large-cap tech and growth stocks such as the Magnificent Seven (Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, Tesla) and the GLP-1 stocks (Novo Nordisk, Eli Lilly), which carry a relatively high weighting in the most commonly used benchmark indices such as the MSCI World Index. While the MSCI World Net Total Return Index (including reinvested net dividends) gained 22.7% (in EUR), the MSCI World Small & Mid Cap Net Total Return Index rose by only 13.5% over this period. Equity funds in the Flex Cap category recorded a gain of 12.2% (see chart below). In a speculative bull market driven by only a few stocks and characterised by increasing market concentration, it is difficult for satellite investments, or for active managers in general, to beat the market. Nevertheless, the Keynote - Spin-Off Fund advanced 29.7% in this market environment and thereby left the global equity markets clearly behind, even though the fund does not hold a single one of the aforementioned market darlings and exhibits a mid-cap bias (median market capitalisation: around USD 11 billion).
Source: Morningstar Direct
One reason for the success: the Keynote - Spin-Off Fund has a completely different focus from «Mr. Market» and most market participants. The fund invests primarily in companies that have been spun off as operating parts of businesses (spin-offs), in the remaining parent companies (parents) themselves, or in companies where a spin-off has been announced (pre-spin). The fund thus operates ina universe that is fundamentally characterised by high inefficiencies.
The Keynote – Spin-Off Fund is a unique fund with a clear focus on spin-off situations. At the same time, the fund pursues different objectives from most benchmark-oriented peers. In selecting its spin-offs, the fund focuses on:
- Generating high, absolute, asymmetric returns
- Preserving shareholders' capital over the medium term (typically 3 years)
- Achieving high risk-adjusted returns over an equity market cycle (typically 5 years)
In order to exploit the inefficiencies of the investment universe, which comprises around 150 to 250 spin-off situations (5 years rolling), the fund employs a rigorous, research-driven bottom-up approach that filters out spin-offs with high risks. Spin-off-specific exclusion criteria relate primarily to excessive debt and problematic assets. At the same time, companies are excluded that exhibit characteristics preventing longer-term outperformance. These include structural risks that put a business model under pressure (among others, retail firms, old technology companies, banks or commercial real estate), companies that generate low returns on capital employed, companies with poor capital allocation or stocks with excessive valuations.
Considered, by contrast, are spin-offs with particularly promising characteristics (spin-off from a conglomerate, incentivisation of management, inside CEO, low analyst coverage, insider buying) as well as those companies that have high returns on capital employed (ROCE), above-average reinvestment opportunities and good growth prospects. Such spin-offs usually also have a strong market position, generate high free cash flows (Free Cash Flow /FCF) and have a competent management with a proven track record that allocates capital wisely.
Source: Keynote
The most important part of the long-proven Keynote investment process consists of investing a great deal of time and energy in the in-depth analysis of spin-off situations. On the one hand, this involves the detailed examination of the company itself (product range, balance sheet, cost structure, management). On the other hand, the aim is above all to select companies that also benefit from strong tailwinds (trends, innovations, growth markets). Against this backdrop, the large deviations in sector weighting relative to the MSCI World Index are not surprising, but rather a logical consequence.
Source: Bloomberg, MSCI, Keynote, Daten per 28.06.2024
For the Keynote Spin-Off Fund, this results in a relatively concentrated equity portfolio of 20 to 25 stocks, which are less influenced by general market developments and more driven by company-specific factors. As at the end of June 2024, holdings such as Constellation Software, Holcim, Knife River, SharkNinja, Bellring Brands, Carrier Global and Sandoz were among the core positions.
Source: Keynote, Daten per 28.06.2024
Keynote - Spin-Off Fund: the ideal satellite investment within an equity portfolio
The Keynote - Spin-Off Fund pursues a disciplined, research-driven investment process that has been developed, progressively refined and improved over the past years. The spin-off strategy (Keynote Spin-Off Composite), which the Keynote team has implemented within mandates and funds since the end of 2011, has achieved its long-term objectives for the benefit of investors in the past.
It is all the more gratifying that, with the launch of the Keynote - Spin-Off Fund — the world's first retail fund to invest in spin-off situations — these results were confirmed in its first year of existence. Compared with the Keynote Spin-Off Composite, which comprised only 10 to 25 holdings, the Keynote – Spin-Off Fund, as a UCITS fund with a portfolio of 20 to 25 stocks, is somewhat more diversified. The return and risk metrics achieved so far, and the portfolio characteristics (low correlation with global equity markets), give confidence that the high risk-adjusted returns of the Keynote spin-off selection, with a development comparatively independent of the overall markets, will also be replicable in the fund over the long term, beyond the first year.
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The Keynote team continues to focus on identifying and exploiting structural and lasting market inefficiencies in the spin-off segment in order to achieve the investment objectives. This commitment applies regardless of how the overall markets develop in the short, medium and long term. Against this backdrop, the Keynote - Spin-Off Fund creates added value as an attractive, diversifying satellite investment in any equity portfolio.