SVN Capital was founded in 2018 by Shreekkanth “Shree” Viswanathan and is based on a global value equity strategy. The fund employs a concentrated portfolio approach aiming to achieve capital appreciation with minimum risk exposure.
While the focus is on US equities, they also pay significant attention to opportunities in markets with corporate laws comparable to the US. Regarding the investment horizon, Shree prefers a “buy and hold” approach since frequent trades tend to disrupt the compounding gains.
Hedge Fund Alpha Interview Shree for the Q4 2020 edition of Hidden Value Stocks and discuss SVN Capital's investment process. Also, Shree revealed one of the fund's investments made in the midst of a COVID crisis, Heico Corp (NYSE:HEI). On top of all we decided to revisit it four years later and how it handled that time frame.
Investment Process
SVN Capital keeps positions in sectors that can be assessed at least 10 years down the road, including consumer staples, financial services, and technology. These also fall in the fund's circle of competence, which is also an important factor when choosing investment targets.
Quality of the business is the second piece of the puzzle required to make a decision to move with the investment. Target companies must have a sustainable long-term competitive advantage. Due to the fact that most companies battle with reversion to mean, SVN Capital is putting all their efforts into finding a small bracket of companies that do not have frequent issues with it.
Important characteristics that a company must have are the generation of a high return on capital and the potential to reinvest it. Only through that process can the intrinsic value of the company grow.
At the top of the priorities is also the quality of the management team. From his point of view and experience, the quality of the capital deployment decisions is higher in cases where managers have higher ownership stakes.
And finally the business must be available at a reasonable price. To analyze the price, he uses several different metrics, because relying on only one cannot catch the whole picture.
What Makes SVN Capital Different
Viswanathan points out that SVN Capital has an investment platform that is not under the downturn influence of the three Ts of investing—turnover, transaction cost, and taxes. Through his career he also observed how funds operate, and one of the goals was to nullify the weaknesses he pinpointed.
The most obvious one he has seen so many times is the lack of interest from hedge fund managers. Out of 15,000 mutual funds in existence at the moment, about 50% of them do not have any capital invested from the side of portfolio managers. This factor can have a significant impact on the fund's performance. On the other hand, he invested over 90% of his liquid capital into SVN Capital.
Another factor is the time horizon that funds employ. While in the 1950s it was eight years on average, today it is just eight months, and one of the causes is the emergence of high-frequency trading. From SVN Capital comes a reassuring voice that the power of compounding is one that can generate meaningful gains but is currently disregarded by many.
If we were to try to identify the reason why trades have become so frequent and holding periods shortened, the sheer amount of information would be on the top. But, in investing, dealing with more information usually results in lower returns.
Richard Thaler, a prominent economist, gave a great example of this theory: if you analyze two groups of investors, in which one owns only equities (more volatility) and the other only bonds (less volatility), and you allow the first group to restructure the portfolio every five years, while the other can do it on a monthly basis, the first group delivers twice as good as the second group.
From that, execs from SVN Capital came to the great conclusion: “Don’t do something. Just sit there!”
What comes as complementary to the issues above is the over-diversification that hedge funds heavily rely on. Today, a fund on average has about 100 equity positions. While there is no formula or a right figure of positions to hold, SVN Capital follows a voice of reason coming from an industry heavyweight, Joel Greenblatt.
According to Greenblatt, a portfolio with eight positions gets 81% of the benefits of diversification, while the maximum 96% comes from sixteen positions. Above that starts reducing this figure. While a more diverse portfolio may sound like an intelligent approach, in reality it becomes difficult to follow so many companies.
SVN Capital prefers to keep a relatively concentrated portfolio of ten to fifteen names that are thoroughly researched.
SVN Capital also made an unorthodox decision in regards to fee structure. In reality it has been a rule that hedge fund managers earn both management and performance fees. In SVN, managers only earn if the investment delivers gains, thus eliminating often significant management fees.
Favorite Geographies
SVN Capital has a wide global mandate when identifying investment opportunities, but they have a couple of rules they follow. The most important one is that the accounting language is English and that they follow GAAP or IFRS reporting standards.
Since there are over 140 that follow one of these standards, they had to come out with specific boundaries. An important rule is the understanding of local governance and intellectual property laws. These should show that they will protect a minority investor and that the risk will not over time move from low to high.
When taking these into account, SVN Capital spends most of the time analyzing markets in North America, Western and Eastern Europe, and specific advanced Asian countries. Japan, with its language barrier, is one of the countries that they avoid.
Love for Family Owned
Family-owned is the core value SVN Capital looks for, and the prime reason behind it is a good management team that stands behind these companies. The primary goal of every company's management is the efficient allocation of capital.
Viswanathan follows on the thought of Warren Buffett when he said that a lot of CEOs have issues with allocating capital because they progressed to that position from different sectors, like marketing, institutional policies, or administration.
On the other hand, family-operated businesses tend to have a better approach to capital allocation. Cash flow and per-share metrics are usually better handled and combined with a healthier ownership culture. The majority of holdings of SVN Capital are family-owned businesses, and they found it to be better suited for their investment approach.
Heico Investment Thesis
Heico Corp. (HEI) is a diversified supplier of aerospace and defense components. The company is divided into two sectors:
- Flight Support Group (FSG) manufactures, distributes, and repairs aftermarket aircraft parts through Parts Manufacturer Approval (PMA), through which the FAA certifies non-OEM parts.
- Electronic Technologies Group (ETG) - sells components for defense applications.
These two sectors have a similar input to the company's revenue. The company came onto SVN Capital's radar during the search of the aircraft leasing sector. Since PMA-approved parts are sold for 40% to 60% of the OEM part price, aircraft manufacturers didn’t like this new competition.
Leasing companies became the main market for these parts, and at that time SVN Capital traced its potential. At the time of the interview, the PMA market was assessed at $50 billion, which encompassed about 400 thousand manufactured parts.
Heico is a big player in the market, holding the license for over 11,000 parts. The sheer scale of production is a big upside for the company and, at the same time, a boundary for new manufacturers who rarely can compete with larger players. The parts share the same quality and characteristics as OEM counterparts, just at a lower cost.
About a third of the company’s revenue comes from cooperation with the defense. Products for it include parts for aircraft, missiles, and launch vehicles. In some cases, it is the primary supplier for a specific program.
Acquisitions also play an important role in the development and growth of the company. Since 1990, HEI has acquired more than 80 companies, buying less than 100% of the ownership and leaving the rest with the management team. HEI allows these acquisitions to operate autonomously, aiming for a decentralized structure.
In the last 10 years, incremental ROIC reached 18%. Despite HEI using debt to make acquisitions, their practice is to repay them in an 18-month period. As a result, debt/EBITDA was always below 1.0x in the past decade.
During COVID, the FSG segment that is dependent on commercial air travel was badly hit, while demand for ETG products remained healthy. It managed to even rise by about 4% during the crisis.
Another upside to the HEI story is that the management has its skin in the game and owns about 19% of the outstanding stocks (valued at about $3.3 billion). The structure of the team is well-designed, and the primary task of the executives is to allocate capital.
The COVID pandemic caused the stock to plummet from $130 to $60, but it slowly picked up the pace and got its valuation up. SVN Capital invested when the stock was at mid $60 with a free cash flow yield of 4.2%.
Revisiting the Investment Four Years Later
Since the initial investment, HEI stock has seen nothing but rise. While it was slow but steady during 2022, in 2023 it picked up the pace, moving the price from $150 to $180. In 2024 the trend continued, and the stock reached its peak in November with $280.
The company is currently undergoing a slight downturn caused by unfulfilled market revenue expectations. However, the sales did increase on the YoY levels by 8.2%, so this should be viewed just as a hiccup in a well-oiled machine.
When looking at their latest 2023 annual report, the company did generate a solid increase in net sales ($2,968 billion to $2,208 billion in 2022). Operating income also grew significantly from $496 million to $625 million. All these metrics show a healthy business that has a lot more to offer.
