Small cap round up and outlook


Transcription of Finance News Network Interview with Fairview Equity Partners Executive Director and Portfolio Manager, Chris Adams

Joel Spreadborough: Hi, I’m Joel Spreadborough for the Finance News Network. Joining me from Fairview Equity Partners is Executive Director and Portfolio Manager, Chris Adams. Chris welcome to FNN.

Chris Adams: Thank you, it’s a pleasure to be here.

Joel Spreadborough: Chris since we last spoke in August, the small cap market has had a bit of a rally to finish the September quarter up 7.25 per cent. What do you attribute this to and do you think it’s likely to continue?

Chris Adams: Yes, it was a strong quarter for the equity markets and particularly the small cap equity markets. And the reason for that was despite the challenging macro-economic conditions, policy makers around the world started responding to that. So you had both more accommodating monetary policy coming out of the US, as well as some significant fiscal initiatives coming out of China. And that’s why equity markets responded. In terms of whether that will continue or not - well that’s always a difficult question, particularly for small cap equity fund managers like ourselves.

We see a number of pros and cons out there. On the positive side, you’ve got very supportive company valuations when you’re starting to see some corporate activity. And yet you’re also seeing lower interest rates, which is going to start seeing flows move back into equities. But on the negative side, you do still have very subdued economic activity both globally and domestically, so there’re no supportive tail winds there. And commodity prices are still quite subdued in many areas.

Joel Spreadborough: Chris were you surprised with the strength of the rally, given a generally negative backdrop of falling commodity prices, several high profile mining projects being shelved and of course, the high dollar?

Chris Adams: Well it’s important to note that in terms of the mining side of the equation which you refer to, it’s not coming to a complete stop. We are seeing a retraction from what were very elevated levels of activity, to what are more normal and more sustainable levels of activity. And even in commodities like iron ore which have come off a long way, there’re still many projects going ahead and that’s driving a lot of spend in places like the Pilbara, and other parts of Australia.

Other commodities like oil and gas, and gold in particular and even copper, have held up pretty well. So there’s still plenty happening in those spaces. The one area which has come off quite dramatically is in coal. And we are seeing a lot of project deferrals and cancellations there, which you do need to be mindful of.

Joel Spreadborough: Now the Fairview Emerging Companies Fund has been going for four years and has just recorded another year about performance. How difficult is it for you to continue to find compelling investments, year in and year out?

Chris Adams: The key to generating consistent returns is to have a strong investment process and an experienced investment team. Our process which revolves heavily around company visits has been the cornerstone to this. And we also have a process which involves a number of risk controls to ensure the performance is generated consistently, across many different cycles.

Joel Spreadborough: Chris have you added much to the portfolio over the last quarter. And if yes, can you give us some examples and briefly explain what it was that attracted you to these names?

Chris Adams: Yeah typically the sort of companies we’re trying to find for the Fund are those which are attractively priced. You know, a low multiples or low DCFs (discounted cash flows) relative to share price, as well as where we think there’s going to be some strong earnings growth. And some of the examples of stocks we’ve added during the quarter are Automotive Holdings Group Limited (ASX:AHE), which is a network of car dealerships. They’ve made a number of acquisitions, both at the dealership level as well as in transport and logistics, which will give them some solid earnings growth for the next few years.

We also bought into FlexiGroup Limited (ASX:FXL) which has developed a number of new products, which are growing impressively. And it’s a company which is on a very attractive multiple and has some very solid growth ahead of it. We also added iiNet Limited (ASX:IIN) which has fairly aggressively rolled up a number of ISPs (internet service providers) out there in the Telco world. And they’ve got a number of cost out and synergies to come from those acquisitions, which will drive growth for that company over the next couple of years.

Finally on the resources side, we added Endeavour Mining Corp (ASX:EVR/TSX:EDV) which is a West African miner. And it’s a very low cost miner compared to a number of its peers, and trading at a large discount to some of those West African gold companies.

Joel Spreadborough: Chris, we’ll stay on the portfolio for just a minute. What did it return for the September quarter, and what stocks either contributed or detracted from its performance?

Chris Adams: Yes the portfolio returned 11.7 per cent net after fees for the quarter, which is about 4.5 per cent ahead of the benchmark. Which was a very pleasing result given the peer group of fund managers, struggled to add value during the September quarter. In terms of performers and detractors, the detractors tended to be on the mining side which started the quarter fairly poorly. And they were names like Atlas Iron Limited (ASX:AGO) and Ausdrill Limited (ASX:ASL) and Mastermyne Group Limited (ASX:MYE), which are mining services companies. They were all sold off fairly aggressively, due to the weaker commodity prices and the weakness in that sector.

On the positive side we owned Australian Infrastructure Fund Limited (ASX:AIX), which received a takeover approach and the gold price was very strong. So two of our strongest performers were Beadell Resources Limited (ASX:BDR) and Regis Resources Limited (ASX:RRL).

Joel Spreadborough: Chris, high frequency trading is having a negative effect on our market. Is it making it more expensive to buy and sell stocks, or is it more of a problem for Funds that invest in the larger cap stocks?

Chris Adams: Yeah this is not as applicable for small caps, but the general comment I would make is that any extra market activities, is good for liquidity. And if it makes stocks more inefficiently priced, well that’s typically good for investors. So if you’re referring to some of the activities which have sort of driven spikes up and down in share prices, well that’s good for fund managers. That can provide opportunities to get set income companies.

Joel Spreadborough: OK and what about low volumes in the market in general. Is that making it more difficult to get set or exit positions?

Chris Adams: Yeah we found volumes picking up fairly consistently since the GFC (global financial crisis). About six months after the GFC volumes did drop off a lot, as turnover basically fell off a cliff. In more recent periods, there’ve been some good volumes across the board in small caps which is very helpful for small cap managers.

Joel Spreadborough: Finally Chris, the Fairview Emerging Companies Fund has over $200 million in funds under management. What do you consider to be an ideal size for the Fund?

Chris Adams: It’s a critical question for small cap investors because if you take on too much money, it can be hard to outperform but then you do need enough to, you know, make a meaningful return for all the stakeholders. We’ve looked at a number of studies and had some direct experiences ourselves, in what is the optimal level of funds under management. And around about $500 to $600 million is the number that we’ve come up with, before performance starts to be impacted.

And the benefit of having a number around there, you are a lot more meaningful for the investee companies which you are a shareholder in. So that allows you to get, you know, more effective company access. So there is a sweet spot there and, you know, we’ve still got plenty of headway before we get to that number.

Joel Spreadborough: Chris Adams, thanks for the update.

Chris Adams: My pleasure, thank you.


Are you a 708 sophisticated investor?

A sophisticated investor is defined under Section 708 of the Corporations Act (net assets of $2.5 million or annual incomes in excess of $250,000).

They are eligible to receive information regarding wholesale investment opportunities that are not available to regular or retail investors.

Please subscribe if you would like to be alerted to these types of opportunities.