INVESTMENTS | FUND COMMENTARY
Emerging Companies Fund
The Emerging Companies Fund (Wholesale) (the ‘Fund’) fell 21.5% in the quarter ended 30 June 2022, underperforming its benchmark, which fell 18.4%. The Fund slightly outperformed its benchmark over the 2022 financial year, falling 22.8% against the S&P/ASX Small Industrials Index which fell 24%.
25 July 2022
Fund commentary
At a sector level, the Fund’s financials outperformed while its technology investments detracted. The technology sell-off has been led out of the US, with microcap and small-cap Australian companies in their earlier stage of commercial development particularly hard hit. We are pleasingly seeing some of our investee companies recognise the cost of equity has risen and consequently pivoting their business models towards free cashflow generation. We don’t believe the rationale for investing into small companies has changed and feel there are currently relatively attractive valuations in the Technology sector.
Outlook for the Fund
Small and microcap companies, which are typically in an earlier stage of commercialisation and investing into growth initiatives, have been disproportionately affected by rising global interest rates. The combination of an increased discount rate used to value company earnings and the fact small company earnings are typically expected further out results in their share prices being hit harder in a rising interest rate environment. We continue to believe superior growth attributes are the primary reason for investing into small and microcap companies and consequently have been adding to some of our underperforming names.
We continue to believe superior growth attributes are the primary reason for investing into small and microcap companies. We like to align our small cap investment with intellectual property and global aspirations, a potentially powerful combo.
Emerging Companies (Wholesale) Fund Performance
As at 30 June 2022*
| fund | benchmark | |
|---|---|---|
| 3 months | -21.5% | -18.4% |
| 1 year p.a. | -22.8% | -24.0% |
| 3 years p.a. | 9.9% | -2.2% |
| 5 years p.a. | 12.0% | 3.3% |
| since inception p.a. | 12.9% | 5.3% |
*Source: FE fundinfo. Benchmark: S&P ASX Small Industrials Index. Past performance is not a reliable indicator of future performance.
Inception date: 30/06/2015.
Emerging Companies (Retail) Fund Performance
As at 30 June 2022*
| fund | benchmark | |
|---|---|---|
| 3 months | -21.5% | -18.4% |
| 1 year p.a. | -23.1% | -24.0% |
| 3 years p.a. | 9.4% | -2.2% |
| 5 years p.a. | 11.3% | 3.3% |
| since inception p.a. | 12.1% | 5.3% |
*Benchmark: S&P ASX Small Industrials Index. Past performance is not a reliable indicator of future performance.
Inception date: 30/06/2015.
Small and microcap companies, which typically in an earlier stage of commercialisation and investing into growth initiatives, have been disproportionately affected by rising global interest rates.
Contributors
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We were pleased to receive a takeover offer for lab testing company HRL Holdings (HRL) priced at a healthy 95% premium to the prevailing share price. HRL was our strongest quarterly contributor (+80%) benefiting from the takeover from testing giant ALS. We believe there will be additional merger and acquisition activity if share prices remain weak.
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Our second strongest contributor was dentistry group Pacific Smiles (PSQ) which appreciated 15% from our opportune entry point after being aggressively sold down after Covid-19 resulted in appointment cancellations and revenue and profit shortfalls.
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Health insurer NIB Holdings (NHF) was extremely resilient over the quarter (+16%) and indeed for much of the covid period as elective surgeries and health insurance claims were dampened, while the number of Australian consumers with health insurance has been modestly growing after years of small declines.
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The top performer over 12 months was online foreign exchange service provider OFX Group (OFX) which appreciated 72%. The company has been successfully diversifying its sales into corporates, online sellers and large enterprises, while currency volatility has assisted its consumer business segment. Additionally, the company completed an earnings accretive Canadian FX business acquisition in 2022.
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Technology employment referencing company Xref (XF1) was the Funds third strongest contributor to investment performance appreciating 39% as it benefits from the great resignation post the economy opening.
Detractors
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The number one detractor was Pepper Money (PPM) which fell 42% over the quarter. Pepper sells residential mortgages and asset finance loans financed through the big four banks and the securitisation market. While the market has derated the banking sector and punished participants in the securitisation market, we continue to see the residential mortgage-backed securities (RMBS) market functioning properly.
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Our investment in content management software-as-service company Bigtincan (BTH) fell 42.2% over the quarter which has been led by the sell-off in US technology companies. We take encouragement that the company is now guiding the market to a more sustainable free cashflow generation position within 18 months.
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Our investment in neurological focusing contract research organisation Cogstate (CGS) was our third worst performer, falling 34%. The market has lost some confidence in Cogstate after Biogen’s FDA approved Alzheimer's therapy was declined funding by government health insurers in the USA. There are however several late-stage clinical trials due to report in the next 12 months which could change sentiment.
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Our investment in workforce management software company Damstra (DTC) fell 86% after the company lost a key client while also disappointing the market with its revenue guidance, forcing the company into a discounted equity capital raise which the Fund participated in.
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Our investment in content management software-as-a-service company Bigtincan (BTH) fell 55% taking much of its lead from the sell-off in earlier stage US cloud software companies. There has been little of no change to near term revenue expectations for the company.
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Our investment in enterprise image management software company Mach7 (M7T) fell 54% taking much of its lead from the sell-off in earlier stage US technology companies. There has been little of no change to near term revenue expectations for the company.
Portfolio changes
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On the basis of a solid outlook, we acquired a meaningful position in dentistry group Pacific Smiles (PSQ) over the quarter having held the company in previous years.
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We have been adding to our underperformers which include Australian Finance Group (AFG), radiology business Capital Health (CAJ), residential property portal Domain Group (DHG) and governance, risk and compliance software name Nuix (NXL).
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We have added technology names EML Payments (EML), Praemium (PPS), McPhersons (MCP) and Nuix (NXL) over the year, while reintroducing dentistry company Pacific Smiles (PSQ) and childcare operator Mayfield (MFD) to the portfolio. We also added gravity fed water product/solutions company Rubicon Water to the portfolio.
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The Fund benefited from takeovers of systems integrator Empired (EPD), Australian Pharmaceutical Industries (API), cloud software distributor Rhipe (RHP) and lab testing company HRL Holdings (HRL).
Fund strategy
Australian Ethical offers investors the opportunity to invest in a diversified portfolio of shares in small capitalisation companies on the basis of their social, environmental and investment credentials. The Emerging Companies Fund utilises an active stock-picking management style with stocks selected for capital growth rather than income. All stocks are chosen on the basis of relative value where we deem the risks are being adequately priced.
*Total returns are calculated using the sell (exit) price, net of management fees and gross of tax as if distributions of income have been reinvested at the actual distribution reinvestment price. The actual returns received by an investor will depend on the timing, buy and exit prices of individual transactions. Return of capital and the performance of your investment in the fund are not guaranteed. Past performance is not a reliable indicator of future performance. Figures showing a period of less than one year have not been adjusted to show an annual total return. Figures for periods of greater than one year are on a per annum compound basis. The current benchmark may not have been the benchmark over all periods shown in the above chart and tables. The calculation of the benchmark performance links the performance of previous benchmarks and the current benchmark over the relevant time periods.
This commentary may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, Australian Ethical accepts no responsibility for the accuracy or completeness of, nor does it endorse any such third party material. To the maximum extent permitted by law, we intend by this notice to exclude liability for this third party material.