NovaPort Microcap Fund Update – October 2020
Alex Milton, NovaPort Principal and Co-Portfolio Manager
- We just wanted to provide an update on the NovaPort Microcap Fund touching on activity and performance primarily since late February which as we all know is the point where COVID hit global equities and has been the primary factor driving markets since.
- We wanted to re-affirm our investment process doesn’t change through various market cycles and has been consistently applied since the Microcap Fund was set up in 2005, just over 15 years ago.
- Also, our adherence to the process has been despite an awareness that significant recent monetary stimulus was driving valuations in popular tech and other growth stocks to levels we weren’t comfortable with and to not participate aggressively in the COVID rally would adversely impact our relative performance.
- Nevertheless, despite our reticence to invest where earnings certainty takes a back seat to top line growth and the market is quick to price the upside risk and not discount enough in our minds for the downside, the fund has performed well over the last 6 months.
- Overall, while there’s certainly been volatility in the unit price along the way as you would expect, looking at the last six months to the end of September the Microcap Fund is up 42.56% (net of fees) versus 30.93% for the Small Ordinaries Accumulation Index over the same period.
- In addition, what has been pleasing to see, is how the fund has performed on days where the market is down materially. We think outperformance generated on those days is attributable to avoiding some of the risk associated with aggressively chasing expensive growth stocks which have been a key driver of the smaller companies’ index but are prone to severe price declines on any sort of negative news.
- Drilling a bit deeper into that, by materially down days we mean days where the Small Ordinaries Index is down by more than 1%; and all up, there have been 40 days since the 24th of February where the index has declined by more than 1%, and if you simply add all the negative days the total is -114.5%. Now, looking at our fund over those days the total negatives add up to -70.3% which is a substantial 44.2% difference.
- So in simple terms, that shows the fund is good at preserving capital on the really tough days and is by far the main reason we have outperformed over the last 3 and 6 month periods.
- Having said that, while the performance of the fund over the last six months has been pleasing largely for its ability to perform better on the material down days, unfortunately that means we don’t perform as well on the strong up days.
- And that we think has had an impact on our longer term numbers in that while COVID has thrown up some tough days along the way as you would expect, what has been more notable has been the strong rally in equities markets since the middle of March which is a continuation of what has been favourable markets for growth stocks versus more value type exposures for a few years now.
- One of the key drivers of this dynamic has been the decline in interest rates since the GFC which has supported longer duration growth stocks where losses in early years are tolerated because the present value for the forecast longer term cashflows have been boosted by a declining discount rate.
- This is relevant because in fighting the COVID crisis central bankers clearly feel the playbook was written over the GFC and they were of the view back in March what this latest crisis needed is an even higher dose of the same monetary policy remedy. And by that what we mean is the mantra was to go even harder and go even earlier in bringing down interest rates.
- An outcome of this is that highly priced companies and in many cases stocks which even supporters acknowledged were expensive stocks going into COVID have become even more expensive coming out of it. Now, while this is understandable, we’ve elected expected to avoid a lot of these high-priced stocks where we feel there’s disproportionate focus on the upside risk relative to the downside thereby exposing investors to significant price declines if expectations aren’t met. I guess that goes back to the earlier point where the fund does especially well in preserving capital during periods of market weakness.
- So, before we take a closer look at performance at a stock level, we might make a quick comment on how we see the outlook for markets and the fund starting with how we see risk.
- As always, as managers we view risk as the risk the companies we own will not meet our expectations regarding issues such as earnings and balance sheet quality rather than risk of moving too far from index. So, to that extent, where markets are driven by a relatively narrow range of companies where valuations are at levels where significant downside risk is evident should expectations not be met, we do tend to lag.
- That’s not to say we don’t like growth; we have growth in the portfolio, but as always, we manage our fund exposure to minimise this downside risk even if it’s at the expense of better relative performance. Which is another way of saying high PE’s are ok, but only to a certain point and overall, we believe the best returns will come from identifying those companies with underappreciated earnings potential while avoiding over bought companies where expectations are optimistically inflated.
- Further to that, should we enter a new phase where virus eradication is accepted as unrealistic, but we’re are able to manage outbreaks effectively so as not to materially disrupt economic activity (ie, fighting the spot fires rather than large scale lockdowns), or if there is a vaccine then we will very likely see more attention paid to cyclical exposures that have been largely ignored in the COVID rally which will benefit a number of the stocks in our fund that have lagged the risk on days over the last few months.
- Now turning to a few comments on stock performance, we’ll highlight some of the biggest positions in our fund and also look at our top 5 contributors and detractors …
- Our top positions at the moment include Data #3, Baby Bunting, Viva Leisure and West African Resources. Just quickly on those:
- Data #3 is an IT services provider and has been a long term holding for the Microcap Fund. It’s done especially well as you’d expect given it is in a position to help companies and agencies in the private and public sectors navigate COVID on issues such as migrating IT infrastructure to the cloud, manage WFH environments from an IT perspective and address important issues such as cyber security and data analytics.
- Baby Bunting as many of you would know is a major, and pretty much the last standing, baby products bricks and mortar retailers left in Australia, but has developed over time, an online presence and delivery to home distribution channel. It’s every day low pricing strategy, strong market position and exclusivity on some major product lines has seen them easily weather the Amazon storm as well as post strong growth over the COVID period.
- Viva Leisure is a network of fitness centres with a particular exposure to Canberra and regional centres, as opposed to large metro CBD locations. You’d think they would struggle with lockdowns but overall, very effective management as well as strong balance sheet and keen customer focus regarding pricing strategies and membership options mean they have come out of the last six months even stronger.
- Lastly of our key holdings, West African Resources is a gold miner that has successfully brought online its Sanbrado operation in Burkina Faso under budget and ahead of schedule and is generating strong cashflows obviously helped by a buoyant gold price.
- Finally, we’ll take a look at our top 5 contributors and detractors over the last year to 30 September.
- Our current biggest positions highlighted above have also been our 4 best contributors with Kambalda nickel miner, Mincor Resources rounding out the top 5.
- Looking at the detractors, of the top 5 Mineral Resources (which with a market cap of nearly $1bn is definitely not a microcap) but its strong share price has hurt our relative performance.
- Of the remaining 4, base metals company, Heron Resources and Australis Oil & Gas underperformed expectations and have been divested.
- Gage Road Brewers is a Perth based craft beer brewer which has been adversely impacted by COVID but we maintain a position in the company given we believe the consumer demand for craft beers is intact longer term. While it’s been a top 5 negative detractor for the year, we not longer term over 5 years it’s actually been a strong performer for the fund.
- Lastly, Clover Corp which manufactures fish oil-based omega 3 ingredients primarily for infant formula has seen some COVID disruption but we maintain a position given favourable longer term demand dynamics. Similar to Gage Roads, while its been a detractor over one year due to COVID, it’s actually been a positive contributor over 2, 3 and 5 year periods for the fund.
- Thank you very much for your time and for those in the fund thank you for your ongoing support and we look forward to catching up with you at the next update.
This material has been prepared by NovaPort Capital Pty Limited (ABN 88 140 833 656, AFSL 385 329) (NovaPort), the investment manager of NovaPort Smaller Companies Fund and NovaPort Microcap Fund (Funds). Fidante Partners Limited ABN 94 002 835 592 AFSL 234668 (Fidante), is the responsible entity of the Funds. Other than information which is identified as sourced from Fidante in relation to the Funds, Fidante is not responsible for the information in this material, including any statements of opinion. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The PDS for the Funds, issued by Fidante, should be considered before deciding whether to acquire or hold units in the Funds. The PDS can be obtained by calling 13 51 53 or visiting www.fidante.com. Neither Fidante nor any of its respective related bodies corporate guarantees the performance of the Funds, any particular rate of return or return of capital. Past performance is not a reliable indicator of future performance. Any projections are based on assumptions which we believe are reasonable, but are subject to change and should not be relied upon. NovaPort and Fidante have entered into arrangements in connection with the distribution and administration of financial products to which this material relates. In connection with those arrangements, NovaPort and Fidante may receive remuneration or other benefits in respect of financial services provided by the parties.