NovaPort Smaller Companies Fund: 2021 FY Review and Outlook
Alex Milton, NovaPort Principal and Co-Portfolio Manager
In this quarterly update we will review the Smaller Companies Fund over the financial year just finished looking at the major factors driving the broader market and how we managed the fund in light of the challenges and opportunities.
We will then look at our key contributors and detractors to fund performance and finish with the outlook and our fund positioning. The Smaller Companies Fund posted a 28.48% gain for the year compared to the index which finished the year up 33.23%.
The major macro issues for investors over the course of last year included:
- the announcement in late 2020 and progressive rollout of multiple COVID vaccines with high levels of efficacy and a subsequent re-opening trend globally,
- enormous fiscal and monetary stimulus leading to rapidly improving economic activity,
- and the gyration in inflation and interest rate expectations based on month by month data points.
While acknowledging the importance of these macro influences on company share prices, we focussed on bottom up stock picking seeking undervalued opportunities with a longer-term perspective and with down-side risk a key consideration.
Regarding portfolio positioning over FY21, we were more active in initiating and exiting investments than at any other time since the GFC given the pricing opportunities afforded by the sharp decline across the board over 4QFY20. Beyond oversold situations, in assessing opportunities, we focussed on undervalued opportunities where we identified company specific catalysts such as change in management, balance sheet restoration, longer term improvement in fundaments and outlook based on related industry and economic conditions.
Opportunities included economically sensitive companies that were ignored during the COVID rally (eg. Sims Group, MyState and IPH) as well as longer duration growth companies where future earnings weren’t reliant on continued lockdown conditions, but rather structural opportunities afforded by industry trends (eg. software as a service exposure Technology One and strong competitive positioning such as Baby Bunting, Nanosonics and Data #3).
From a fund performance perspective, the announcement of multiple vaccines in late 2020, re-opening activity and higher interest rates (on inflation concerns) worked to our benefit with appreciation across our economically sensitive exposures featuring heavily in FY21.
This offset some of the underperformance across late FY20 early FY21 which was a result of our decision to avoid some of the lockdown winners where we viewed the risk assessment to be heavily skewed to the upside (underpinned by unsustainably low interest rates and over optimistic expectations) and too little consideration for the downside.
As the table shows, while disappointing to be below index at the end of the financial year, relative performance improved since the point last year where the highly price COVID winners were key drivers of index returns.
Importantly, capital preservation in down markets which has been a long term feature of the fund still holds with the portfolio outperforming on 51 of the 61 days the index has been down by more than 1% on the day since COVID became a global issue for markets in late February 2020.
Key stock performance over FY21
Turning to performance at a stock level and in line with the above commentary that while we hold a diversified combination of what would be considered “value” and “growth”, our key positive contributors primarily consisted of economically sensitive companies, as well as ones where investors revisited the thesis as COVID related concerns dissipated.
The top contributor for the year was metals recycler Sims Group as demand and pricing for scrap metals increased on a ramp up in industrial demand globally. Second was Fletcher Building posting an improved operational performance further boosted by buoyant housing related activity in Australia and New Zealand. Credit Corp’s share price was up strongly unwinding excessive levels of pessimism on the initial COVID impact and on effective management execution as well as growth prospects in the US.
The spread of the virus through aged care facilities last year, primarily in Melbourne, combined with a Royal Commission weighed on share price of the aged care operators. Nevertheless, we maintained an exposure to the sector (via our fourth best contributor Estia Health)given our long term view the COVID impact would eventually be managed thereby increasing occupancy rates and the Royal Commission was highly unlikely to return an adverse finding for the companies operating in the sector which turned out to be the case.
Rounding out the top 5 contributors was Regis Resources which the fund did not hold. The next best performer held by the fund was Nick Scali up strongly for the year with a large cohort of customers buying bulky furniture online while in lockdown. In addition, significant pent up household savings, buoyant house prices, high consumer confidence levels and rapidly declining unemployment were no doubt supportive.
The top detractor for the year was Gold Road Resources. We reduced the weighting on share price strength making it the fourth best contributor to performance over three years, However, gold price weakness through to the end of the March quarter adversely impacted its one-year contribution. At current prices the position is underpinned by base case assumptions with further upside from project scope expansion and discoveries.
Lynas Rare Earths was the second biggest detractor and not held by the fund. While we reduced our weighting in medical devices company Fisher & Paykel, on share price strength over FY21, the level of profit taking market-wide impacted performance and it was the third largest detractor for the year. However, despite this, it is our fifth best contributor over three years.
The fund’s other gold exposure Saracen Mineral Holdings is a top 5 contributor over three years but was a detractor over FY21. We reduced the weighting on share price strength which ameliorated some of the impact.
Our fifth detractor was Pilbara Minerals which is not held by the fund. Nanosonics, which manufactures and markets high level disinfection equipment for ultra sound probes to reduce instances of cross contamination, was impacted by severely restricted access to hospitals across North America and Europe which impeded selling efforts and new product roll out plans.
Outlook & Fund Positioning
In comparing current market conditions to last year, we would note lower investor tolerance for highly priced stocks reporting key revenue, cost and growth metrics below expectations.
The outlook remains volatile over the short term as several cross currents weigh on sentiment and market direction. The upward trend in long term interest rates underway since the September quarter last year, and signifying much stronger economic conditions ahead, and therefore potentially inflation, peaked in late March and has been in decline since. The fall is largely attributable to the transitory inflation argument asserting its dominance in the “transitory vs more permanent” debate given the absence of irrefutable data points suggesting price spikes are stickier than initially expected.
In addition, the delta variant wave emerged as a macro consideration which not only served to soften inflationary pressure, and therefore the argument for higher long-term rates, but also cast into doubt the strength of recovery. Lastly, interest rate expectations softened on more hawkish statements by the US Fed which were viewed by markets as premature and a threat to an already weakening outlook thereby flattering the yield curve.
In short, the net outcome of these competing forces is something of a reversal in recent months of the growth to value transition underway since late last year, although whether this is a stumble along the path to higher rates and less liquidity over time remains to be seen. This saw some retracement in our relative performance to the index over the final quarter of FY21.
Nevertheless, we remain constructive on the macro outlook despite short term challenges especially with the accelerated roll out of vaccines which is something we didn’t have this time last year. Our portfolio includes a mix of growth companies for the longer term as well as economically sensitive companies which have been weaker of late because of the issues just raised. Key exposures on that front include IPH, Seven Group, Fletcher Building and Healius.
While these macro issues will likely echo in markets over the remainder of 2021, we continue to seek opportunities via a continued focus on company specific opportunities and assessment of fundamentals and risks. We seek to find investments with positive catalysts and outlook as well as attractive valuation support. We remain wary of investments requiring sustained proliferation of liquidity support, in particular companies reliant on the generosity of capital markets to realise their growth ambitions.
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.