NovaPort Smaller Companies Fund Update – May 2021

Alex Milton, NovaPort Principal and Co-Portfolio Manager

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Transcript:

We just wanted to provide an update on the NovaPort Smaller Companies Fund for the year to 30 April.

The fund finished the month just above index up 5.3% vs the Small Ordinaries Accumulation Index which was up just under 5% over April.

Overall, a solid performance last month continues a positive trend that we saw emerge in late calendar 2020 with vaccines, overall better management of the virus in Australia, enormous fiscal stimulus and a much better than expected recovery in broader economic conditions prompting the widely discussed rotation of growth into value which has been to our benefit performance wise.

With this change in market dynamics since late last year where the market is reassessing the sustainability of the valuations of the so called COVID winners and at the same time being presented with disappointing updates relative to optimistic expectations the fund has outperformed over 4 of the last 8 months since September last year. This compares favourably to the previous 8 months to September last year where the fund outperformed in only two of those months.

On the topic of the widely discussed growth vs value and the rotation into the latter, while we’ve always held growth companies in the fund, we are mindful of the sustainability of valuations, especially in frothy or bullish markets where investors have a tolerance for high valuations and where a lot of attention is paid to the upside risk and very little focus to the downside should news flow or earnings not meet highly optimistic expectations.

We’ve seen that reflected in our six-month performance. For example, for the six months to 30 April this year the fund is up 20.91% which while still 52 basis points below index is a material improvement on the six months to 31 August last year when the fund was 12.1% below index.

So effectively the fund has posted a 12% turnaround in rolling 6 month numbers which at a high level reflects our reluctance to have too high an exposure over the COVID rally to some of the long duration growth companies, in many cases loss making companies, where the short term price was being driven by aggressive monetary policy in response to an unfolding pandemic and revenue growth expectations predicated on a large percentage of the population remaining in lock down.

However, since late last year our absolute and relative performance has improved as investors turn to companies that were ignored over 2020 but with fiscal stimulus, vaccines and broadly positive economic conditions these companies now present as opportunities with both earnings and valuation upside. Examples in our fund include retailer Kathmandu, aged care operators Estia and Regis, steel recycler Sims Limited and financial services company, MyState Bank.

Lastly, our focus on capital preservation is, as has always been the case, a paramount consideration for us. Since COVID came really into focus in the final week of February last year the fund has outperformed on 45 of the 57 days the Small Ordinaries Index has been down by more than 1% which in line with how the fund performs historically in risk averse markets.

Turning to fund positioning given this environment and key contributors to performance for the year to 30 April, one of the reasons for our improved performance since late last year is the weighting we’ve carried in economically sensitive companies which we thought would come to the fore should social and economic conditions normalise as the world learns to live with the virus either with or without a vaccine.

Key companies in the fund include Estia Healthcare which as you would recall was facing extremely tough circumstances last year with COVID infections and adverse implications for occupancy levels where many families understandably wanted to delay moving elderly loved ones into aged care homes given the infection risk. As would be expected however, conditions are starting to improve on that front and that’s been reflected in Estia’s share price over the last few months with the stock up 51% since January.

Fletcher Building which is up 24% so far in 2021 has been a large position for us, and a key contributor to performance over the year with construction related activity a lot better than expected obviously helped by government assistance in the form of the HomeBuilder grant.   

Improving economic conditions globally has been a big tailwind for scrap steel recycler Sims Limited and rounding out our top 5, Gold Road and Independence Group remain our key resources picks giving us exposure to gold, lithium and nickel.

Looking at our 1-year performance on a stock attribution basis, our top five key positive contributors include Nick Scali (with both COVID and fiscal stimulus, combined with high consumer confidence levels and buoyant house prices driving strong furniture sales).

Our second-best performer Sims Limited has seen its price up 22% since January reflecting its exposure to the improving outlook for steel scrap prices as the global economic recovery takes hold.  

Fletcher Building mentioned above was our third best contributor to performance for the year as a beneficiary of buoyant housing construction activity. Our last two contributors out of the top five are retailers Baby Bunting and Kathmandu. Both are omni channel retailers with a good combination of bricks and mortar store networks as well as the capability to sell online.

Baby Bunting fared a lot better than Kathmandu given its position as an essential services provider and remained open during COVID whereas Kathmandu’s share price is only now starting to recover and price in the normalisation in activity levels we are currently experiencing.

Turning now to our top five detractors, Gold Road has been our key detractor with profit taking on a weaker gold price having an impact. Nevertheless, as commented earlier it remains a key position for us in the fund.

Oil and gas producer and project developer Cooper Energy is no longer in the fund, however, its share price weakness over the year reflecting some production ramp up issues in its offshore Victorian assets impacted our performance.

Our third detractor, Nanosonic has been a key positive contributor to the fund over the last three years as our second-best performer over that time period but recent price weakness has adversely impacted contribution for the last 12 months. The company is a global manufacturer of high-level disinfection equipment for hospitals but with continued restrictions in non-COVID related activity within hospitals limiting the number of hospital procedures requiring the use of their equipment the company has fallen short of expectations in the short term.

Lastly, we would note Gold Road, Cooper Energy and Fisher & Paykel were in our top five detractors for the year and were, or are, stocks we owned over the period. The other two of the five detractors were Lynas and Mineral Resources which are not currently, and were never, in our fund but strong share prices over the year and not owning them adversely impacted our performance relative to the index.

In summary we’d highlight two key points: (1) Performance for the fund has shown material improvement in both relative and absolute terms since September last year and that reflects some of the market darlings which drove the index over the COVID rally between March and September last year coming off the boil on the realisation earnings and growth expectations were too optimistic and in a rising interest rate environment carried very expensive valuations into this year that allowed no margin for error and as such have subsequently been sold off.

And (2), we continue to hold a diversified group of what would be considered growth as well as value companies but always with an eye on sustainability of high valuations on a stock by stock basis and overlaying that is the constant focus on capital preservation should downside volatility impact markets at any point.

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.