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Small-cap fund enjoys early support

Tony Featherstone  |  24 Dec 2012Text size  Decrease  Increase  |  

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Tony Featherstone is a former managing editor of BRW and Shares magazines, and a Morningstar contributor. All prices and analysis at 5 December 2012.


In a market dominated by short-term thinking, Avoca Investment Management's long-term approach almost seems unfashionable. The small-cap equities fund forecasts a company's earnings over six years to understand its valuation throughout the business cycle.

Avoca's approach has seen its assets under management increase about tenfold since the fund partnered with Bennelong Funds Management and launched in July 2011. Its investment skill helped the award-winning UBS Australian Small Companies Fund [11595], which the Avoca team previously managed, rank as the number one small-cap fund over seven years to April 2011, according to Morningstar.

The Bennelong Avoca Emerging Leaders Fund [19125] is not designed to top performance league tables over short periods: it is almost always fully invested, avoids speculative companies with negative cash flow, and often holds high-quality companies for years rather than trade them.

The fund aims to deliver consistent outperformance over the ASX/Small Ordinaries Accumulation Index and be a small-cap manager for all sharemarket conditions. A permanent position as a top-quartile performer is beyond many small-cap managers who deliver outstanding returns when small-cap shares are hot, and perform terribly the next year when the party stops.

Avoca's first-year investment performance was mid-ranking: a 9.8 per cent return in the year to November 2012, compared with a 1.1 per cent fall in the Small Ords Accumulation Index.

Three years of performance history will provide a better insight into Avoca, but recent commitments from investors have already taken its assets under management to around $100 million and suggest early confidence in the fund's management team, investment approach, and performance history while at UBS.

Led by John Campbell, Jeremy Bendeich and Michael Vidler, the fund's conservative approach seems a good fit with long-term investors who use small-cap managers to deliver alpha (a return greater than the market) for portfolios, with more consistency and less volatility of returns.

I asked Avoca managing director, John Campbell, about the fund's investment approach and top stock holdings:

Tony Featherstone: John, how would you describe the Bennelong Avoca Emerging Leaders Fund's investment style?

John Campbell: Our approach is based on deep fundamental analysis of companies and bottom-up stock-picking, using long-term valuation modelling. We avoid mining exploration, life science and other early-stage companies that have negative cash flows, aim to hold 30 to 35 stocks in the portfolio, and minimise turnover where possible. The fund is designed for long-term investors.

Featherstone: In a volatile market, it seems near impossible to forecast a company's earnings over six years. Why do you favour this approach?

Campbell: We accept that the earnings forecasting error rises the further you look out. But it's dangerous to value a company only on one or two years of forward earnings, and not consider how those earnings could change through the cycle. Take resource companies as any example: many were valued on peak-cycle commodity prices a year or so ago, even though it was clear to us that those prices would not last and that the majority of small resource stocks were badly overvalued.