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3 top rated small-cap funds to watch

Emma Rapaport  |  25 Sep 2018Text size  Decrease  Increase  |  
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Mushroom cap

Rigorous research and attention to cashflow and earnings potential are the key attributes of three medal rated small-cap funds covered by Morningstar.

Fidelity leads 3 top rated smaller companies funds to watch

Silver-rated Fidelity Future Leaders has avoided some of the major stock disasters of the past year by applying a disciplined approach, says Morningstar senior analyst, manager research Ross MacMillan.

Key to that success is a thoughtful portfolio manager, rigorous investment process, and structured portfolio methodology.

The Fidelity process is led by portfolio manager James Abela, whose team of analysts select companies after a thorough round of detailed business assessment, extensive management meetings, in-depth industry reviews, and proprietary financial forecasting. Abela then screens the companies, based on the three pillars of viability, sustainability, and credibility.

This approach has allowed the fund to avoid some of the major stock disasters of the past year, MacMillan says.

The portfolio contains 40-70 stocks with turnover averaging between 60 and 80 per cent each year. The strategy, based on three-year trailing returns to 30 June 2018, has materially outperformed most category peers and the S&P/ASX Small Ordinaries index.

"As portfolio manager of this strategy, since inception in 2013, James Abela has established a well-structured and highly competent investment approach," MacMillan says.

However, MacMillan does have some reservations. He notes the recent high turnover of analysts in the investment team, saying the strategy's success is now highly dependent on Abela's decisions, abilities, and skill.

"In the past few years, five members of the Sydney-based research analyst team and the director of research have departed. We view this level of turnover as too high."

Dynamic duo at Pengana Emerging Companies

With an experienced duo at the helm and a disciplined approach to cash flow and earnings potential, Pengana Emerging Companies remains an excellent option in Australian small caps, says Morningstar senior analyst, manager research Michael Malseed.

Portfolio managers Ed Prendergast and Steve Black have managed this silver-rated strategy since its inception in 2004, which Malseed says shows a "strong and effective partnership." He regards them as being among the top portfolio managers in the Australian small-cap sector.

Prendergast and Black apply a straightforward approach to investing, focusing on future cash flows and earnings potential. The portfolio looks very different from the benchmark, with managers eschewing property trusts, biotech, and pure-play mining stocks based on their quality, earnings, and risk profiles.

The portfolio contains 50-60 stocks has a broad spread among mid, small and micro-cap names.

However, fees are a cause for concern. A high base fee of 1.33 per cent per year plus a performance fee of 20.5 per cent levied on index outperformance makes this one of the most expensive funds in the peer group.

The fund is currently soft-closed, meaning it is unavailable to new investors, although existing investors can make additional contributions.

Historically, the team has demonstrated superior performance across a variety of market conditions.

Novaport ready for a comeback

Silver-rated Novaport Smaller Companies has endured a tough couple of years, but Morningstar fund analyst Andrew Miles thinks the team’s quality will ultimately shine through.

"The strategy’s valuation discipline kept it away from owning high-growth highly priced names like A2 Milk and WiseTech Global that drove the market higher," Miles says.

"Unfortunately, the underperformance was compounded by misjudgements in some stocks including Retail Food Group, I-Select, and Village Roadshow."

The fund’s returns have been underwhelming over the trailing three and five years (to July 2018). Calendar year 2017 was particularly painful.

But despite these disappointments and challenges, Miles is pleased the team is "resolutely sticking to its process" and believes the "talented team" can turn it around.

Co-portfolio managers Sinclair Currie and Alex Milton and senior analyst Mitch Ryan adopt a collegiate approach and demonstrate detailed research at a stock and industry level. They focus on company meetings when developing conviction, which Morningstar thinks is sensible in the more risky small-cap sector.

Miles says the base fee of 0.9 per cent with a performance fee of 20 per cent on returns in excess of the S&P/ASX Small Ordinaries Index is reasonable for the strategy, adding that sluggish performance means investors won’t have a performance fee impost on future excess returns until the losses are recovered.

Growth on $10k since June 2013
Fund total returns v index returns

Total return funds v index

Source: Morningstar Australia 

 

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Emma Rapaport is a reporter for Morningstar Australia

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is an editor for Morningstar.com.au

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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