15 Nov Fund Manager Focus – Ironbark Karara Aust Small Comp
Our Fund Manager Focus Newsletters focus on a fund manager within our investment portfolio and provide information to help our clients understand their investment philosophy and outcomes.
This newsletter focuses on The Ironbark Karara Australian Small Companies Fund.
It has been some years since we have invested into the Australian Smaller Companies equity space. Even now, we are only recommending this exposure to those a little higher up the risk curve. There are a number of issues with investing in the small cap* universe, particularly in a relatively small market like Australia:
» The index is heavily weighted towards small resource companies. This makes the index quite volatile and a difficult benchmark with which to assess managers in this space.
» As the size of the market is quite small, good managers in this space quickly reach capacity and effectively close to new investments.
The attraction of this sector is that there are substantial valuation inefficiencies. This means a good manager can find significant opportunities to add value, providing their analysis is sound. Although many companies in this sector will be familiar to you, i.e. JB HiFi, Flight Centre etc, many others will be less familiar.
As noted above, you will generally find the price volatility of smaller companies substantially higher than the more familiar large companies. Even good quality companies in this sector will be affected by changes in the macro-economic environment. If investing in this sector, you should be clear in this respect and expect significant variability of capital.
Nevertheless, as this sector has substantially underperformed the large cap market in recent years, we believed it is opportune to re-enter the Australian Small Caps equity sector. In selecting the appropriate manager for this exposure, we referred to our base investment philosophy – invest in companies with strong balance sheets, strong cash-flows and sustainable business models. We believe this approach helps ensure that while stock prices may vary, quality stocks will rebound and continue to grow over the longer term.
About the Manager
Karara capital was established in 2007, following the re-organisation of several predecessor investment management companies. Ironbark Asset Management was established in 2009, and is the distributor and responsible entity for the fund.
These administrative functions are outsourced to allow the fund managers to concentrate on their primary undertaking.
The fund is run on a day-to-day basis by Nick Greenaway who has over 14 years’ experience, the last 8 of which specifically in the small cap area. The managing partner and founder of the company is David Slack, who has over 35 years’ experience, and was previously involved with the establishment of small cap investment capacities at some of the biggest managers in this space. As Karara Capital is wholly owned by its employees, we believe the interests of the manager are well aligned with those of investors.
The investment philosophy of the manager is consistent with our approach in that they search for high quality companies with sustainable earnings and/or are materially under-priced compared to their asset position. One of the key factors relevant to this approach is avoiding companies that are impaired or in structural decline i.e. investing in companies that are on the up, rather than on the way down. Because of the approach of the manager, the fund will generally have a lower than benchmark exposure to exploration companies and the resource sector in general.
The fund is relatively concentrated with the manager generally holding between 25 – 55 stocks. Various risk management parameters are employed to ensure the portfolio is diversified and concentration in any one stock is avoided.
The following table illustrates the performance of the fund to September 2013 (after fund manager fees):
It is worth noting that this fund ranks in the top quartile in terms of returns compared to peers since inception and over 5 years. Over shorter time frames, the fund ranks in the second quartile of its peers. This information highlights the limitations of comparison to the index in the above table – in this case most good managers out-perform the index, it is a matter of by how much and by what means this is accomplished.
Over the 12 months to 30 September 2013, the Small Ordinaries Index grew by 0.28% (before dividends). However when this index is further dissected, Small Cap Industrials contributed a performance of 22.4% while small cap Resources contributed a performance of -41.5%. This illustrates the potential divergences within sectors in the Small Cap universe. The conservative approach followed by this manager helps to meet our criteria of providing adequate returns with a lower level of capital volatility.
The following provides an illustration of the fund’s top 10 holdings as at September 2013:
The manager has protocols in place to deal with investments that grow to the extent that they are no longer part of the Small Caps universe. An example of this is Ramsay Health Care. The fund has been invested in this company for many years, and it has grown to such an extent that it is now included in the S&P/ASX 100. The managers continue to maintain a holding in this company, choosing to divest the holding only when valuations suggest it is prudent to do so.
We expect this manager to keep providing returns in excess of its benchmark while the broader market retains a focus on quality. The fund is likely to underperform in an environment where markets are driven by momentum, rather than underlying company performance. Again, we stress that any exposure to small cap shares will increase volatility of capital. However, these should be rewarded by superior long-term returns.
For further information regarding this or any other investment, please contact this office.
*Small Caps refers to small capitalisation. These are listed companies that generally sit outside the S&P/ASX 100 index. The relevant index for these companies is the Small Ordinaries Index.