Focus on the company, not the market as volatility reigns

From
Callum Burns

Callum Burns

While the ASX100 companies in aggregate have struggled to grow earnings, there are many other companies with sustainable long-term earnings growth outside of this cohort, says SG Hiscock’s Callum Burns, portfolio manager of the SGH ICE fund.

“Some investors are focused on market movements and volatility, and how low the market can go. Our focus is less on the market as a whole and more on stock picking, and finding value,” Mr Burns says.

“This is not a new concept. It has been the case for the 10 years that the SGH ICE fund has been established. It is only now that markets are volatile and the return outlook from large cap companies is less certain, that consideration of alternative ways of generating long-term sustainable return have come to the fore.

“The key for us to investing for sustainable future growth is to look for good quality companies with a business franchise with a sustainable competitive advantage where it is difficult for clients to discontinue using the product or service.

“Companies displaying these characteristics are typically outside the top 100 and tend to deliver more certain earnings growth than those that don’t.”

Mr Burns says now is the right time to be focused on individual companies.

“We see that there are opportunities for a significant number of ex-ASX100 companies, regardless of the broader market environment.”

The success of this approach has been demonstrated by the capability of SGH ICE, which over the past 10 years has outperformed on a total return, and a risk-adjusted, basis.

In the 10 years to end of February 2016, the ICE fund has returned 12.2 per cent a year with a level of risk (as measured by standard deviation) of 15.6. In contrast, the the Small Ords has returned 0.4 per cent a year with a standard deviation of 19.6. while the ASX300 over that period has returned 4.3 per cent a year with a standard deviation of 14.4.

“The key difference is active management with investment in quality business franchise companies. We have found that companies that have a competitive advantage tend to perform better in uncertain environments, but that investors often underestimate the power of this advantage.

“There continues to be a significant difference in performance between those companies with a structural advantage whose operations are doing well, and mediocre companies. As a result, it remains a stock pickers’ market.

“With low or no earnings growth in the large cap stocks experienced in recent times, advisers are increasingly looking further afield for attractive opportunities with many investors prepared to discount the risk being taken for returns.”

Mr Burns says there is increased adviser interest in small cap funds. The SGH ICE fund, has recorded significant inflows over the last twelve months and has recently been added to the MLC Wrap as well as the model portfolios of IOOF’s Bridges and Consultum businesses.

“Over the 10 years that the fund the has been running, we have seen ebbs and flows in the popularity of small caps. But with growth in the large end of the market volatile and uncertain, there has ben a renewed interest in small caps.

“There are definite opportunities outside of the ASX 100 and there is no question that small cap stocks have delivered some good returns to investors in recent times. But those embracing small caps for the attractive opportunities they offer for greater returns, should also be mindful of the risks.

“There are hundreds of stocks in the small cap universe, covering a diverse array of industry sectors. The companies are spread across the lifestyle spectrum from early start up to growth to the peak of cash generation and to maturity.

“But the returns are only half of the story. The level of risk taken to achieve those returns needs to be a focus as well.

“Diversification is also a critical aspect, and taking a whole portfolio approach with many shots on target is the most reliable way to achieve strong risk adjusted returns.

“The focus needs to be on the better quality small cap stocks.”

SG Hiscock & Company is a boutique investment manager established in 2001 and 100% owned by its staff. It has a broad range of funds and a mix of some of the largest wholesale clients in Australia. The customer base also includes a large number of high net worth and retail clients who predominantly invest through financial planners and platforms.

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