Pengana Emerging Companies Fund celebrates 20 years, sees no end to alpha opportunities in smaller companies

One of Australia’s longest standing investment teams is celebrating 20 years together, and says history shows active management will remain key to small cap stock investing regardless of what challenges emerge in the years ahead.

Smaller companies specialists Ed Prendergast and Steve Black, Senior Fund Managers for the Pengana Emerging Companies Fund, which was launched in November 2004, say it’s possible to deliver alpha through the market cycle by targeting smaller companies.

The last 20 years have brought a bit of everything to contend with in markets, Ed Prendergast said. “It has been an incredibly interesting time to have been investing in markets. We have seen some extremes and it has been hugely challenging, but it has only galvanised our belief in smaller companies as a critical part of an investment portfolio.

“Across bull and bear markets, including major events such as the GFC, Covid, high and low inflation, and high and low interest rates, there have been opportunities to invest.

“This sector has been fertile ground for active managers to add alpha but it doesn’t just fall in your lap – this end of the market requires a special kind of focus, and it demands flexibility.”

Mr Black said a stable team, process, and investment philosophy has been critical over the journey. “Smaller companies provide a lot of choice but it all comes back to the people, the process, and the decision-making, and how well you complement each other as a unit.

“There may be plenty of choice but there are also many opportunities to make mistakes. And we’ve made our share of mistakes over 20 years, but how we then mitigate those and turn things around comes down to our unique combination of process and people.”

Since establishment in November 2004, the Pengana Emerging Companies Fund has delivered 12.1% per annum net of fees to investors, outperforming the Small Ordinaries Index by 7.2% per annum net of fees for the period to 31 October 2024.

In practical terms, $100,000 invested in the Pengana Emerging Companies Fund at inception would now be worth $983,844, whereas $100,000 invested in the Small Industrials Accumulation Index would have grown to $288,245 over the same period.

For the last 12 months to 31 October 2024 the Fund has returned 29.5% to investors net of fees. The Fund has approximately $800 million assets under management.

Notwithstanding the recent rally, Australian small cap industrials remain overlooked and creating a rare environment to invest. “This has seen part-time small cap investors leave the market, creating a number of highly attractive overlooked situations”, Prendergast said.

“We saw this after the tech boom in 2000, and in the aftermath of the GFC and Covid. We love uncrowded markets, confident that our patient, long term approach is likely to be rewarded. Our preference is for stable, long term growth stocks such as Generation Development, Propel Funerals, TechnologyOne, HUB24, Netwealth and Mainfreight.”

Prendergast and Black say the key to consistency is maintaining contact with company management. “We’re turning stones over continually to generate returns for the fund. In an inefficient area of the market there’s no substitute for meeting management personally”, Prendergast said.

The other key is to embrace volatility, which may be pertinent given the potential economic impacts of Trump’s second term as US President. “We are used to dealing with volatility, and it can provide opportunities for us”, Black said.

“When markets are weak there is often money taken away from small caps, and that disruption can result in incredible buying opportunities in companies with proven management, with longevity, and predictable earnings streams.

“Active stock picking works in the small cap space – it’s all enduring, delivers strong outperformance and strong alpha when properly managed”, Mr Black concluded.