Nicholas Cregan

Global equities manager Fairlight Asset Management believes concerns about the potential impact of artificial intelligence are creating a growing disconnect between market valuations and business fundamentals across quality global small and mid-cap companies.

Speaking at an investor briefing late last week, Fairlight Portfolio Manager and Partner Nick Cregan said investors had become increasingly focused on potential AI-related disruption, despite many businesses in the quality SMID universe continuing to deliver strong earnings growth and resilient operating performance.

“Markets have become highly focused on identifying potential AI winners and losers,” Mr Cregan said.

“In the process, a number of high-quality small and mid-cap companies are being valued as though disruption is inevitable, despite continuing to produce strong operating results and maintain leading competitive positions.”

Fairlight noted that the majority of its portfolio companies either met or exceeded expectations during recent reporting periods, with no portfolio company reporting so far this quarter downgrading full-year guidance.

This strength is yet to be recognised by the market with many businesses across sectors such as property classifieds, consulting and information services trading near the bottom of their historical valuation ranges.

“This valuation compression reflects investor uncertainty rather than deterioration in underlying earnings performance,” said Mr Cregan.

In addition, he said that 63 per cent of Fairlight’s portfolio companies currently have active share buyback programs in place – the highest level of buyback activity observed across the portfolio since inception.

Fairlight is also seeing increased insider buying activity and growing interest from private equity investors in companies trading at discounted valuations.

“We continue to see a significant disconnect between market expectations and business fundamentals,” Mr Cregan said.

“For long-term investors, that is creating attractive opportunities across a range of quality global small and mid-cap businesses.”

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The Fairlight Global Small and Mid-Cap Fund (‘the Fund’) invests in a concentrated portfolio of 30-40 businesses with market capitalisations of between US$500m and US$20bn.

The Fund predominantly targets Global SMIDs in developed markets, with a strong focus on quality. Its goal is to outperform the MSCI World Small & Mid Cap Index (Net) in Australian dollars by 3-5% p.a (after fees) over rolling seven-year periods.

Fairlight was established in 2017 and actively manages approximately $350 million on behalf of investors.

Commenting on the Fund’s performance and investment strategy, Lonsec said: “Preliminary indications are positive, with the Fund returning 23.3% p.a. over the two-year period to 31 December 2020, outperforming the benchmark by 7.6% p.a. and the Lonsec global peer median by 5.9% p.a. Pleasingly, these returns have been delivered with lower volatility than the peer median.

“While this has been driven by strong stock selection especially within industrials, financials and consumer discretionary, Lonsec notes that the Manager’s quality style has provided a strong tailwind over the period, especially during the COVID-induced downturn.”

Fairlight’s four partners are Nicholas Cregan, Ian Carmichael, Will Dowd and Alvise Peggion. Cregan and Carmichael are responsible for Portfolio Management of the Fund, supported by a team of GSMID experts.

Mr Cregan said: “We are delighted to have been awarded a ‘Recommended’ rating, which is our first from Lonsec.

“Historically, emphasis was on diversification to large international equities and it was difficult for Australian investors to access the GSMID space, a significant but under-researched area of the market. We set up Fairlight to give Australian investors access to the best quality niche leaders in this investment universe.

“Over the past two decades smaller global firms have had higher risk-adjusted returns than larger stocks on average and as such we think an allocation to GSMIDs is beneficial to total portfolio outcomes. We also believe current valuations make it an opportune time to invest in this exciting space.”

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Nicholas Cregan

Leading independently-owned investment research provider Zenith Investment Partners has recognised Fairlight Asset Management’s Global Small and Mid Cap Fund with a Recommended rating.

Zenith’s research process seeks to identify investment managers the firm considers to be ‘best of breed’ through a comprehensive, multi-dimensional selection process. Zenith deems Recommended products to be strong investments within their respective asset class, typically rating in the first quartile for most criteria.

“Zenith’s Recommended rating is a rigorous and welcome endorsement of the Fairlight investment strategy,’ said Nicholas Cregan, Fairlight Portfolio Manager and Co-Founder. “We believe the small and mid cap sector, as compared to its large and mega cap counterparts, represents a significantly under researched segment of the market. There is a wealth of evidence to support the claim that globally, smaller companies outperform their larger counterparts over the long-term.”

“Zenith believes that Cregan and Carmichael are experienced and capable investors with complementary skill sets. In addition, we believe the investment team is sufficiently resourced to provide high levels of analytical research.  From a business stability perspective, Fairlight’s partnership with the founders of Perennial, which was struck in May 2019, provides Zenith with a high degree of comfort. Overall, Zenith believes the Fund is well positioned to deliver upon its investment objectives,” said Mr Quan Nguyen, Head of Equities at Zenith.

Sydney-based boutique investment manager Fairlight specialises in global small and mid cap stocks, with a strong emphasis on quality. The Global Small and Mid Cap Fund aims to deliver investors an 8% – 12% net return through the market cycle with lower volatility than the index, employing a concentrated, long-only strategy investing in 30 – 40 businesses in markets outside Australia.

Commenting on the rating, Cesar Farfan, Perennial’s Head of Retail Distribution, said it is welcome affirmation of the growing interest in the small and mid-cap market, complementing Perennial’s existing offerings.

“Recent research shows a growing interest in this segment of the market, with several of the incumbent managers either approaching capacity or more focused on larger capitalisation stocks.  At Perennial we know firsthand the benefits of having exposure to this sector of the market, having built a successful mid-small-micro cap boutique ourselves, headed by Andrew Smith, with funds under management of circa $1.4 billion across wholesale and institutional clients. We are very excited to introduce the Fairlight offering to our clients,” said Mr Farfan.

Fairlight’s principals have direct equity ownership to maximise alignment between the interests of investors and the firm’s staff and deliver superior investment outcomes. The Fund has delivered strong annualised returns above the MSCI World Small & Mid Cap Index since inception. Fairlight is a signatory to the United Nations Principles for Responsible Investment.

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