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Is Naos Emerging Opportunities Company Ltd (ASX:NCC) one of the best ways to invest in ASX small caps?

Naos Emerging Opportunities Company Ltd (ASX: NCC) is a listed investment company (LIC) that focuses on small cap shares with market capitalisations of less than $250 million.

It is operated by Naos Asset Management, with chief investment officer (CIO) Sebastian Evans at the head of the investment team.

I find it more comforting knowing that LIC management have a lot of skin in the game – they lose when other shareholders lose and win when returns are good. After today’s dividend re-investment announcement, it was reported that Mr Evans now has nearly 1.22 million shares – worth $1.45 million.

However, it’s not just management – shareholder alignment that I think is compelling.

This LIC targets the smallest shares on the ASX, meaning those businesses have (theoretically) the largest growth runways. Those targets could also be unknown to most other investors, meaning a lower starting valuation.

Some of its recently-highlighted holdings include Consolidated Operations Group Ltd (ASX: COG) and Enero Group Ltd (ASX: EGG).

But, it’s only worth investing in small shares if it actually leads to results. At the end of September 2018 it calculated that since inception in February 2013 the portfolio has returned 16.2% per annum after expenses but before fees.

The fees aren’t too excessive, but still sizeable with an annual management fee of 1.25% and also a performance fee of 15% of the outperformance of the benchmark of the S&P/ASX Small Ordinaries Accumulation Index if it beats it. Any underperformance must be recouped first before performance fees are paid.

Since inception it has generated better returns than most other LICs on the ASX. It has been paying out this strong performance as a regularly-growing dividend since the second half of FY13.

I really like the strategy of Naos holding a high-conviction portfolio of around 10 shares that it believes are long-term market-beating choices.

Foolish takeaway

Naos Emerging Opportunities currently has a grossed-up dividend yield of around 8.5% and is trading at a small discount to the last reported post-tax NTA for September 2018.

I believe it is one of the best LICs on the ASX to invest indirectly in small caps, along with WAM Microcap Limited (ASX: WMI).

I’d be happy to buy a parcel of Naos today and buy more on market weakness with the rise of volatility.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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