Motley Fool Australia

How this small-cap fund manager is shooting the lights out year after year

Jeremy Samuel Anacacia
Image Source: Anacacia Capital

Most fund managers focus on the larger end of the share market. You know, the companies you’ll find listed on the S&P/ASX 300 Index (ASX: XKO).

Those shares are generally seen as carrying less risk. They’re also more liquid than smaller shares, enabling larger fund mangers to buy or sell a large quantity of holdings without significantly moving the share price.

But here’s the thing. When you limit your share options to the biggest 300 companies by market capitalisation, you’re more likely to see returns mirroring the benchmark.

To give you an idea of that benchmark, over the six months to 31 August, the ASX 300 returned 20.1%. Over the one year to 31 August it lost 7.8%.

Now let’s turn to Anacacia Capital’s Wattle Fund, which invests into leading small to medium-sized enterprises (SMEs) in both the private and public realm.

Over the six months to 31 August, the Wattle Fund delivered a net return of 25.6%. Over the one year to 31 August it returned 47.8%.

And this was no one-off streak.

The Wattle Fund has delivered net annual returns to investors of 21.0% over the past three years (to 31 August) and 19.6% over five years.

Now the fund won’t be for everyone, as its minimum investment amount is generally $500,000. But if you had invested $500,000 with the fund five years ago it would be worth more than $1 million today.

A bit of history

The Wattle Fund launched in 2015.

Its first investment after inception was into data services company Appen Ltd‘s (ASX: APX) initial public offering (IPO). Before the company went public, Anacacia held some 70% of the company in its private equity fund. Today, it owns less than 1% of Appen and has developed a diversified portfolio of other leading SMEs.

With this kind of history and returns, the Motley Fool reached out to Jeremy Samuel, the Managing Director of Anacacia Capital.

Now you might think that the Wattle Fund jumps in and out of shares frequently.

Samuel told us that’s not at all the case, “If we are doing our job right and successfully backing quality businesses, then our holdings should be for many, many years.”

Read on for the full interview with Jeremy Samuel below:

Can you give us some insight into why the Wattle Fund focuses on the smaller end of the equity market? 

Anacacia’s heritage was in private equity investing. Our investors (typically family offices and institutions) actively encouraged us to expand into public equities. It was natural for us to keep our focus on the smaller end of the market.

We have developed a team with a high level of interest and capabilities to work with the smaller end of the market. This is not better or worse, but is different from investing in larger companies.

In the public markets, this is typically a significantly less efficient end of the market. There is little broker coverage and little interest or expertise from the large fund managers that are good at focusing on putting large amounts of capital into large cap stocks. For our target smaller companies, we try to understand the public information thoroughly and try to add value to the portfolio where we can. There’s a lot of sharing of knowledge and insight across our private equity and public equity markets. We do avoid the very smallest companies that are often too illiquid to invest. However, there are some great emerging companies on the ASX.

Ultimately our philosophy is about backing great people.

How do you identify the companies that you believe will see strong share price growth?

We look at several criteria. These include the quality of the management team and board, such as their track record and level of personal investment in the company and alignment with shareholders. We also look at the opportunity including the market size and competitive advantage of the business, as well as why customers buy its products and services.

Ultimately, we are then trying to come to a view as to the maintainability and growth of future profits and cashflows. We ask ourselves whether the current price fairly reflects the people and opportunity.

What triggers you to sell out of a position?

We generally take a longer-term view when forming an investment thesis.

The reasons we might sell include if there’s new information that makes us doubt our initial assessment of the quality of the management or opportunity. Sometimes, the share price can rise too much in advance of the opportunity so we might reweight our position.

We are not day traders or focused on graphs. We are looking at the underlying business and its prospects. If we are doing our job right and successfully backing quality businesses, then our holdings should be for many, many years.

What kind of risk management do you employ?

Everyone in our team has a material personal investment in our funds. So our interests are aligned with our investors. This includes myself, Tom Granger, and Shashank Gupta who focus mainly on the Wattle Fund and indeed all our other wonderful investment and finance team and our experienced business advisory council who together all contribute to our performance.

We have a high conviction fund, but we do build in some diversification typically with about 20 positions that are not closely correlated together.

We worry about capital protection. If there’s no compelling investment opportunity, we are not afraid to hold a material balance in cash and await the right opportunity to invest in the businesses we like at reasonable prices. For example, in early 2020, we had a cash balance over 30% and then deployed a considerable proportion around March time where we saw value.

Most of our risk management though is at a stock level, trying to understand the businesses really well and invest in strong sustainable businesses. We’ve never tried to leverage our returns with debt, and that assists during tougher times to manage risk also.

You’ve had consistently strong returns over the past 5 years, and the past 1-year returns are exceptional, at 47.8%. How have you achieved this?

We have just stuck in a disciplined way to our strategy of backing leading SMEs — great people, opportunities and fair prices. We try not to focus on short-term performance. We can only really judge our performance over the long term.

Volatility can assist in times like 2020. When some other investors in smaller companies get swept up in the emotion of markets, that can create greater inefficiencies. Our target returns were and remain 10%+ per annum net to investors. It’s been pleasing to exceed those returns, but we’re more focused on how we continue to target strong risk-adjusted returns for investors into the future.

We have a wonderful team of talented investment professionals.

What do you view as the biggest threat to investors in general, and your fund specifically, over the next 12 months?

COVID has clearly hit the overall economy hard and some sectors worse. The market in general has bounced back quite strongly, including in some companies where it’s difficult to see how they will make sustainable profits to support their current valuations.

If the recession is deeper than anticipated, then I think that will be quite challenging for many retail investors, particularly those that have bought in a high levels or have very concentrated portfolios in stocks that they do not know so well, and are not focused full-time on absorbing the fast pace of changing information.

For our fund, we need to remain disciplined and focus on the same elements that have served us well historically. We are fortunate to have good long-term investors who understand that investing is risky and a team with aligned interests.

Our biggest challenge and opportunity in the next 12 months is to continue to back businesses that we think will be stronger in decades to come.

Speaking of COVID-19, how did the pandemic impact your investment decisions?

COVID-19 heightened our focus on the balance sheets of companies to ensure that they can withstand a temporary hit to their earnings for many months, as well as an assessment of whether anything structurally may have changed in their industry. We then look to see if the share price reflects those risks and opportunities.

For example, we saw many businesses with recurring profitable revenue from government clients sold down with everything else earlier this year, whereas we thought it was actually a good opportunity to increase our holding.

There will be ups and downs in markets and we think a major downturn is still quite possible. We remain calmly focused on executing our strategy of backing leading SMEs.

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Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Appen Ltd. 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.