Ask a Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part three of this edition, Michael Steele, co-portfolio manager at Yarra Capital Management, highlights a promising ASX small-cap telecom share and explains how the fund is positioned for higher interest rates.
Motley Fool: Yesterday you shared your two top ASX small-cap shareholdings in the outperforming UBS Yarra Australian Small Companies Fund. Are there other ASX small-caps that look particularly strong?
Michael Steele: A position that's in our top-five and looks attractive is TPG Telecom Ltd (ASX: TPG), an Australian telco company.
In terms of the investment thesis, there's a large opportunity to increase market share. Now they've got the full product offer, with both mobile and fixed telecommunications products post the Vodafone merger. They have a really large opportunity to take market share off the incumbent, Telstra.
TPG now has a large mobile business that is recovering from a cyclical low. So we expect higher mobile pricing and subscriber growth along with the upside of the cost synergies of putting the two businesses together, Vodafone and TPG. They really were a great fit given the network overlap.
TPG will also benefit from having historically had headwinds from NBN access costs. That cost headwind has now peaked and they are going to get some cost-benefit going forward, given they have a fixed wireless product.
And if you look at telecommunications infrastructure, there's a number of transactions in the market recently. We think those transactions highlight that TPG is undervalued. If you look at their mobile towers and their fibre infrastructure, this really is an amazing infrastructure business.
MF: With the outperformance of your Fund, you've clearly gotten a lot right. Are there any moves you regret?
MS: My key regret is a missed opportunity with what happened with the COVID-19 correction.
We saw financial markets sell off very aggressively in the first three to four months. And I do regret not taking on more risk at that point. It was a great entry point in the equity market. I was expecting it to hit a lower low and missed it when it bounced 10% from the bottom. That was a great opportunity.
I guess, my point is, if you see the equity market down 20% to 25%, you should strongly consider averaging in.
MF: Has Russia's invasion of Ukraine changed your investment approach?
MS: Our investment process hasn't changed because of the Russia-Ukraine conflict.
There are three takeouts from the investment process that we already capture, but which highlight how important those are.
First is sovereign risk. In the small-cap part of the ASX, we think sovereign risk is undervalued. There's a lot more risk in some of these developing nations than is generally understood. And that's something we're really cautious of. We add a risk premium when investing in companies with exposure to those countries.
The second is the sustainability of supply chains. You've seen this with COVID-19 as well. You've really got to understand if supply chains are sustainable in terms of sourcing, whether that's a raw commodity or a manufactured product. That could be anything from where semiconductor chips are sourced from to the sourcing of raw materials.
And the third element is thinking through commodity prices. We invest for the longer term, but we are constantly thinking about the sustainability of commodity prices. When you look at what's happened with the Russia-Ukraine conflict and also COVID-19, it's caused a massive spike in commodity prices.
If you take a longer-term view, commodities like wheat and coal are clearly way above fundamental levels. So, we're not going to invest against that backdrop. When you take a longer-term view, we think those commodity prices are going to be a lot lower.
MF: Are you concerned about the potential impact of rising interest rates on your ASX small-cap shares?
MS: We've been positioned over the past 12 months for a more rapid increase in interest rates. Our economist Tim Toohey has done a great job at correctly forecasting that interest rate expectations would be brought forward and they'd have to move higher.
So, the portfolio is underweighted in a number of sectors which typically have underperformed when interest rates have gone up, such as the property sector.
We also own a number of companies that actually benefit from higher interest rates. They have revenues linked to interest income.
We are cautious on what higher rates will do to global economic growth in 2023.
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If you missed the earlier installations of our interview with Yarra Capital's Michael Steele, you can find part one here and part two here.
(You can learn more about the Yarra Australian Smaller Companies Strategy here.)
