How to avoid "speculative junk" on the ASX and manage small-cap risks

This interview was filmed on 16 April 2024.

Fund profile

• Name of the fund: Airlie Small Companies Fund
• Asset Class: Australian equities
• Investment objective: to provide long-term capital growth and income through investing in Australian-listed small companies.
• Link to fund page

Even the most bullish amongst small-cap investors would concede that it’s not all roses in the index. Or as Will Granger, portfolio manager for the Airlie Small Companies Fund, put it, there’s a lot of “speculative junk in the index.” 

It’s part of the reason why small-caps, on the whole, are often hit with the perception of being high-risk and volatile. They don't need to be, however, argues Granger. In the interview, he shares his tips for sifting through the weeds and managing risk in the small-cap space.

Three measures for downside protection (and avoiding junk)

Granger believes in a concentrated portfolio of best ideas for the Airlie Small Companies Fund, with the top 15 ideas accounting for 75% of the portfolio. To become part of the portfolio, there are three components Granger views as critical.

“We buy businesses with good balance sheets, we buy quality businesses with quite resilient earnings streams, and we make sure we don’t overpay for those businesses,” he says.

This means those businesses with opaque operating models, or unproven business models don’t get a look in. He also chooses to stay away from companies involved in resource discovery or drug approvals, where success can be both more speculative and binary. 

It’s about what you exclude, as much as what you include in your portfolio.

“If you only buy the businesses that are profitable on a cashflow basis and you exclude the loss-makers, you can actually comfortably outperform the index over the long term,” says Granger

He adds that Airlie’s aim is to go a step beyond this, i.e. to identify not just the profitable companies, but the ones with the best- deas within that cohort. 

What best ideas look like in the current market

Valuations are relatively elevated across the market, with Granger noting some stocks have a lot of optimism priced in. Some sectors that are looking more attractive are those where the outlook is more pessimistic or a bit unloved, such as consumer discretionary.

That said, whether the market is looking cheap or expensive is not a focus for Granger as a bottom-up stock picker looking at individual risk-return characteristics. And, with more than 700 companies in the small-cap universe, Granger argues you’ll always be able to find a concentrated portfolio of high-quality companies.

“Some of the greatest opportunities we’re seeing are in our core long-term holdings. It’s businesses like News Corp (ASX: NWS), Premier Investments (ASX: PMV), Gentrack (ASX: GTK), Mader Group (ASX: MAD). 

We think these are a collection of really high-quality businesses that are undervalued by the market that we’d love to own for the next decade,” Granger says.

In the interview above, Granger discusses the rally in ASX small caps, provides more detail on how he avoids speculative junk, and also nominates three holdings he thinks will hit large-cap status in the next decade.

An experienced team with a proven track record

Airlie is a specialist Australian equities fund manager which brings together some of Australia’s most experienced industry participants. For more information on the Airlie Small Companies Fund, please visit their website or fund profile below.

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Airlie Small Companies Fund

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