Top performing funds: A high-conviction idea from a manager that delivered 35% in FY24

Stick to your process, ignore negative noise, and focus on avoiding poor-performing positions just as much as finding those that generate alpha. 

That's the advice from one of Australia's top-performing Australian equity fund managers from FY24, Liam Donohue of Lennox Capital Partners, whose Australian Microcap Fund delivered its investors a return of 34.73% in FY24. 

Despite this stellar performance, and the ASX Small Ordinaries already rebounding 18% since the beginning of November 2023, he's bullish on the outlook for Australian small and micro-caps in FY25. 

"From what we’re seeing in terms of the number of new opportunities coming across our desks it must just about be time for small and micro-cap stocks to shine," Donohue says. 

"We can see very early signs of that starting to happen in the US market, and when we think of the cumulative underperformance in the smaller end of town versus large caps over the past three years there’s a strong case that now is the time to be in small and micro-caps." 

In this wire, Donohue shares the decisions and stocks that helped the Fund top the charts in FY24, outlines what the team got wrong (even the best make mistakes!) and shares his highest-conviction position for the year ahead. 

1. What was the biggest decision or call that you made in FY24 that helped drive your performance?

The biggest driver of overall performance for us was probably ‘time in the market’ instead of ‘timing the market’. And by that, I mean that even when the market wasn’t looking too flash in late FY23 and your natural instinct was to pull back from things that felt risky, we stuck to our process and worked hard to find some really good quality conviction positions for our investors. 

We view our job as fund managers as providing investors with exposure to exciting, quality businesses at the smaller end of town that generate returns through time – and that is especially the case when markets are wobbly because that can often provide the best opportunities for longer-term investing.

2. What was your best trade from the last 12 months?

It’d have to be MMA Offshore (ASX: MRM, formerly Mermaid Marine) which is an offshore vessels business that many in the market have had a history with. The company saw their share price peak at around $14 in the last offshore boom (circa 2014) but it all came crashing down when demand for vessels dried up and ultimately the stock bottomed at $0.25 in 2020.

From there, the new management team did a phenomenal job of cleaning up the business including some hefty recapitalisations and ultimately were able to capture the upswing in the offshore vessel market through 2023 and 2024. Unfortunately for investors, management may have done too good a job and the company has just been taken private by a Singaporean investor. 

Luckily for those looking for a way to play a similar dynamic, there’s a small domestic vessel operator named Bhagwan Marine that is just about to hit the ASX boards and we think looks like a compelling opportunity.

3. Did you get anything wrong or would you have done anything differently looking back? i.e. is there a stock you wouldn’t have backed, or one that you wished you did, or do you regret not holding enough of a stock etc?

We absolutely got some things wrong – everyone does! In terms of things that we missed, one part of the market that has been strong through FY24 has been defence-linked businesses – and that is ‘defence’ as in war/conflict as opposed to stocks with defensive characteristics. 

Our process doesn’t include businesses that are linked to armaments and munitions so much of that market is un-investable for us, but there have definitely been some big returns printed by just about any business linked to military activities over the past 12 months.

4. What is your outlook on Australian equities over the next 12 months?

It has to be positive! We definitely don’t pretend to be macro forecasters – that’s for people smarter than us. But from what we’re seeing in terms of the number of new opportunities coming across our desks it must just about be time for small and micro-cap stocks to shine. 

We can see very early signs of that starting to happen in the US market, and when we think of the cumulative underperformance in the smaller end of town versus large caps over the past three years there’s a strong case that now is the time to be in small and micro-caps. 

The compounding positive here could be that if markets kick-off, the floodgates might open in terms of new businesses IPO’ing onto the ASX and that tends to be a strong source of returns for our investors.

5. What is one thing investors will need to get right to be successful over the next year?

I think avoiding the bombs is always a key strategy that investors need to get right. Everyone tends to focus on their winners (and pretending that their poor performers didn’t happen), but the real risk of under-performers is that they eat away at the good returns generated by your winners. 

That’s why some have the view that small caps are not a great investment – there are plenty of winners, but the losers dilute your overall returns. Just ask anyone who’s ever seen a holding in their portfolio go to $0.00 (…..examples not recent enough to talk about include the likes of Slater & Gordon or RCR Tomlinson). 

Our view is that we need to be as focused on avoiding the bombs as we are on finding the winners so that we keep as much of the positive alpha as we can without giving it back on negative alpha positions.

6. Which high conviction positions in the portfolio do you think will keep your performance humming over the next 12 months? Have you bought anything new recently? And if so, why?

A high-conviction position that we are really excited about is Botanix Pharmaceuticals (ASX: BOT). 

The company’s key product, Sofdra, has just received FDA approval to treat excessive sweating – ‘primary axillary hyperhidrosis’ for those playing along at home! This is a surprisingly common issue, and in the US as an example, roughly 3.7 million Americans sought treatment for the condition over the past year alone.

We also like the market structure for the product because Sofdra is effectively a painless gel applied to the body, whereas current treatments have typically been less effective and more invasive including the use of targeted Botox injections. 

With binary approval risk in the US no longer being an issue, we think the opportunity in front of the company is immense, especially when you couple that with management’s history of commercialising dermatological products in the US.

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Lennox Australian Microcap Fund

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