Australia-based global small-to-mid cap stock specialist, Fairlight Asset Management, ticked off some big numbers in 2023: five years in business, A$1 billion under management and a 33 per cent annual return for its flagship (and only) fund.
The singular focus on so-called SMIDs is somewhat out of fashion as a handful of glamourous mega-stocks (or perhaps just one, the high-end tech super model, NVIDIA) take centre-stage but Fairlight portfolio manager, Abbey Cook, said the sector still looks good from certain angles.
“There’s a lot of academic data that shows smaller companies outperform large ones by a significant premium over the long term in developed markets,” Cook said.
And when blended with a quality overlay, a key feature of the Fairlight process, the SMID combo has just about always outperformed developed market large caps over any 10-year period, she said.
For the time-being at least, however, the historical attractiveness of small-to-medium companies appears to have faded from memory.
“The SMID versus large cap discount is now at the largest level in almost three decades,” Cook said.
If the discount is flashing a buy-signal for seasoned small-cap investors, other macro factors might also support a re-rating of the sector.
“Micro- and small-caps tend to outperform when inflation is flat or falling – and following a recession,” she said.
Regardless of short-term economic data, Fairlight remains a bottom-up stock-picker targeting global SMIDs that meet its quality standards including sustainable earnings growth, low-debt and good management.
The manager holds a concentrated portfolio of 30-40 companies after winnowing down a potential investment universe of 5,000 to about 200 through qualitative screening. Small is relative, though: the criteria sees Fairlight investing in companies valued between US$500 million and US$30 billion (average US$15 billion) – larger than almost all Australasian stocks.
The style leans to buy-and-hold outcomes with just five exits and six additions (three of which Fairlight had owned previously) to the fund last year.
In an overview of last year, the manager notes: “Portfolio turnover in 2023 was 22%, the lowest figure recorded since the inception of the Fund.”
“… Fairlight is of the view that once we have found a high-quality business which is compounding earnings it is best not to interrupt this process unnecessarily with high turnover.”
Presenting at the Heathcote Investment Partners ‘Meet the manager’ series in NZ last week, Cook showcased one of the new Fairlight holdings in 2023 – the US retail chain, Ulta Beauty.
“Ulta is different to what we typically invest in,” she said, flagging the manager’s preference for business-to-business companies. “But it meets our quality measures.”
Founded in 1990, the beauty product retailer has built a network of over 1,350 stores across the US, growing organically with each outlet usually generating 30 per cent profits just two years post launch.
Offering health and beauty items “over every price point”, Cook said Ulta has built a unique brand presence in the US shopping psyche.
“It’s selling accessible luxury,” she said, boosted by cultural tailwinds that associate beauty with health or ‘wellness’ and a loyalty club membership of 42 million.
Beauty is also a “resilient” category, likely to hold up well during a broader economic slow-down.
On her first visit this side of the Tasman in Fairlight colours, Cook is optimistic investors will also warm to the particular charms of SMIDs.
She joined the firm last year following stints at Magellan and Perpetual, bringing the portfolio manager count to four (plus a quantitative analyst) – all co-investors in the fund with ‘skin in the game’.