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 1 of our interview, Eley Griffiths portfolio manager Nick Guidera tells why Aussie Broadband is his biggest ASX holding, although it's competing against massive rivals.
Investment style
The Motley Fool: What's your fund's philosophy?
Nick Guidera: I work for a company by the name of Eley Griffiths Group, and we have two strategies — the Eley Griffiths Group Small Companies Fund and the Eley Griffiths Group Emerging Companies Fund.
We're a specialist in that area of the market, so we focus only on small and emerging companies. We're style agnostic, so we can own growth and value companies to construct portfolios, which we believe will outperform.
The Emerging Companies Fund, [which is the subject of this interview], offers investors exposure to a diversified portfolio of Australian-listed emerging companies that reside outside the S&P/ASX 200 Index (ASX: XJO). We can also invest directly into the New Zealand Exchange.
The fund is benchmarked against the ASX Small Ordinaries Accumulation Index, and is about 4 years old. What we do is combine fundamental bottom-up research in companies with an in-depth qualitative assessment of their management and also the industry structure that they belong to.
MF: To give our readers an idea, what are your two biggest holdings?
NG: So the two biggest holdings in the Emerging Companies Fund are Mainfreight Limited (NZE: MFT) and Aussie Broadband Ltd (ASX: ABB).
Mainfreight is a global freight business based in New Zealand. Aussie Broadband is an Australian-listed company that IPOed at the back end of last year, and is obviously in the telco space and the consumer broadband space — as well as more recently, the enterprise broadband space.
It's a very simple story in that they are providing a very genuine alternative to the major telco providers. So much so that you are seeing this particular business take a significant proportion of new subscribers to NBN, or churn subscribers versus their market share. I think the most recent stat, they took close to 9% of new subscribers to NBN, [although] their market share was closer to 3%.
So they're really winning share from the majors by having a really solid customer service offering, as well as a quality of service that is superior to a number of the other resellers and other telcos out there. You've got consistency of broadband through the day and the night.
At the same time, it's founder-led, built from the ground up, is Australian-owned and the management is very well aligned with the strategy. In addition to that, we can see a path to improved earnings over time, as they're spending a significant amount of capital on their network to improve the gross margin.
The costs that they have to pay to provide these services over time, rather than paying those [to another company], they'll have their own network. [This] will ensure that there is… a gross margin uplift over time, which will ultimately drive earnings. At the same time, they're seeing very solid subscriber growth, and that's largely because of their no-nonsense approach to broadband and their very successful marketing campaigns.
MF: It's not an easy field to be in though, because they're competing against bigger companies with very, very deep pockets?
NG: That's correct. But I think they have been clever around how they've targeted customers through very much a non-conforming way of advertising — a lot of direct mail… People are also looking for alternatives when they're not happy with their NBN service providers.
I think it's fair to say that a number of the majors have struggled with providing appropriate customer service and resolving consumer issues. As a result of public ratings et cetera for particular products… there's a really good groundswell and positive attitude towards this brand.
MF: Did you buy in during the IPO or after it floated?
NG: We did both. We participated in the IPO and we also bought on market in the days post-IPO to build on that position.
Buying and selling
MF: What do you look at closely when considering buying a stock?
NG: We've got a proprietary investment process. It's known as SCOPE — stands for Small Company Optimal Portfolio Evaluation. It's a process we've had in place for about 18 years, since the history of the business.
What it does, in a nutshell, it's a relative stock-scoring tool that ranks stocks from highest to lowest based on the score. We consider a number of factors — probably most of interest to your readers is management track record and alignment of key staff.
Has the management suggested that they were going to take a particular path for the company and delivered on it? Are they invested alongside external investors, so they own shares in the company? Do they have equity-incentive plans? Not just the CEO and CFO — are the key people within the business aligned?
The second thing we focus on is capital management and how well this particular management team would deploy capital. Are the investors getting an appropriate return on equity? [Is] management getting an appropriate return on capital for what they're deploying?
The third factor we look at is the strategic plan. Is the company just plodding along without a whole lot of great ambition? Generating plenty of cash, but doesn't have a great plan to actually grow or optimise the business over time? The outlook to the industries, I think, is really important. It's certainly a lot easier to invest in a stock with solid industry tailwinds than one that's fighting the tide [in] an industry going backwards.
Probably the most important factor, which I think is pretty overlooked by a number of investors, is liquidity. Especially at [the emerging] end of the market, a lot of these stocks can move on news flow or on not much, particularly if there's not a lot of stock supply. So we spend a fair amount of time understanding the liquidity parameters — so that we can be comfortable that when we're investing our investors' money into these stocks, that we're sure that we've got an appropriate liquidity hurdle… Should our investment thesis change, we can exit the stock, or we can add to the stock comfortably enough that we don't end up owning something above our risk controls.
MF: What triggers you to sell a share?
NG: Typically for us, a change in investment thesis [is] the key reason for selling a stock.
When we invest in a stock, it's very clear — we're backing a management team with a really strong strategic plan in an industry that we think has great prospects, and ultimately, we expect the earnings to grow, or there's a valuation differential that attracts us to the stock in the first place.
So [for example] if for some reason a key CEO departs, [or] you see a deviation from the strategic plan. A company's always said they're going to grow organically their revenue 10% per annum, and all of a sudden they look like they're going to grow 3%, but they do an acquisition to supplement the growth — is that because the organic story is petering out?
The third thing is, often stocks can go above their valuation bands, and as such in this end of the market, you can see stocks move very quickly through growth hurdles. And sometimes retail investors can not have the same-eyed evaluation that others do, and hysteria can creep in.
As such, you need to have a disciplined approach to harvest some of your winners rather than just holding on. Because even though the investment thesis hasn't changed, the valuation… looks incredibly stretched.
MF: Do you also have an investment horizon in mind when you enter a position?
NG: In the Emerging Companies Fund, we're always looking to invest beyond the 12-, 18-month period. Ideally, it's a 3-year period… If anything, COVID taught you a lot of things, that what was a defensive [stock] in one month was not a defensive the next, and what was a COVID beneficiary was all of a sudden the COVID loser.
Having the agility to be nimble and to question your investment thesis can shorten your investment horizon, but fundamentally, the stocks that we're backing and the management teams that we want to be on board with, we see these stocks likely to enter the ASX 100 in time.
Tomorrow in part 2 of our interview, Guidera tells us 2 ASX shares that are ripe for the picking now.
