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Fund in Focus: Global SmallCap

In this episode of Fund in Focus, investment advisor Nick Peters is joined by Toby Bucks, fund manager of the Marlborough Global SmallCap Fund.


*Risk adjusted return - a calculation of the profit or potential profit from an investment that considers the degree of risk that must be accepted to achieve it.

Fund in Focus - Global SmallCap

[00:00:00] Nick Peters: Hi, my name's Nick Peters,investment advisor at Marlborough Group, and this week's podcast is with Toby Bucks, fund manager at Ausbil, and he manages the Marlborough Global SmallCap Fund. Hi, Toby.

[00:00:22] Toby Bucks: Hi, Nick.

[00:00:23] Nick Peters: Okay, so there will be some who are not familiar with Ausbil, so could you give us some background on yourself and the group, please?

[00:00:31] Toby Bucks: Ausbil has always been focused on active equity management since we were founded in 1997 here in Sydney,Australia. We've got over 15 billion Australian dollars in FUM and we've got a very strong long term track record and a clear investment philosophy. We incorporate ESG and we've got a top down, bottom up process.

[00:00:54] Nick Peters: Perhaps just talk a bit more about the small cap team and your approach to picking stocks in the small cap world ?

[00:01:01] Toby Bucks: So Simon and myself have been investing in global small caps together since 2007. We started working together at Bearings in London and here at Ausbil. We've got Joseph working with us on the team, he's been with the team a number of years.

[00:01:15] Toby Bucks: And we're part of a much wider group of investment professionals that help with the top down situation andalso a very strong ESG team which is incorporated into our bottom-up investments.

[00:01:27] Toby Bucks: We love Global Small Caps, Simon and I have always been fascinated by the asset class and we've been running money together since 2007.

[00:01:36] Toby Bucks: Global Small Caps is a great asset class, produces one of the best risk adjusted returns in equities and a much better risk adjusted return than Global Large Cap.

[00:01:45] Toby Bucks: And our approach is really to find those best management teams out there that run the best niche businesses or services where they can expand geographically and further integrate vertically and into associate verticals and newer products that can help them grow earnings and grow earnings much more than the market currently expects. And we get a number of those opportunities in small caps.

[00:02:13] Nick Peters: Okay, thank you, and the team recently wrote a really interesting piece on shifts like onshoring, AI and decarbonisation, and how they could benefit smaller companies.

[00:02:24] Nick Peters: Can you just give us a bit more colour, please?

[00:02:27] Toby Bucks: So, Simon and I always believe that there's a bull market somewhere in global small caps, and that's what makes it such a great asset class. We've got a few sort of ESG led themes that are dominating investments globally over the next few years, and we've got these great demand cycles of increased demand for the changes that society wants and is going to make.

[00:02:49] Toby Bucks: And these are causing bottlenecks in key industries and services, and these companies are really benefiting from these trends. And there's some excellent opportunities out there in terms of businesses with great earnings growth coming through and attractive valuations.

[00:03:04] Toby Bucks: I mean, onshoring is a major themeand in some sense can be seen very clearly to be led by ESG concerns.

[00:03:12] Toby Bucks: We've got concerns for the assuredness of supply after going through COVID and all the complications in supply chains, but also we've got a changing geopolitical landscape and that's got subsequent technology complications and that's meaning that a lot of supply chains all the way up are being relocated more and more towards North America and Europe.

[00:03:34] Toby Bucks: And in addition, away from the 'S'side of things, on the 'E' side of things, what we're seeing is a big movetowards decarbonisation, and that's been in place for a while.

[00:03:44] Toby Bucks: The world wants to improve theoutlook for the world's climate. And we're seeing a new era of investments, andI think one of the biggest ones to get to, to deliver on our goals for decarbonisation, which is, you know, more renewables in the grid, a change ingrid structure, and also different fuels for our industries to use andmobilities to use.

[00:04:05] Toby Bucks: That's going to require huge amounts of investment in the grid. It's not just transforming the electricity grid in the Western world at the major level and at the minor level, it's alsoan expansion.

[00:04:16] Toby Bucks: We're going to need to see a lot more of these types of products get installed and managed. So we see a hugeopportunity there in decarbonisation.

[00:04:25] Toby Bucks: And then one area that's been growing a lot over many years is renewables, but sort of overtaking that nowis, if you look forward, is the power demand from data centers.

[00:04:34] Toby Bucks: So data centers are quite complex,they do require a lot of different products in terms of the construction, andthen in running them in terms of thermal and power solutions.

[00:04:43] Toby Bucks: So we're really excited about the explosive growth in demand for data centers in the near to mid term. We're invested in companies that benefit directly from these themes.

[00:04:53] Toby Bucks: So the great outlooks for these demand cycles They're not going to change depending on who wins what election and we've got some key exposure here trading at really attractive valuations

[00:05:05] Nick Peters: Thank you. We were talking about it earlier and I think you mentioned that something like over 50 percent of thefund is currently exposed to these areas. So really backing your view that how strong these shifts are.

[00:05:18] Nick Peters: There's a general perception that small companies look very good value on a relative basis. Do you agree with that?

[00:05:24] Toby Bucks: Yeah, they are very attractive on a relative basis to large caps at the moment. I think last time small caps were this cheap relative to large caps was in 2003 and we saw small caps go on a robust period of sort of 10 years of outperformance. I think there's a backdrophere that can explain it in a bit of detail, hopefully a bit more color, is that if you go back to sort of the 1950s and 1920s, in the long term data, yousee small caps outperform large caps most of the time.

[00:05:53] Toby Bucks: A period where small caps have struggled against large caps has been the sort of last 20 years, ever since we've had a lower bound on interest rates and low interest rates. In an environment where we've got real nominal interest rates, which is what we return to with sort of 5 percent in the US. In an environment where we've got positive nominal interest rates, yet at the same time the outlook for growth's reasonably robust, that is a backdrop where small caps should do well. Particularly if we see rate cuts come through into the picture in terms of benevolent or positive rate cuts.

[00:06:26] Toby Bucks: So in terms of the backdrop, I think there's some explanation there why small caps are at cheap levels. We've seen 20 year period which, which isn't the best environment for smalls versus large, but we are now moving into environment here which should benefit small caps over large caps and given the valuation disparity does look attractive to me.

[00:06:45] Nick Peters: You mentioned earlier that strong management is very important part of your process and stock selection. What are you hearing from companies at the moment?

[00:06:55] Toby Bucks: Really interesting in the lastresults season that we've had the difference from what different management teams are saying. I think if we concentrate on the US and look at what we're seeing over there, we are seeing parts of the consumer start to weaken, particularly towards the lower income brackets where we're seeing the consumer struggle.

[00:07:13] Toby Bucks: The high end income brackets, the consumer is still very strong. In terms of on shoring, we're seeing continued demand growth in expectations from the US manufacturing complex. And in terms of the grid, I think the grid's probably the area of the biggest surprise. Our companies that we invest in had a good seller results with strong outlooks and increased order book growth.

[00:07:36] Toby Bucks: We're seeing order books for key areas of the grid and data centers up 40 to 50 percent year on year. A large cap company to mention that people may be more familiar with would be General Electric, Nick, rather than to talk about some maybe less known smaller companies.

[00:07:54] Toby Bucks: General Electric saw a 50 percent year on year growth in their order book for their GRIG segment and we're seeing similar levels in the companies we invest in, but it's pure exposure to this investment cycle.

[00:08:09] Toby Bucks: On the other side of Industrials which obviously affected GE in a bad way and lots of other companies, we did see automation investments Both in Europe and the US disappoint and we're also seeing expectations for autos and auto components drift lower.

[00:08:25] Toby Bucks: So we are seeing some bifurcation in the market, higher interest rate environment is starting to bite on areas of the economy, we're seeing managements talk about this, particularly in areas of consumer or in areas that require finance.

[00:08:39] Toby Bucks: But then on the other side, we're seeing positive surprise and upgraded earnings estimates for businesses that are exposed to the change and the expansion of the electrical grid and businesses that are exposed to on shoring in the US.

[00:08:52] Toby Bucks: And we expect that bifurcation to continue because we're seeing fiscal stimulus be very strong and at the sametime we're seeing real yields tick up towards two and a half percent. So it makes sense for us that that continues.

[00:09:05] Nick Peters: Okay, thank you. Perhaps to bring the process to life, can you talk about the last purchase you made in the portfolio?

[00:09:11] Toby Bucks: Yeah, so the last stock we bought was Hammond Power Solutions. It's a stock that came to the top of our screen,which we used for our idea generation process. And when we started to look at the business, we saw a very strong management team that were niche leaders in making dry type transformers, which a necessary key part of the grid build out and also for supplying power into data centers.

[00:09:33] Toby Bucks: So we saw a lot of demand growth when we looked at the business. We saw that they were increasing their manufacturing facilities at a substantial rate in order to increase their capacity to serve a market that was expanding strongly.

[00:09:45] Toby Bucks: As we looked at the peer group, we could see they were a key player in that space and also Hammond power solutions is set to benefit at a very attractive valuation of only 13 times earnings.

[00:09:57] Toby Bucks: It's a small stock so it's come in at a small position But we're excited about the demand growth over the next five to ten years Which is driven by data centers and the expansion of thegrid.

[00:10:07] Nick Peters: Okay. Thank you. You've sort of touched on it Before but perhaps take us through the team's outlook and how you've positioned the fund?

[00:10:15] Toby Bucks: So we're relatively positive on the market Obviously higher interest rates will start to bite but we do believe that the economy in the US can continue to expand trend or slightly below trend growth with real interest rates at two to two and a half percent, buoyed by a considerable stack of savings.

[00:10:37] Toby Bucks: So we've we've gone down from sort of three and a half trillion dollars down to two and a half trillion dollars of savings, but still a big savings base and then we're seeing onshore decarbonisation and growth of other key areas really support a very buoyant job market in the US So we think that a lot of people are probably too negative on the US economy for next year and also with the opportunity of positive or benevolent rate cuts to keep a real yield down at 2 percent as we see a sticky inflation soften over the next 12 months.

[00:11:08] Toby Bucks: We think that's a robust environment for small caps the funds positioned for that, we're expecting continued positive earnings surprise out of our investments across the boardsome of the key areas that we're positioned for would be The expansion of thegrid in the US and in Europe and the investments that need to be made for onshoring and decarbonisation and data centers.

[00:11:32] Toby Bucks: So the funds Very overweight industrials with sort of 20 percent overweight industrials at just over 40 percent of the fund and the funds heavily invested in IT. and businesses that are set to benefit as well.

[00:11:45] Toby Bucks: So, that's how we're positioned. Ithink people are too negative on the US economy, particularly that area of onshoring and data centers that continues to beat expectations.

[00:11:57] Toby Bucks: On the other side of the world, Ithink China, while stimulus is coming through, still remains quite a difficult area to see valuation uplift from and as such, the funds heavily weighted towards the US and Europe, and we're underweight Japan at the moment. I think that's sort of a nice summary of it, Nick.

[00:12:16] Nick Peters: Thank you very much Toby, for joining us.

[00:12:19] Toby Bucks: Thanks, Nick, it was great talking.

[00:12:20] Nick Peters: So that was Toby Bucks, Fund Manager for Marlborough's Global Small Cap Fund.

[00:12:25] Nick Peters: If you'd like to find out more about the fund, then please go onto our website Thankyou.