Over the last two years, we’ve had slowing economic growth and small caps have underperformed large caps significantly, and that’s exactly what we’ve seen through history, but also through history, when economic growth slowdown bottoms and then starts to recover, small caps, and particularly active small caps, outperform significantly. When we look at the market today, valuations are cheap despite a very healthy earnings outlook on a three-year view. Small cap earnings are expected to grow 13% per annum over the next three years, relative to less than 2% per annum for the large caps, and then there’s additional tailwinds now emerging, which get us even more excited. For instance, institutional investors are showing clear intent and are starting to allocate to small caps. We think it’s rare you get all the ducks in a row like this, and we think it’s a great opportunity to invest in small caps.
There are three key features of the Firetrail Australian Small Companies Fund I’d like to draw your attention to. Firstly, we’re unconstrained by style. We can invest in both value and growth companies, and that allows us to outperform throughout market cycles. The second way in which we believe we have an edge is our industry expertise. We have mining engineers, actuary, technology experts, and that allows us to invest with conviction in all parts of the market. Finally, it’s a concentrated portfolio. We have 30 to 40 holdings in the fund at any one time, and that has allowed us to deliver 12% outperformance since inception.
This stock is a top five holding in the fund, and that is Regis Healthcare. Now, Regis operates 63 aged care homes across Australia. They’re very high quality homes, which is important, as you’d know if you have a loved one living in aged care. We believe the public market is missing the compelling supply-demand backdrop in aged care. If we think about the population over the age of 80, it’s expected to double over the next 20 years. However, we’re just not seeing that supply in terms of new beds come onto the market. At the moment, we need another 100,000 beds to be built, we currently have 200,000 beds, and that’s going to cost about 50 billion. Clearly, the government needs to incentivise operators to start building beds.
Right now, the return on capital doesn’t make sense. You’re receiving 4% to build a new bed versus the cash rate at 5%. So we believe the solution for government is clear: they need to increase the profitability of the sector. They’ve already put through a 20% funding increase and they’ve recently appointed an aged care task force, which is going to hand down their proposals at the end of this year, and they’re focused on trying to figure out how to attract new greenfield capital into aged care. So we believe the funding backdrop is about to get even better in the sector. If we look at consensus earnings, that is not factored in. We see 30% upside in Regis just using the current funding regime. However, if we incorporate the expected funding uplift, we see 60% upside in Regis, which is why it’s a top five holding in the fund.
This article is prepared by Firetrail Investments Pty Limited (‘Firetrail’) (ABN 98 622 377 913, AFSL 516821) as the investment manager of the Firetrail Australian High Conviction Fund (ARSN 624 136 045), the Firetrail Absolute Return Fund (ARSN 624 135 879), the Firetrail Australian Small Companies Fund (ARSN 638 792 113) and the Firetrail S3 Global Opportunities Fund (ARSN 653 717 625) (‘the Funds’). Pinnacle Fund Services Limited (‘PFSL’) (ABN 29 082 494 362, AFSL 238371) is the product issuer of the Fund. PFSL is not licensed to provide financial product advice. PFSL is a wholly-owned subsidiary of the Pinnacle Investment Management Group Limited (‘Pinnacle’) (ABN 22 100 325 184). The Product Disclosure Statement (‘PDS’) and Target Market Determination (‘TMD’) of the relevant Fund are available via the links below. Any potential investor should consider the PDS and TMD before deciding whether to acquire, or continue to hold units in, the Fund.
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