Benefits of investing in the Smallco Investment Fund

The main benefit the Manager aims to achieve is high compound returns by investing in the securities market, although returns are not guaranteed.

It is the aim of the Manager that high compound returns will come mostly from capital appreciation which will be reflected in the unit price, but net realised profits, if they occur, will be distributed annually shortly after 30 June of each year. These distributions may carry imputation tax credits. The Fund is generally not taxed itself, but investors will usually be taxed on the realised gains they make from the Fund. See section 18 Tax' for more details. It is important that investors seek their own professional advice, including advice regarding tax.

Under normal circumstances you can redeem all or part of your investment daily subject to a minimum withdrawal amount of $5,000 and a minimum holding balance of $40,000. Further details are included in section 14 of the PDS Withdrawals daily'.

Investor suitability

Smallco expects that a typical investor in the Fund would be seeking some income but mostly capital growth and understands and accepts that the value of their investment can rise and fall. The Fund is not a short-term investment and Smallco suggests that investors adopt a minimum three year time horizon for investment in this Fund.

About the Fund

SIF is a concentrated, Australian equity smaller company focused fund that invests predominantly long but can effectively short when suitable opportunities are found.

Investment Objective

Smallco aims to provide good performance in SIF through actively looking for high quality, smaller companies whose share price is significantly less than what Smallco considers to be the true underlying value of the shares.

Investment style

Smallco has historically limited the number of investors in the Fund when necessary to protect capacity and limit liquidity issues. It will continue to manage capacity and limit inflows using its power under the Fund's constitution to reject applications at its discretion.

Smallco will limit inflows at a FUM level it considers will keep SIF nimble by reducing the risk of liquidity issues and reducing the time needed to establish or exit a given stock position.

Smallco actively looks for high quality, smaller companies with share prices significantly below what it considers to be the true underlying value of the shares. The Manager selects individual securities with an emphasis on achieving growth in the value of the Fund whilst also aiming to achieve some income.

Some characteristics of quality, smaller companies that Smallco seeks to identify include:

• Strong competitive position. The company should have a business that has a strong or dominant market position in its particular industry or sector. Barriers to entry for new competitors, for example, could create such a market position.

• Attractive and predictable earnings outlook. It is essential for the longer term success of an investment that the company has the ability to grow its profits significantly over an extended period of time. Implicit in this is the ability to at least maintain its profit margins, which usually relates to good pricing power for the products or services it offers.

• High return on funds employed and cash generation ability. For a company to be an attractive investment, its business should be capable of generating good returns on the cash invested in the business. Typically this will show up as a high historical return on funds employed and strong cash generation.

• A strong board and good management team. Not only is it important that the management is competent, but also that the management's interests are aligned with the interests of the shareholders. The most common way for this to occur is for the management to have shares in the company so they think more like shareholders.

Shares are valued using a combination of measures including price to cash flow, price earnings, dividend yield and EBITDA ratios. These assist the Manager to determine whether the share is trading significantly below its intrinsic value and may be worth investing in.

Where the Manager thinks it appropriate, it will meet with management and competitors of a company to assist in the evaluation process.

How we invest your money

Smallco manages SIF with a "Growth at a Reasonable Price bias employing a bottom up approach with a strong focus on earnings direction and risks.

We are strong believers that earnings are the key driver of share prices and that more accurate forecasting of earnings will drive greater and more consistent outperformance.

Focus is placed on identifying stocks through fundamental analysis which are likely to exceed consensus earnings expectations or stocks which are out of favour and we are confident will at least meet earnings expectations. 

Smallco actively looks for high quality companies whose current share price is significantly less than what it considers to be the true underlying value of the shares.

In selecting shares to invest in, the Manager typically focuses on a three year horizon, after which time it believes earnings forecasts become of considerably less value.

Smallco's philosophy is that it is better to have a small number of good investments rather than a large number of mediocre investments. Accordingly, the Fund will usually be relatively concentrated - generally invested in between 25 and 35 securities.

To make sure the Fund is not too concentrated, the Fund maintains holdings across at least 4 of the ASX's 10 Global Industry Classification Standard (GICS). Additionally the Fund's exposure to any one security is limited to 20% of the total assets of the Fund. If a security were suddenly to increase in value and breach this limit (as a result of a takeover bid for example) the Manager would reduce the Fund's holding in a timely manner which also recognises the financial interests of the Fund.

Investments can (and do) fall in value as well as rise. Generally speaking, the value which the market attributes to an investment will be a function of (amongst other things) the growth in the underlying earnings of that company. However, the Manager believes that, in the short term, market values are often more representative of investor sentiment towards a company, rather than the true underlying value of the company's business.

Investment Universe

Smallco invests mostly in smaller Australian listed companies, but may invest up to 20% of the Fund in larger Australian listed companies and may also hold some cash. The Manager classifies a smaller company as one outside the top 100 ASX listed companies by market capitalisation at the time the Fund makes its initial investment. Smallco focuses particularly on companies with $100 million to $500 million market capitalisation.

The Fund's securities lending arrangement as described in Section 6 may be classified as a derivative transaction. Accordingly, the Fund may invest in derivatives when it borrows shares as part of its investment strategy. These types of derivatives are known as "over-the-counter" or OTC derivatives being derivatives not listed on any financial market. The Fund's constitution permits it to invest this way.