Small Companies Fund - July Update
We're not predicting a recession, but we are prepared for one.
Is Australia's record of unbroken economic growth about to come to an abrupt end? That's the question on everyone's minds.
It's no secret that we could be on the cusp of a recession. Falling property prices have rocked the view that ‘property only ever goes up', which could eventually hurt consumer confidence and spending, and ultimately, economic growth and employment.
But we're not in the business of making predictions, and certainly not of the macroeconomic variety. Our job is to identify attractively priced businesses and assemble them into appropriately balanced portfolios that can ride through the bumps in the road. Instead of predicting economic collapse we merely try to limit the damage one might cause.
We normally use these updates to discuss some of the InvestSMART small company fund's investments, but this time we're taking a look at how we put the portfolio together.
Our stock selection has been guided by how a business makes its money. Our caution about the economic outlook has meant we've been very discerning about the businesses that are likely to be hardest hit by a downturn – think builders, mortgage brokers and retailers. We don't own any of these types of businesses in the fund, as we've not found their prices to be low enough to compensate for the risks.
We do own some businesses that service discretionary expenditure – notably the two IVF providers, Virtus (ASX:VRT) and Monash IVF (ASX:MVF) – as we think we're being appropriately paid to take on the risk. But this is only a smaller part of the portfolio.
We've been focusing our attention on companies with good prospects of surviving a recession with their earnings power intact, and we've found more than a few.
In fact, around half the revenue generated by the fund's investee companies comes from outside of Australia, which goes some way to mitigating Australian-centric risks (not to forget the possibility of a currency boost). Companies in this bracket include Adacel (ASX:ADA), Hansen (ASX:HSN) and RPMGlobal (ASX:RUL), which also have the added benefit of providing services that are somewhat insulated from the economic cycle.
Expecting to be completely insulated is likely to be wishful thinking though, at least in the short term. Even if the earnings of our investee companies hold up, the multiples investors ascribe to them is likely to be hit. But this is where our cash balance comes in and, with almost 20% of the portfolio in cash, we've got plenty of firepower should better opportunities arise.
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