AN ALTERNATIVE WAY TO GAIN EXPOSURE TO AUSTRALIAN EMERGING COMPANIES SEBASTIAN EVANS CHIEF INVESTMENT OFFICER NAOS ASSET MANAGEMENT

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1 AN ALTERNATIVE WAY TO GAIN EXPOSURE TO AUSTRALIAN EMERGING COMPANIES SEBASTIAN EVANS CHIEF INVESTMENT OFFICER NAOS ASSET MANAGEMENT

2 About NAOS Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 2

3 ABOUT NAOS NAOS was founded in Seek to provide investors with niche product offerings, in asset classes and sub sectors where they often lack the time, resources or expertise to research and invest themselves. NAOS manage two Listed Investment Companies (LICs) NAOS Emerging Opportunities Company ASX:NCC 6.40% Fully Franked Yield 54.23% (Nom) Since Inception Return (31 st May 2015) NAOS Absolute Opportunities Company ASX:NAC 4.40% Yield > 50% Fully Franked 10.92% (Nom) Since Inception Return (31 st May 2015) Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 3

4 The Challenges Facing Investors Today Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 4

5 THE CHALLENGES OF THE INVESTMENT LANDSCAPE Secular Booms in Mining & Residential sectors Where to from here; Infrastructure, Manufacturing, Retailing, Tourism? Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 5

6 THE CHALLENGES OF THE INVESTMENT LANDSCAPE Source of Earnings Growth Earnings growth has been subdued Primary source of earnings growth has come, in the large part, from cost cutting in areas such as: a. Debt financing b. Wage deflation c. Deferral of capital expenditure Importantly: earnings growth has not been derived from growth in revenue. Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 6

7 THE CHALLENGES OF THE INVESTMENT LANDSCAPE Valuations Focus on: Enterprise Value /Earnings Before Interest & Tax Enterprise Value = market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents. EBIT = An indicator of a company's profitability, calculated as revenue minus expenses, excluding tax and interest. Importantly: Do not use EBITDA or NPAT, as Depreciation and Amortisation as well as tax rates can have significant influence on valuations Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 7

8 A NOTE ON DIVIDEND ETF S Dividend focused ETF growth in outstanding shares Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 8

9 LARGEST ASX SHAREHOLDINGS (% OF COMPANY FREE FLOAT) HELD BY PASSIVE DIVIDEND ETFS; SPLIT BY SHAREHOLDING OF EACH ETF (AS OF MARCH 30, 2015) Source: Bloomberg, ishares, Vanguard, Russell, BetaShares, S&P, Factset, Goldman Sachs Metcash: Recently announced it would not pay a dividend for 18 months. Share price fell by ~18% as a result. Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 9

10 Overcoming the Challenges: Why Emerging Companies Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 10

11 EMERGING COMPANIES; A DEFINITION What is an Emerging Company? 2 primary definitions: 1. Company which is rising from an obscure or inferior position or condition Growing market share and industry dominance through growth in product/service Characterised by business owners/management with significant alignment of interests to that of investors 2. Company which is rising from or coming out into view of Emerging Company may also be one which has fallen on hard times and is seeking to rise from levels of distress via turnaround and/or restructure. Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 11

12 WHY ARE THERE OPPORTUNITIES WITHIN THE EMERGING COMPANY SPACE Opportunities exist primarily due to size & certain operational characteristics Size: has a direct impact on: a. Research coverage by brokers b. Interest from institutions c. Liquidity d. Investment horizon/type of investor Operational characteristics, such as a niche industry focus, can lead to: a. Dominance of market share b. Pricing power c. String brand recognition and good will d. Exclusive contracts, patents and/or licences e. Opportunities for growth from vertical integration Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 12

13 CASE STUDY: BOUTIQUE VERSUS INSTITUTIONAL FUND MANAGER Boutique Fund Manager has AUM $200m to invest. Investment limits are: 1. No more than 10% of portfolio can be invested in any 1 stock 2. Portfolio cannot own >20% of a company s issued capital Manager would like to invest in a small company with market cap of $100m. Within the constraints of his investment mandate he invests $20m of his fund - (10% of his portfolio). 1 year later AUM= $2bn. Manager s $20m investment makes up only 1% of his fund. Even if the returns are phenomenal, the impact is tiny. Fund manager, with scale, is resigned to looking for larger opportunities. Outcome: Fund manager, with scale, is resigned to looking for larger opportunities. Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 13

14 THE BENEFITS OF INVESTING IN EMERGING COMPANIES Potential for Market Dominance/Share Typically operate within industries that many ASX-100 companies either do not operate in or have little focus on. Allows many emerging companies to become dominant players within the core focus industry in which they operate. > 80% of Australia s Honey Sales are of Capilano Honey Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 14

15 THE BENEFITS OF INVESTING IN EMERGING COMPANIES Relatively higher margin and more consistent earnings profile A consistent earnings profile allows companies to maintain excellent dividend levels and enables companies to increase earnings profiles in certain years whilst growing the business organically or via acquisition. TWD have increased or maintained their Dividend Per Share for each of its 15 years as a listed entity (2015 final to be declared) Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 15

16 THE BENEFITS OF INVESTING IN EMERGING COMPANIES Lower corporate cost structures relative to larger counterparts: Generally operate with smaller overheads and business capital expenditure Strong alignment of interests with shareholders: Generally not incentivised by salaries and bonus structures. Leads to long term view of building business growth and success. Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 16

17 THE BENEFITS OF INVESTING IN EMERGING COMPANIES Strong alignment of interests with shareholders: Generally not incentivised by salaries and bonus structures. Leads to long term view of building business growth and success. Example: NAOS Holdings, % Owned by Operator (market cap) Investment A: >25% ($16m) Investment B: >15% ($125m) Investment C:~3% ($70m) Investment D: >40% ($250m) Investment E: >30% ($40m) Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 17

18 An Alternative Way of Gaining Meaningful Exposure Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 18

19 OPTIMISING YOUR INVESTMENT IN EMERGING COMPANIES We believe the primary focus of any investment should be capital preservation and potential to generate meaningful returns for the cost and risk undertaken. We believe the optimal portfolio structure to achieve this focus is one which embodies: 1. Absolute Return Focus 2. Long term valuation bias 3. Focus on Quality 4. Concentration of Best Ideas 5. Ability to Long/Short Securities Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 19

20 A FOCUS ON ABSOLUTE RETURNS Absolute return is the amount an asset appreciates or depreciates over time on an absolute basis. By focusing on absolute returns an investor is able to discount the market and focus purely on what return they are able to achieve for the sum invested and risk associated the investment opportunity. Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 20

21 IS LIQUIDITY SOMETHING TO WORRY ABOUT? Liquidity is often used as a screening mechanism Generally those stocks that are less liquid are discounted by the market Can represent quality, long term investments.for the patient investor A focus on quality and having a long term view can lead to attractive investment opportunities As the value of the Company increases so does the liquidity of its shares; illiquidity may not be forever! Warren Buffett: "I buy on the assumption that they could close the market the next day and not open it for five years." Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 21

22 CASE STUDY IN LIQUIDITY: CAPITOL HEALTH LIMITED (ASX:CAJ) Capitol Health Limited (ASX: CAJ) is an Australian public company providing medical diagnostic imaging services. It is the only ASX-listed company operating exclusively in diagnostic imaging. Since commencing operations in 2006, Capitol Health has grown to become Victoria s largest provider of diagnostic imaging services by clinical facilities in a community setting. Liquidity profile- $m value of daily traded shares ( ) Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 22

23 ADOPTING A CONCENTRATED APPROACH As the number of stocks in a portfolio increase, the managers ability to cover each stock diminishes and the competitive advantage can be lost Around 90% of the maximum benefit of diversification was derived from portfolios consisting of between 12 to 18 equally weighted stocks. Source: CFA Institute Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 23

24 ADOPTING A CONCENTRATED APPROACH Contrary to popular belief The key to successful investing is not necessarily picking the best performers but avoiding the poorest performers over a given timeframe and mitigating the risk of permanent capital loss. 1 Yr. Return Series ASX 200 (as at 30 th June 2015) Average Total Return +4.49% Median Total Return +3.52% Top Quartile Return Bottom Quartile % Average Return Excluding Bottom Quartile % Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 24

25 INCORPORATING THE ABILITY TO LONG/SHORT 1. Truly express both their positive and negative views 2. Capitalise on any market opportunity to improve performance and consistency 3. Profit from falling prices in order to defend investment portfolios in times of crisis. 4. Increase the number of investment opportunities in the covered universe Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 25

26 Summary & Questions Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 26

27 KEY POINTS Investors are facing significant investment headwinds; Dilemmas and Decisions.. HOWEVER, there are still opportunities out there; particularly in the Emerging Companies space! To make the most of the opportunities, Investors should focus on 1. Delivery of positive absolute returns 2. Value and Quality of investment 3. Adopting a long/short approach 4. Best ideas; remove distraction Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 27

28 Contact & Further Information Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 28

29 FURTHER INFORMATION/CONTACT Sebastian Evans Chief Investment Officer T: E: Ben Rundle Portfolio Manager T: E: Jeff Kim Portfolio Manager T: E: Rob Miller Portfolio Manager T: E: Anneke Senden Business Development T: E: More information about NAOS strategies, product offerings and News and Views can be found on our website: or contact one of the team, we would be more than pleased to assist! Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 29

30 Disclaimer This presentation has been prepared by NAOS Asset Management Limited (ACN ). The information in this presentation is only intended for Australian residents. The purpose of this presentation is to provide information only and the contents of the presentation doesn t purport to provide investment advice. We strongly suggest that investors consult a financial adviser prior to making any investment decision The presentation does not take into account the investment objectives, financial situation or particular needs of any person and should not be used as the basis for making investment, financial or other decisions. The information is selective and may not be complete or accurate for your particular purposes and should not be construed as a recommendation to invest in any particular investment or security, or Fund/Company offered by NAOS Asset Management, NAOS Emerging Opportunities Company Ltd or NAOS Absolute Opportunities Company Ltd. The information provided in the presentation is given in good faith and is believed to be accurate at the time of compilation. Neither NAOS Asset Management, NAOS Emerging Opportunities Company Ltd or NAOS Absolute Opportunities Company Ltd, nor its directors or employees make any representation or warranty as to the accuracy, reliability, timeliness or completeness of the information. To the extent permissible by law, NAOS Asset Management, NAOS Emerging Opportunities Company Ltd or NAOS Absolute Opportunities Company Ltd and its director and employees disclaim all liability (whether arising in contract, tort, negligence or otherwise) for any error, omission, loss or damage (whether direct, indirect, consequential or otherwise). Performance figures quoted in the report are past performance. Past performance is not an indicator of future performance. NAOS Asset Management, NAOS Emerging Opportunities Company Ltd or NAOS Absolute Opportunities Company Ltd or its directors or employees guarantee or make any representation as to the performance of the Funds, the maintenance or repayment of capital, the price at which shares may trade or any particular rate of return. Conviction Absolute Long Short Investing Copyright 2015 NAOS Asset Management Limited 30