Small Caps in focus with Melinda White

Portfolio Manager Melinda White discusses Small Caps portfolio construction – and two things Longwave does differently to deliver alpha and a lower fixed fee for clients.


Melinda White:

So we think that people should always think about having small caps in their portfolio because, when you look at the long-term returns from the Australian index and then from small caps in particular, they’ve produced really strong returns relative to both the MSCI World and the MSCI Emerging Market Index over a 33-year period.

So when we look at the long-term returns that the Australian market has produced, and then also the long-term returns that the small-cap index has produced, what we can see is that the Australian market has outperformed over 33 years, both the MSCI World Index and also the MSCI Emerging Market Index. Aussie shares have returned over 9.5% per annum in that period of time. But within that, active small-cap managers in Australia have returned 12.4% per annum over 33 years. It’s a really great return profile.

What we are looking at right now in the small cap part of the market, but overall, in markets, is we’ve seen a very large drawdown. It’s very similar to both the GFC and the tech wreck. Dave and I were both working in markets in those two time periods, and the small cap index is a lot further through this drawdown relative to large caps than most people think. So in the tech wreck, that drawdown went for 18 months. In the GFC, the relative underperformance lasted for 15 months. And we’re now 23 months through that relative underperformance of small cap versus large caps. We’re also seeing a lot of preconditions for a market bottoming. Liquidity is really drawn out of the market in small caps, and we’re seeing a lot of really high-quality companies that we hold in our portfolio on sale.

At Longwave, we do a couple of things really differently from the average small cap manager in order to produce a more consistent alpha at lower fees for our clients. So the two things that we do differently is that we systematise some of our fundamental stock-picking and portfolio construction decision-making. We do that because we know from 50 years of academic research that there are a myriad of human biases and blind spots in expert decision-making and judgment that can creep into investment processes. We want to protect ourselves and our investors from the worst of those biases and blind spots and the outcomes that that can produce. So that’s the reason for systematising some of that fundamental decision-making.

The other thing that we do differently is that we hold a much more diversified portfolio of stocks. So today, we’re holding 115 stocks in our portfolio. Now, a lot of people think that the only way to outperform the index in small caps is to hold a very concentrated portfolio of stocks, but we can see that that delivers a very wild ride of alpha generation for the client base, and it can be very painful. So by holding this more diversified portfolio of stocks, we help protect against some of that wild ride, and we produce a much more consistent alpha. It also allows us to offer a much lower fee to the market, and you can see on this slide here that we offer a fixed fee of 89 basis points with no performance fee, and it will ratchet down over time as the AUM goes up.

So referenced earlier, that we’re seeing a lot of really high-quality stocks on sale today. One of the ones that we hold in our portfolio is Nanosonics. I’m not sure how familiar you are with the Nanosonics business. It’s a global medical device business. It has a medical device called the trophon, which they sell into hospitals and ultrasound clinics, that helps clinicians disinfect ultrasound probes between patient treatments.

Now, I won’t go into the details of why you might want your ultrasound device disinfected, but it’s really important, and it does help to protect patients from cross-treatment contamination. So that trophon device, they’ve been selling it into global markets for over a decade, and they’ve produced a 27% compound annual revenue growth over that period, and it’s a classic razor and razor blade business model. So they sell the trophon device into a clinic, and then every year they’re selling consumables into that trophon device, which produces quite a smooth revenue growth profile.

So the Nanosonics business is only 25% penetrated in their global markets, which means they have a really long runway for continued growth in that business, and it used to trade on an EV to sales multiple of 10 to 15 times for a very long period of time, but more recently that EV to sales multiple has collapsed to five times. So relative to its history, it’s representing really great value.

The other aspect of the Nanosonics business, which is really interesting, is, they’ve been taking all of the free cash flow generated from their underlying trophon business and they’ve been reinvesting it in order to extend their product portfolio. They’ve got this new product that they’ve just launched at the market called Coris, which is adjacent to the trophon device and for a different type of probe that’s used in clinical settings.

So just recently they’ve broken out the EBIT that they’re actually earning from the trophon business, and we can see that it’s trading on an EV to EBIT multiple of 16 times at the moment, which again represents really good value in comparison to Cochlear and ResMed, and we genuinely believe that it’s going to continue that long period of growth.


This communication is prepared by Longwave Capital Partners (‘Longwave’) (ABN 17 629 034 902), a corporate authorised representative (No. 1269404) of Pinnacle Investment Management Limited (‘Pinnacle’) (ABN 66 109 659 109, AFSL 322140) as the investment manager of Longwave Australian Small Companies Fund (ARSN 630 979 449) (‘the Fund’). 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 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.

Link to the Product Disclosure Statement: WHT9368AU

Link to the Target Market Determination: WHT9368AU

For historic TMD’s please contact Pinnacle client service Phone 1300 010 311 or Email

This communication is for general information only. It is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. It has been prepared without taking account of any person’s objectives, financial situation or needs. Any persons relying on this information should obtain professional advice before doing so. Past performance is for illustrative purposes only and is not indicative of future performance.
Whilst Longwave, PFSL and Pinnacle believe the information contained in this communication is reliable, no warranty is given as to its accuracy, reliability or completeness and persons relying on this information do so at their own risk. Subject to any liability which cannot be excluded under the relevant laws, Longwave, PFSL and Pinnacle disclaim all liability to any person relying on the information contained in this communication in respect of any loss or damage (including consequential loss or damage), however caused, which may be suffered or arise directly or indirectly in respect of such information. This disclaimer extends to any entity that may distribute this communication.
Any opinions and forecasts reflect the judgment and assumptions of Longwave and its representatives on the basis of information available as at the date of publication and may later change without notice. Any projections contained in this presentation are estimates only and may not be realised in the future. Unauthorised use, copying, distribution, replication, posting, transmitting, publication, display, or reproduction in whole or in part of the information contained in this communication is prohibited without obtaining prior written permission from Longwave. Pinnacle and its associates may have interests in financial products and may receive fees from companies referred to during this communication.
This may contain the trade names or trademarks of various third parties, and if so, any such use is solely for illustrative purposes only. All product and company names are trademarks™ or registered® trademarks of their respective holders. Use of them does not imply any affiliation with, endorsement by, or association of any kind between them and Longwave.

Receive news and insights