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650] - Speaker 1
Good afternoon everyone and thank you all very much for taking the time to join us
today.

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My name is Tony Andronico I'm a.

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Distribution manager covering the intermediary market at Yarra Capital Management
and it's my pleasure.

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To welcome you to this update with Joel Fleming, Portfolio Manager for Microcap
Equities.

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Entitled Where to Next for Aussie Micro Caps.

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We are very pleased to have you with us today.

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Very shortly Joe will take you through an update which explores, amongst other
things, some of the key themes impacting the.

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Opportunity for microcap investors at this time. A quick couple of housekeeping
items before we get started.

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You are listening to this webinar using.

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Your computer speaker system by default and.

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All participants are in listen only mode.

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You will have the opportunity to submit.

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Questions by typing them into the questions pane of the control panel.

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At any time during the discussion, just.

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Look for the question mark symbol and.

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We will do our best to address them during the Q and A session.

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At the end of the presentation you.

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Will need to use your PC to type a question. And thank you to those of you.
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Who have already submitted a question and.

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As with all of our webinars, we will aim to wrap up in around 35 minutes time.

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And with that I'll pass you to John.

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Thank you for the introduction.

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Tony good afternoon and thank you for taking the time to listen to this webinar
today.

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I think it's an opportune time to be talking about the microcap space as.

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We approach 18 months of difficult trading.

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Conditions, which has seen microcap stocks generally.

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Sold off aggressively and liquidity exit this.

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Part of the market as investors seek.

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Perceived safer harbors to wait out the storm.

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Our belief is this the inefficiency that.

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Exists in this sector has been exacerbated and this is providing compelling
opportunities to buy unknown or misunderstood businesses.

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Our fund will be nine years old in August.

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We have navigated various positive and negative.

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Operating environments during this period.

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Today I would like to provide a.

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Quick recap on the microcap space and.

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How our fund operates, including performance and attribution data.
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A discussion on some key themes for.

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The current environment and why a combination.

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Of underperformance and lack of liquidity creates.

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An environment for significant medium term capital.

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Growth, implications of the current environment on.

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The portfolio and some case studies of.

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Portfolio positions will then open for some Q and A.

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So why microcaps?

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Firstly, we have a lot to choose from and unlike the market generally, it's getting
bigger.

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As businesses that once traded above our $250,000,000 threshold come back to our
investable.

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Universe, we can talk at length of.

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The concentration of the top 100 in microcaps. We can find niche exposures to
emerging.

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Themes where companies can build out leadership.

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Positions and deliver sustainable, high returning, growing.

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Profitable businesses from very humble beginnings.

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The AFR had a piece today on.

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The growth in the critical mineral space.

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Comprising a select group of companies in.

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The lithium, rare earth, graphite and nickel.
[00:03:11.000] - Speaker 8
Space, which has experienced market cap growth.

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From 8.67 billion a decade ago to 18.2 billion five years ago to $86.2 billion
today.

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This group of 33 companies market cap.

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Now exceeds the market cap of the S and P All Awards Gold index.

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Worth $86.1 billion at yesterday.

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This is a fascinating data point and underlies the benefit of a large and dynamic
investable universe, Australia is blessed with natural resources.

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However, the speed and agility of the junior mining sector has allowed many of.

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These businesses to discover, develop and move.

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To sustainable profits in a very short space of time.

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Nimble companies are another attractive feature of.

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Microcap investing and while inefficiency has always.

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Been a trait of the microcap space.

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This is exacerbated in times of stress and uncertainty.

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The unwind of exuberance and cheap money.

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Has seen this inefficiency increase with investors not prepared to look at anything
perceived.

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To be small or risky.

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Despite the underlying fundamentals of these businesses.

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Liquidity has moved out of the sector.

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And we believe many businesses are making.

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Huge steps in their development that is.

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Going unrecognized or trading at a risk return basis.

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That is compelling and it's a matter of when, not if.

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When investors return to these fundamentals.

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Microcaps have always offered outsized return potential.

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The current underperformance reinforces this and provides.

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Further confidence on the medium term upside.

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That exists, as we discussed earlier around critical minerals.

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This is the area where these emerging themes begin.

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Governments need to spend on infrastructure, companies.

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Need to hit decarbonization targets.

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AI is emerging business.

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Businesses have to become more efficient and the population continues to age. These
themes will support longer term demand and microcap companies offer both the
exposure to these thematics and the opportunity to build out leadership positions
in these areas. We would summarize by saying that the universe continues to offer
investors long term capital growth potential, and the current uncertainty is
providing an improved risk return trade off and underpinning our medium term
confidence. Moving on to performance. The following table highlights the UBS
Microcap Fund's net performance since inception. As a reminder, our benchmark is
the ASX small ordinaries. While the last 18 months have been difficult, we continue
to work hard to increase continue to protect the downside well in times of
uncertainty and also provide longer term capital growth, illustrated with a 12 %
per annum returns since inception. Our focus on the longer term opportunity,
balance sheet, cash flow, and risk management has been tested through various
market conditions and continues to deliver solid results. Times of uncertainty
create opportunity, and this reset in markets, we believe, will allow us to
construct portfolios that deliver strong earnings growth and improve valuation
multiples as the market moves into a period of stability.

[00:06:22.670] - Speaker 1
On the next slide, we've got our five year attribution. What's really interesting
this is the diverse range of businesses that has delivered our positive
performance. From Kodam producing metal detectors to supply network providing parts
to the truck and bus industries. Mainstream, a fund admin business involved in a
bidding war and an engineering company in like a podium. Very diverse different
types of business and really in terms of their contribution to overall return, much
more significant than our detractors. While the left hand side of the screen is
always disappointing, we would highlight Red Hill Education as a business that we
owned going into COVID, impacted by border closures and things like that, and
something that we've since thought back into and has delivered very positive
returns, showing the life cycle of these businesses in the microcap space. Now,
moving across to some of the key themes that we're trying to outline in today's
webinar. The first and I think the most obvious one is the small versus large
dispersion, the difference in the performance that we're currently seeing. The key
call out is the rapid unwinding of loose economic conditions. Throughout time, risk
off times of uncertainty leads to liquidity moving away from perceived risky parts
of the market.

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This trend tends to be a trait from retail investors through to large institutions.
Money was cheap and plentiful, and prior to the tightening phase beginning, buy the
dip, pay more for growth were well rewarded strategies. We have observed a general
decline in liquidity and the move up the market cap spectrum which underlies this
point. Our mandate of buying our initial stock position below $250 million market
cap clearly anchors us to our microcap universe. This is this chart from Aquari
highlights the fact of performance over one month and one year. Clearly, small caps
have been the laggard, reinforcing this point. On the next chart, we can see total
returns as a good illustration of this dispersion. This is also being represented
in major indexes around the world. I would point to the one year returns,
highlighting large cap performance of 3.2 %, midcaps up 4.7 %, smalls down 6 %
while the emerging company's index is down 15 % at the index level. That's
highlighting the move up the liquidity spectrum and the level of dispersion that is
now being observed. On the next slide, we can look at the performance gap becoming
compelling. This is resulting in increased market inefficiency.

[00:09:29.540] - Speaker 1
Fundamentals are being ignored, creating opportunities for patient investors with a
longer time horizon. Economic pressures are bringing opportunity. The consumer
discretionary space is one example of a sector under pressure where investors can
oversell high quality operators providing opportunity. It's been some time since
these businesses were in our investable universe. And illiquidity provides
volatility and leverage. This chart just highlights some valuation measures,
showing that typically small industrial is traded at 20 % discount to large, which
is 5 % below the 20 year average. And more resources, perhaps reflective of what's
happening in the critical mineral space, actually trading at a 7 % above the 20
year average. These valuation metrics apply between small and large cap, and
they're further exacerbated, as we spoke to, around the performance of the emerging
companies or microcap segment. And these current discounts are opening up future
outperformance opportunities for the fund. And we continue to believe that this
risk of behavior is widening these inefficiencies. On the next slide, we've done
some analysis around volatility and leverage. My colleague Josh has run some
analysis on the performance during stock market draw downs of the key industries
across large cap, small cap, and emerging companies.

[00:11:04.520] - Speaker 1
Peak to trough represents the percentage draw downs during these periods of risk of
and uncertainty. So if we look through the periods 2008, 2011, 2018, the COVID
drawdown, and 2023, we can see that the returns that follow the trough over the 3,
6, and 12 months are very supportive of the notion that the smaller the index, the
harder it falls. However, the flip side to this, in most instances, across three
and six months in particular, the rebound is seen most in this smaller end of the
market. This is worth keeping in mind given the current under performance
differentials and continues to support our belief that as liquidity moves up and
down the market cap spectrum, that can be a significant driver of returns. And
we're at a point in market conditions where a patient and disciplined approach can
be very well rewarded. And this is done at an index level too. Within those
indexes, there will be stocks that perform significantly better. Our job as
portfolio managers is to make sure that we're positioned in those names. The next
theme that I'd like to talk about is M&A. This chart represents the number of
transactions over the last two months by deal number and market cap band.

[00:12:32.430] - Speaker 1
Interestingly, 70 % of pending or completed deals were below $250 million. This
remains a source of opportunity in an environment of uncertainty, and we continue
to think think that the smaller companies will be active participants in this
theme. If we assume lower growth environments generally, bolt on M&A remains a key
pillar for larger companies to help supplement their growth prospects. And
microcaps have always been a happy hunting ground for larger companies looking to
M&A targets. On the next slide, we point out some of the recent winners and losers.
It's helpful to look at what companies are saying. And while we think we've all
been waiting for tighter economic conditions to hit the consumer, it appears it's
finally happening as a raft of small cap retailers update on trading conditions
through May and June. And some interesting quotes, universal store, trading
conditions throughout April and May to date have further tightened. Baby bunting,
sales have been unprecedentedly low with comparable store sales of around negative
21 %. And what's interesting about those two particular businesses is there was a
view that they were more resilient given that people needing to purchase for their
babies and their young children.

[00:13:56.550] - Speaker 1
And a cohort that were younger had more discretionary spend available in terms of
universal store, both being hit quite aggressively by the slowdown through that
April and May period. Cityship Collective talks to heavily discounting requiring to
drive demand, and adheres about subdued trading and lower traffic observed. These
are really interesting data points and we think that while it's been known for a
long time that the consumer discretionary should be one of the first impacts felt
by tightening rates, rising cost of living, and all the pressures that we're well
aware of. The stock market movements on these updates have been quite significant.
And in time, probably, it creates an opportunity. On the flip side, we point to a
number of our holdings, again, quite diverse in terms of some of their recent
updates. Supply network. Our current rate of growth remains well above historical
levels. They provide parts to the truck and bus industries in Australia. Next dead
is the old Red Hill education we spoke to previously. It's benefiting from the
borders reopening. More international students arrived, more international
capacity. And speaking to the international education industry is recovering and
growing quickly. Probiotec is a producer of medicines and products like that.

[00:15:25.430] - Speaker 1
Cold and flu season is about again. And again, they've had significant growth in
orders through the second half, and they expect sales to reset above hysterical
levels for the foreseeable future. And like a podium, an engineering company
involved in helping to support some of these critical minerals, continuing to see a
high level of activity across all operating sectors, delivering a robust order book
project. We would argue that the current strong performance of these companies is
not being reflected in their share prices, and the earnings outlook continues to
remain robust. We might move now to two very distinct and diverse holdings in the
portfolio. The first is like a podium. It's been a significant contributor to
performance over the last five years. It's involved in supporting through the
design, the construction, the optimization of many of these projects required to
address some of the challenges as global economies need to decarbonize. We believe
it's got underappreciated exposure to resource spend, infrastructure, and emerging
ESG solutions. Its pipeline is very, very strong, and they've got a very strong
band. They execute well, the management team is aligned, and it's trading on a PE
below 10 times and a fully French yield above 7.

[00:16:54.130] - Speaker 1
With the debate twofold, it's small in a liquid, so it's too hard. And is this peak
cycle in terms of its trading outlook. We've done significant due diligence,
meetings with various levels of management, lots of client and industry feedback,
and analysis of the pipelines and expansions that sit within their order books.
Again, this is a business where we think that there is a long term demand tailwind.
It's of extremely high quality. And as the market grapples with whether this year
is the peak, we continue to believe they have a very robust medium term growth
profile. And this is the business that sits high up within terms of our portfolio
weight. As we judge that risk reward to be a significantly skewed to the upside.
The balance sheet is very strong and we think that it will continue to surprise the
market to the upside. The next stock worth discussing is something very different.
A relatively new position for the fund called Botanics. It's a drug manufacturer
for a medical condition called hyperhidrosis, which involves excessive sweating.
And they're currently pre FDA approval, which is unusual for us to enter a position
in where such a key milestone had not yet been met.

[00:18:16.770] - Speaker 1
There is a rather large unmet need for this product in the market. But what gives
us confidence is the drug has successfully passed the mid cycle FDA review with no
significant issues. And we're expecting a key catalyst for the stock in September
quarter this year with FDA approval. We think the product is D Rist, sold in Japan
through a partner, and they have also decided to distribute the product into Korea.
When we look at the US market, we expect it to be far more lucrative given the
attractive reimbursement rates and the number of patients who we believe will seek
treatment to this product. It's late stage, it's far too cheap in terms of
valuation for what it has. And we see as these catalysts are met in the near term,
that valuation discount will decrease dramatically. We've done a huge amount of
work on this to give confidence. We've met with management to understand how they
plan to commercialize this. We've spoken to lots of industry experts in dermatology
who looked at the trials and were involved in customer feedback, and we built a
high level of confidence. As we said, the stock remains cheap with a significant
catalyst on its way.

[00:19:36.010] - Speaker 1
Significant upside is to be realized once they start selling product in market. We
believe they have a very compelling plan to be able to do that effectively with
management well entrenched in the dermatological industry in the United States. And
once approved, they become very attractive acquisition targets because they're de
risked and larger industry participants have much greater sales and marketing
potential. Two very distinct examples in terms of the stocks that we've currently
talked to. This, of course, it's much lower in its portfolio rating because of the
risks associated, but we think that they're overly discounted. That FDA approval
will prove to be a pretty compelling point in both the business's development and
the way that either the market or potential acquirers may look at the opportunity
that exists in this stock. Just moving forward in summary, why microcaps? It's an
attractive segment of the market as it always has been for generating that long
term capital growth. And we would argue that the blanket approach to selling
anything that is small, in risky, the fact that liquidity has drained out of the
market has meant that when we look at that broader risk reward, we're able to buy
much better businesses that are now in our investable universe at much better
valuations, where we look at that risk return and find that that relationship is
compelling.
[00:21:11.940] - Speaker 1
It remains highly inefficient. We can t continue to see participants leave this
part of the market. We don't see a raft of new funds being launched. It remains an
area well suited to active managers with deep experience. And we think that our
approach, very focused on the long term, a focus on sustainability, balance sheet,
cash flow, and risk means that we can drive our process and take full advantage of
some of those businesses that are very small today but can go on to become leaders
in their field and deliver outstanding economics to their investors. What we've
tried to demonstrate today is that valuations, liquidity, and performance
dislocation is widening the inefficiencies out there. Earnings improvements are not
being recognized, and multiple should improve as well as the market stabilizes,
providing a double effect in terms of better earnings, higher multiples, and much
better returns on stock prices from this point. Our investable universe continues
to evolve and it's well placed for growth. As we said, this is all about tapping
into some of those emerging trends, and that critical mineral space is a key
example of that. And we think it will be a key beneficiary.

[00:22:35.970] - Speaker 1
The market continues to develop, the market continues to change, but the nimble
microcap space will continue to offer us great opportunities to drive that longer
term capital growth. And finally, in summary, why Yara? Why the UBS Microcap Fund?
It's all about a focus on tomorrow's market leaders. It's high conviction, long
term approach, and we're trying to find those undiscovered businesses that have
that significant growth potential. We spend a lot of time thinking about industry
changes, finding businesses that are exposed to some of these positive dynamics,
and leveraging our networks and our experience to find the best businesses to
benefit from some of these broader themes. The structural opportunity remains key,
and that will be a continual driver of returns in a rapidly changing economy. And
we continue to anchor to microcaps. We can't move our fund up the market cap
spectrum when things get hard because we must buy things at initial purchase below
$250 million. And we're able to continue participating in that long term success,
but our investable universe is getting bigger and stocks that once traded on
valuations much higher than 500 and a billion are finding their way back down to
our market cap segment, potentially as a result of short term cyclical issues.

[00:24:07.040] - Speaker 1
And that creates opportunity to really build out the quality of the portfolio that
we're holding. We have a long term track record of out performance. We've done a
good job, I think, of protecting the downside during draw downs. And importantly,
in microcaps, we've got significant capacity availability, which is the thing that
makes your job much harder. The more money you run, the harder it gets. And that
capacity piece is key and being very firm on how much money a fund should be able
to invest successfully. So with that, I hope you've enjoyed and got something out
of the webinar. I might pass back now to Tony for any Q&A.

[00:24:54.040] - Speaker 2
Great. Thanks, Joel. We might move to Q&A now. First question on offer is, given
the rapid ascent of interest rates, which presumably impacts smaller companies more
materially, is it fair to assume that your performance over the past three to five
years is not a decent barometer for the period ahead?

[00:25:16.960] - Speaker 1
Thanks for the question, Tony. It's a very good one because I think there are a lot
of people not used to investing in an environment where interest rates are at the
level as they are. But if we go back in time, obviously, that these were far more
normal issues. I continue to point out that there are always sectors and stocks
winning, and they're usually found within that microcap space. And so while the
returns of the last five years capture the COVID dip, the rally, and now the last
two years is conditions have tightened, I remain of the belief that the inefficient
nature of this investable universe means that there are great businesses that are
unrecognized today that will continue to build out market leadership. I continue to
think because of those capital gains that are on offer in this space, because we
are probably going into a lower growth environment generally as a result of those
higher rates, that microcaps actually should stand out and be valued more highly
because they are growing more quickly, they are involved in future facing
developing industries and offer low base, it's much easier to grow than rather
trying to protect an industry where you have significant market share and it's
moving at the winds of GDP.

[00:26:42.990] - Speaker 1
So we continue to aim to deliver that long term capital growth. I think interest
rates have obviously been a headwind across the economy and caused a tightening in
conditions. But it also means the prices you pay for some of these businesses that
you can now buy presents a really compelling, longer term risk return trade off.
And we're confident, I think, that we can continue to drive solid long term capital
growth over the investable universe that's on offer.

[00:27:18.960] - Speaker 2
Joel, just another question in regards to rare herbs. So we've seen a boom here,
but are there any legs left for microcaps, or is the cohort now all out of the
investment universe? Well.

[00:27:31.920] - Speaker 1
It's interesting. In that AFR article today, they talked to the fact that there
were 88 names, I think, who were either producing, looking for or developing, with
their own projects. I think that's a really interesting statistic. One of the
criticisms of the microcap space is whatever's hot happens to a lot of companies
pivot and start looking for that particular product. But for me, I think that
there's been a shift and it has been a structural shift. It's both on a strategic
level in terms of who controls and who has access to some of these critical
materials, and also the requirement to help us facilitate this longer term
decarbonisation goals that have been set. I think clearly in all of these
materials, whether it be copper, whether it be nickel, in the longer term, we will
need significant more of these products to help deliver those gains. On rare earth,
it's very interesting. While there are a significant number of microcap companies
looking for these products, it's exploration. You have to find the deposit. It has
to be economic. But there's certainly lots of money going into the ground seeking
to do that. Jurisdiction is key.

[00:28:51.200] - Speaker 1
Australia has been very good at bringing some of these projects on board. While
there has been a significant performance from some of these stocks, I continue to
look for something that can continue to become a leader as a Pilgrim Minds has done
in Lithium. And I think that that's entirely possible in the microcap space,
because we need to control more of this product, and we need more of this product
to facilitate some of those bigger trends. So I don't have a particular stock that
I can point to at this time, but it's an area that we continue to focus on.

[00:29:28.580] - Speaker 2
Great. Joel, we probably have time for one last question, and that is, how
optimistic are you now that some of those beat up names, for example, with Adairs,
City Chic, and Universal Store approaching lows and offering up good value?

[00:29:45.720] - Speaker 1
Look, it's a great question. These are very cyclical businesses. The consumer,
whether it be from some of the COVID stimulus we had, have been over earning to an
extent. I think that people forgot that and took it as the new normal. But the
share price reaction to that slowing consumer has been significant. The first thing
that I often do is look at where some of these businesses are traded and what
they've earned in the past and where they are now. And fundamentally, they are
becoming more interesting. We continue to think that the consumer probably faces a
tougher time in the coming months as those mortgage rates increase, people roll off
their fixed mortgages and those generally cost of living pressures. But the fact
that they are back in our investable universe and you can ascertain who has a great
brand, who has a great management team, there is able to be in the right locations,
manage inventory well, is very, very exciting. Because in time, when these stocks
are upgrading and everyone owns them as part of their portfolios, they tend to get
overdone on the upside, and the same thing happens on the downside.

[00:31:05.610] - Speaker 1
And while it's very easy to get pessimistic in the short term, even though I think
that the pressures remain fairly significant, I wouldn't be surprised over the next
6 to 9 months that we'd added one, two, three names to the portfolio where we think
great management team, weathered the downside well, are now looking to take
advantage as the consumer has to come back and start spending. That's a great
example of a sector where these stocks became significantly larger than allowed us
to look at, and we're going to have a choice of a big basket of them now. I think
that we continue to believe that things are tough, they're going to be tough in the
short term, but then post that, there will be a recovery and good management teams
will take full advantage of that. So again, we're looking at all these scenarios as
opportunities to buy things that were out of favor, but those fundamentals are very
sound and benefit from that rebound that will occur because the disloc between what
has happened in the bigger part of the market and the smaller part of the market is
being driven in part by factors which aren't overly rational in terms of those
fundamentals of the underlying investment.

[00:32:26.120] - Speaker 1
We're really looking forward to the opportunity to buy some great businesses at
compelling prices.

[00:32:34.840] - Speaker 2
Great. Well, thanks, Joel. Looking at the time, we're going to have to leave
today's update there for now. Thank you to those of you who have submitted a
question we didn't get to. There are a few in the queue, but we will take those
offline and be back in touch with you soon. If anything in today's session has
particularly grabbed your attention, please contact either myself or any member of
the distribution team. Our contact details are now on screen and we'd be happy to
answer any questions or arrange a follow up session. Once you leave today's
webinar, you'll receive a survey on the session. As ever, we would welcome your
feedback. And on behalf of Yara Capital Management, thank you for attending today's
update and as ever for your continued support.