Morningstar remains an admirer of the Pendal Smaller Companies fund, despite the fund’s poor performance over the past year, and has reaffirmed its ‘gold’ rating, citing its solid research process and reasonable pricing.
Pendal uses bottom-up fundamental research, applying qualitative assessment and valuation discipline. It assesses three qualitative aspects of a company: riskiness of the financial structure; strength of the business franchise; and quality of management.
Each company is scored on these criteria. Analysts are put through a peer review process.
“But ultimately solid stock-picking is the critical element that separates this strategy from peers,” Morningstar says.
The fund has underperformed in the short term but it is a long-term outperformer. Over 12 months to the end of September the fund has lost 2.15 per cent, compared with a 3.95 per cent return for the index, the S&P/ASX Small Ordinaries Total Return.
Over the past five years it has returned 9.3 per cent a year, compared with the index return of 9.6 per cent a year. And over 10 years it has returned 9.9 per cent a year, compared with the index return of 4.5 per cent a year.
Morningstar says recent performance has been dragged down by its holdings in a couple of underperforming stocks, food company Costa Group and insurance broker AUB.
In its most recent investor update, Pendal says: “Insurance services company AUB Group delivered a soft set of earnings, driving near term underperformance. While the underlying insurance cycle remains supportive, some of this has been offset by changes to iCare (formerly WorkCover NSW), which has led to a transitory slowdown in referrals.”
Pendal says its favoured tech stock is Technology One. Its largest positions include the mining service company Seven Group, logistics company Mainfreight, Invocare and Ryman Healthcare.
A couple of stocks that made a positive contribution to performance were the ship builder Austal, which has had a steady stream of new contracts recently, and car dealer AP Eagers.
Pendal says: “We continue to seek and find attractive niches within the small cap universe. We have a good mix of exposures within the portfolio, including areas with attractive organic earnings growth, such as mining services, with strong free cash flow generation (AUB Group and Bapcor), leveraging disruptive forces (Nonsonics, Technology One) or where management strategy is improving the quality of the franchise (Austal and Invocare).”