Eureka Report: NAOS Emerging Opportunities - A concentrated approach

Source: InvestSMART Group

Since listing in 2013, NAOS Emerging Opportunities has been a star performer.

One of the major advantages of a listed investment company (LIC) is that it offers a diversified portfolio of stocks that are actively managed by a fund manager at a price that should stay reasonably close to its net tangible assets (NTA).

If the stocks are chosen well then the NTA can rise rapidly, and the share price with it – and that’s been the case with NAOS Emerging Opportunities Company (ASX:NCC) which has returned an average of 22 per cent a year (before fees and after operating expenses) since it listed in 2013 compared to 3.5 per cent by the Small Ordinaries Accumulation Index.

This is an outperformance of 18.5 per cent per annum when measured before fees and after operating expenses. Of course, four years is a relatively short time in the life of any investment portfolio and it’s best to measure performance over longer periods. However, it’s still a great start.

Concentration

Sebastian Evans, chief investment officer of NAOS Asset Management, attributes the performance to a number of factors.

He believes a concentrated portfolio of between 10 and 15 investments is ideal for enabling a good return while minimising risk. Watch our video interview with him, where we discuss stocks, markets and NAOS’s investment approach.

The concentrated portfolio allows NAOS to have a more intimate understanding of its investments, and this is where NAOS believes it has its competitive advantage. NAOS focuses on emerging companies, which can be overlooked by the broader investment community.

The five largest holdings in the NAOS Emerging Opportunities portfolio are:

• BSA Limited (ASX:BSA);
• Armidale Investment Corporation (ASX:AIK);
• Enero Group (ASX:EGG);
• MNF Group (ASX:MNF);
• CML Group (ASX:CGR).

Investments

NAOS’s two largest holdings are BSA Limited (ASX:BSA) and Armidale Investment Corporation (ASX:AIK).

BSA Limited is a technical services company that provides a range of services and customer solutions. This includes the manufacturing, commissioning and maintenance of heating, ventilation, air conditioning and fire systems for large-scale commercial, residential and industrial buildings. BSA also provides communication, installation and maintenance services for major Australian telcos and media operations. In 2016 it was awarded a five-year NBN infrastructure contract to add to its existing NBN operations and maintenance contract. BSA has also won significant contracts with Foxtel and Ericsson.

Over the last couple of years, Armidale Investment Corporation has grown to be Australia’s largest network of asset finance brokers. It is transitioning from being a listed investment company to being an operating company, which means the market will begin to value the stock according to its profitability rather than its NTA.

Risks

The concentrated approach has worked so far for NAOS, but it also brings risks. If one or two of the bigger investments fail, it will have a big impact. This hasn’t happened so far, but it may, and overall performance is best measured over much longer periods of time.

The fee structure is fairly standard. The management fee is 1.25 per cent (excluding GST), and performance fees are 15 per cent (excluding GST) of the amount the fund outperforms its index. Any underperformance is carried forward to the following year and needs to be recouped before the manager is entitled to any further performance fees.

NAOS has a policy of shareholder alignment, with directors and staff owning between 15 and 20 per cent of the LIC.

The stock is currently trading at $1.34, in between its pre-tax NTA of $1.39 and its post-tax NTA of $1.27.

We like the LIC and its management style but we’d want to see it at a discount to its post-tax NTA before buying it. In the meantime it’s an interesting one to watch, for its investment selections, and for any potential opportunity this LIC might offer.

Published February 9, 2017