Why the Next Six Months Could Get Tough for Small Caps: On The Couch with Chris Stott

VIDEO AVALIABLE: https://vimeo.com/1181449274

Chris Stott (1851 Capital) joins Callum to break down the current small cap landscape - and why the next six months may be more difficult than many expect.

In this discussion, Chris outlines how rising interest rates, geopolitical volatility and shifting investor sentiment are shaping opportunities in Australian equities.

Despite near-term caution, he highlights where value is starting to emerge – particularly in beaten-down sectors and less crowded parts of the market.

Topics covered:

• Why interest rates are still the key driver for markets
• Where opportunities are appearing after recent sell-offs
• How to manage risk and position portfolios in volatile conditions
• The reality of small cap investing, and why 6/10 decisions is enough
• AI, data centres and where structural growth is actually happening
• Why IPOs are drying up and capital is becoming more concentrated

Chris also shares how he thinks about portfolio construction, cash levels, and identifying companies that can genuinely outperform.

About Chris Stott:

Chris is Co-Founder and Chief Investment Officer at 1851 Capital, with over 20 years’ experience in Australian funds management. He was previously CIO at Wilson Asset Management and was named one of the AFR’s top young fund managers.

Learn more: https://1851capital.com.au/

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Transcript

Market Whiplash And Ceasefire Bounce

SPEAKER_01 0:04

All right. Well, Chris, what a day to be talking. Trump has well, Trump and Iran have negotiated some sort of ceasefire. We've got a really big upday on the market. I just want to take you back over the last 12 months because we've had multiple things hit the market. We've had the interest rate expectations reverse, a meltdown in the tech sector, and then the Iran thing. In your experience, which is very long and varied in the ASX, how has the last 12 months been?

SPEAKER_00 0:38

In probably the most volatile period I can remember, Callum, over 20, 20 years. You know, we've had the GFC, we've had COVID. COVID was very short. The GFC was difficult. But you know, it feels as though as investors, we just get, we've been thrown, as you as you described, very, very several curveballs more than usual over the last 12 months, uh, which has exacerbated the volatility. And we're seeing that today, aren't we? With the ceasefire agreed supposedly between Trump and Iran for two weeks, seeing the share market trade a lot higher today.

SPEAKER_01 1:13

Well, I mean, you have to make these decisions in real time. From your perspective, do you see this rally as durable for the moment? Or are you still cautious? Or what do you think of it all?

Inflation Risks And Rate Hike Watch

SPEAKER_00 1:24

We're still cautious. We have a few things that we need clarity on. Primarily, it's interest rates. So Australia has an inflation problem. Going in going into before the even the award broke out only six weeks ago, inflation was too high in Australia. And we're starting to see the RBA acknowledge that with respect to interest rates going higher again. And there's now expectations that interest rates, the RBA could put rates up again another two or three times uh this calendar year. So that's that's something that we're really watching very, very closely and to see what the RBA say in their minutes, particularly in their commentary on the back of their next meeting in May, where we do expect that they'll put up the cash rate again by 25 basis points. So we're we're now more focused on that and what that means for companies. We're expecting it's going to be a tough six months for a lot of small industrial companies that we invest in, primarily ones that are plugged into the economy, such as retailers. We think that there'll be some negative news to come out of some of those companies over the next six months in the form of earnings downgrades. And the market's sort of telling you that some of the share prices in these companies, like Adair's or Baby Bunting, have more than halved since their peak in October of last year. So the market's telling you that there's that there's some bad news to come. But that being said, we think there's some incredible buying opportunities starting to appear at the moment. Um, you know, things that have been sold down the levels that we haven't seen for many, many years.

SPEAKER_01 2:52

Now, I'm just uh famously, I believe you don't invest in resources. And I feel over the last 12 months, we had gold go up, we've had lithium come back. Has it been difficult for you not being able to access that sector?

SPEAKER_00 3:09

Oh, incredibly difficult. So at N51 Capital, our fund, the Emerging Companies Fund, has been going for just over six years. And at the outset, in our in our mandate, uh, we specifically stated that we don't invest in resource companies. We're not experts in resource companies, we're not geologists, we don't have that expertise, and we don't want to try to be pretend to be someone that we're not. Um, but in as you mentioned there, Callum, not only the last 12 months, but the last six years resources have significantly outperformed the small industrials, and in fact, they've been the strongest sector by far over that period where you've seen outperformance of the small resources sector versus small industrials of over 150%. We haven't seen that level of outperformance for many, many years. And that's primarily been driven by gold over the last 12 months, before that, lithium and coal and iron ore have also been strong at various times as well. So certainly it has been a quite a big headwind for us. And so pleasingly, we've still been able to deliver really strong performance, outperforming over most time periods.

SPEAKER_01 4:09

Can you can you do things that are kind of tangential to resources like mining services, or or you you just don't go there at all?

SPEAKER_00 4:17

We can and we do. So companies that we own right now in the mining services space, NRW holdings, you know, Jurotech's a good little small cap that we like, primarily plugged into the defense space, but also you know has mining engineering capability. And there's various other companies that we've owned over time. Uh, Solar Cross Electrical is another one that we we see as quasi mining exposures, but it we are bottom-up stock pickers. We'll only invest in these companies where we see them trading at you know good valuations with catalysts that can re-rate the share price.

SPEAKER_01 4:50

Let's circle back. So you mentioned like since October last year, things have become difficult with the interest rate adjustment. Around about that time, we started to see the tech sector derate here. And that's for companies that you may that are even bigger than what you would normally look at. Did you sort of recognize that the how did you recognize it at the time, or did you just assume at first that it was volatility, they were selling off? Uh, it was interest rate related, perhaps, or at what point did you go? Or there's something actually a bit bigger going on here?

SPEAKER_00 5:19

Two or three months later, after October, I think, you know, there's been various sell-offs in that space, in that tech sector, over the last three to five years. And we we were early to call it in terms of saying that there was a lot of hot air and you know, think things are expensive in that space. And typical stock market always overshoots to the upside and overshoots to the downside. And as a classic example here. Look, AI is certainly a threat. It's a it's a threat and opportunity. You know, it's a it's a it's a threat in the sense of particularly for software companies. So they're it's potentially eroding their competitive advantages that they've had for many, many years. And it's an opportunity on the other side for companies, and we've seen various companies come out, you know, with cost-out programs. So when I say it's opportunity, uh, it's primarily in the form of you know reducing their workforce, optimizing their margins, optimizing their profits. So at a at a human cost, of course, which is never good to see, but we're very much in the early stages of AI, and it is far more advanced overseas and places like the US than it is in Australia right now. In fact, you know, we use AI every day now within our business. It has changed, it's changed the way we uh analyze companies, we can do things more efficiently. Um, I remember using Chat GPT two years ago. I was preparing to meet Cedar Woods, you know, good Western Australian property business. And historically, I'd sit there going through the annual reports, presentations, you know, financials, spending a few hours researching the company, I'd write out 20 or 30 questions before I met the company. Whereas now you can upload all those things to Chat GPT and say, pretend you're a fund manager, can you write me 25 questions to ask Cedar Woods? Now I did that two years ago in Chat GPT, and it was pretty, it was pretty hopeless. So it might, out of the 25 questions, there might have been three or four questions that you would ask the company. When I do it now, I'd say the strike rate is more like 20 to 22 questions, where I'd say, yeah, they're pretty good questions to ask. So it's come a long way.

SPEAKER_01 7:15

You think at the other end the CEO's going, give me 25 answers for the fund manager that's coming today?

SPEAKER_00 7:20

Well, that's probably what they're doing, Calum. They just don't tell me.

SPEAKER_01 7:25

Um I was gonna ask you about zip actually, because I remember you were quite positive about that, and it was one of your bigger positions. It had a big drawdown recently, just from a portfolio management position. It doesn't matter so much about the company in this case. How do you do you sort of scale down your position or you're happy to write it out if you have a higher conviction in that particular name? Or when you get a kind of indiscriminate sell-off and it's going against you in the short term, how do you approach it as a portfolio management?

Managing Risk With Zip And Cash

SPEAKER_00 7:54

It's a very good question. And that's probably the key to what we do is managing risk within the portfolio. And with that particular example, Zip, it was one of our larger holdings, I think six or 12 months ago. We did fully exit zip over$4. We thought that the valuation was expensive and a lot of the catalysts we felt had played out. We've only just re-entered zip actually over the last couple of weeks, in fact, and taken another position back in the company. We like the company, we like the company. You'd be happy today, then very happy today, but who knows what's going to happen tomorrow. This is the volatility we spoke about earlier. It could be down again, who knows? But um, yeah, they're doing very, very well, they're executing very, very well in Australia and particularly in the US. And they're taking market share, they're signing on big retailers, household names, really well run, um, good solid management team. So, yeah, in that example, that's one case where, from a risk perspective, typically in better markets, we'll trim the position as it goes up and keep it at a certain portfolio waiting, like a core waiting for the portfolio. And then also on the other side, making sure that we're generally holding some cash at all times, whether it be typically five to 10% cash for us, where when you get events like we've had in particular over the last six months, where it's AI, pressure from AI on the tech sector or the the outbreak of war in Iran, where you've got dry powder to deploy on big down days and take advantage of that volatility, which we think we've done in more recent times.

SPEAKER_01 9:18

I know your buddy Matthew Kidman was in the paper the other day saying that he went to 40% cash at one point. Would you ever get that high? Did you get that high at all?

SPEAKER_00 9:26

No, we we we we we we don't. In our IM, we state we don't, we won't go beyond 20% cash. Our philosophy and the feedback we've had for investors is that typically they invest money in our fund to get exposure to Australian small caps. So that's what we want to provide them. And uh typically we find investors say to us if they want to be in cash, they'll make that decision themselves, which is fine. But at the same time, you know, got a really high respect for Matthew, obviously, and one of the Australia's great investors, in my opinion. And he he manages risks in a different way, and that and that's his way of managing risk right now, is to is to flex the cash around. And I know Matthew well, and he could quite quickly change that position and likely will.

SPEAKER_01 10:12

So I mean, I should say this was a couple of weeks ago, so he probably already has, to be honest. Yeah, I was just saying as yeah as a risk management type of strategy. I was I spoke to his offsider Michael the other day, actually, and they told me to ask you who were your mentors, actually. I'm assuming he was he one of them.

SPEAKER_00 10:29

He is, yeah, he knows that too, Matthew. So that's a that's a leading question. Two mentors, Matthew and Chris Cuff. So Chris Cuff was the one of the founders and CEO of Colonial First State going back in the late 90s and early 2000s, with Greg Perry as the leader of the investment team there. So yeah, Chris has been terrific for us, previously chairman of Unisuper, um, uh and a lot of philanthropic interests as well in the form of Third Link and Australian Philanthropic Foundation, which we're involved in as well at 1851 Capital Proudly. So, yeah, I'd say Matthew Kidman and Chris Cuff would be the two mentors that I'm lucky to have.

SPEAKER_01 11:07

And you mentioned small caps. How big are you prepared to go? It's always a bit rubbery. What is a small cap, depending on who you're talking to? So, how big would you go?

SPEAKER_00 11:16

We wouldn't eventually so we only invest outside the ASX 100. We won't we won't go inside the 100. So the the market cap threshold typically for that, I haven't checked recently, it's normally about three to four billion in terms of the market cap of those companies that sit around the ASX 100 level.

SPEAKER_01 11:33

Um, and there's a limit to how small you'd go?

SPEAKER_00 11:36

50 mil market cap typically. Yeah. And the reason we've got that is primarily just to, you know, one thing that we think is really, really important is liquidity. And going through GFC, going through COVID, we saw it firsthand how important liquidity is, and particularly in small caps, which are generally high risk, high reward, higher returns over time. But stuff goes wrong, as we've seen. You know, in the last six months, it creates great opportunities. So liquidity is really, really important to us. And so we've we we look at it every month, and that's why we've got those self-imposed limits on where we can invest.

SPEAKER_01 12:13

And do you have a typical number of positions, like 20 or 30 or a little bit more?

SPEAKER_00 12:18

Uh, we say 30 to 80 positions, but over over six and a half years, we've averaged anywhere from 50 to 70 positions, I'd say is our average over time. And that's very deliberate. We like a diversified portfolio. Um the old adage, we don't like all our eggs in one basket. You know, it's a simple one, but it it holds true. And yeah, and small caps, things can go wrong, you know. And typically, as they say, if you're making out of the stock decisions you're making, if you're getting six out of ten right, that's a good batting average. So you want to have the flexibility to move around and take advantage of sell loss, as we talked about.

SPEAKER_01 12:53

Do you think people would be surprised at that number, like six out of ten? That do you do you find that people people who are new to the stock market would expect it to be a little bit higher?

SPEAKER_00 13:02

No, that you're absolutely right. They do. They think it's they think that we're that we get nine or ten out of ten, right? It's just not the case, and it's not realistic. So typically the way that works is you're out of the 10 decisions you're making, 10 stocks to buy, you know, your first or second highest conviction bet is typically a higher weighting in the portfolio versus the ninth and 10th best. Um, so typically, you know, you if you're getting one or two of those um bigger positions, right, it typically carries your performance. And what we found over time here at 851 capital in the previous hit Wilson Asset Management is that if we're lucky enough to find a stock that can double or triple for us over a 12-month period, that typically has carried the performance for the portfolio over that period. Um and we always typically see those opportunities sub 500 million market cap. So that's typically the most fruitful hunting ground.

SPEAKER_01 14:00

Just thinking in terms of the ASX, one of the general points is there hasn't been a lot of IPOs lately, especially outside of the resource sector. There's a lot of little miners coming up. Do you think it are you feeling a little bit starved for fresh opportunities?

SPEAKER_00 14:15

Absolutely, we are. And the IPO market has been stagnant now for almost five or ten years. There's some structural forces at play here, and it's not just in Australia, but it's globally. So, first of all, the availability of capital these days is is a lot wider. And so you're seeing things like private credit as a sector grow dramatically. Um, company, there's more compliance these days. Second, there's more compliance for a listed business these days than there was 10, 20, or even 30 years ago. You know, it's expensive for that reason, board, public boards, et cetera, dealing with the regulators, so that it's more expensive. So the attraction the attraction for a company to list on the ASX is just not what it was 10 years ago. And that's starting to reflect, in my view, in the lack of listings that we're seeing. Um the other point I'd make is over the last 10 years, we've seen a huge increase in Australian funds, small cap funds, investing in unlisted opportunities. So they invest in a company unlisted with the hope that it's going to hit the ASX over a six or 12 month period. So what that's done is is you know, historically you'd have, let's say, 100 different small cap funds in Australia looking at an IPO and none at the moment. So you've got 100 marginal buyers for that particular company that's looking to IPO. Nowadays you might have like let's say Fermos, that's a hot IPO that's coming, right, in the next few months. Out of the hundred funds that that we spoke about, maybe half of them already own Fermos. Might be maybe more. So you get to I the IPO and there's there's less funds, there's less less people putting putting their hand up to invest in that IPO. A lot of them already invested and actually probably looking to sell on the in the IPO. So I think that's those three key factors of why the IPO market has been soft, and I I think will likely continue to be soft. It it won't go back to what it was. There'll still be the odd listing here or there that comes in and does well, but it's just not going to be the same volume as what we're used to.

SPEAKER_01 16:26

Does that mean then that capital just is sort of forced to crowd into what's already there, basically?

SPEAKER_00 16:32

100% it is. And so we spend a lot of time also at 8051 capital understanding how crowded our how well owned our positions are. As I talked about earlier, if we can find that company to double or triple in a 12-month period, it's typically sub 250 mil market cap. There's no other institutions on the share register. So that that's our sweet spot, as opposed to, you know, another good business that we sold out of over the last six or 12 months was Generation Life that we'd own for four or five years. Great business. Grant Hackett, one of the best CEOs out there, in my opinion. Share price went from$1.50 to$7 over a few years on the back of great execution. But it got to the point that I went to an invest today they held about six or nine months ago, and every fund was there. All of the competitors were there. Everyone was long. And you go that two or three years before that, not many people owned it. So it's just that simple analysis that we do. Um, which, yeah, crowding is very, very prevalent, and um you've got to be very aware of it.

SPEAKER_01 17:36

I want to go back actually. I remember in 2023, there was a period there where the the Aussie small caps were just dead. They were dead, and there was just no momentum. I was writing a small cap newsletter at the time. And it was just like day after day, it just a grind and a grind and a grind. Then we had a sort of rally. Do you feel like sentiment is not as bad as it was back then in the small cap space, even though, in a strange way, the news is kind of worse with the rising rates and the oil price going up and all that type of thing? What how do you view the general dynamic of like investor sentiment at the moment?

SPEAKER_00 18:15

It's definitely better than what it was in 2023. I think 2023 was probably the hardest year for small caps in 20 years, primarily driven by, as you said, Callum higher interest rates. And our experience is that the Australian small cap market typically outperforms or does better when rates are falling as opposed to when they're rising. So, and that was evident last year for the calendar year 2025, where the small cap market was up north of 20% for the calendar year. So it had its best year in a number of years. But as you say, it was probably due, wasn't it, after such a lean couple of years and we felt it. Now we're entering another period where rates are going up again. So it's going to be a tough period, we think, for the next six months for the Australian small cap market. But as I said, there's some significant opportunities starting to pop up now, you know, in the form of some retailers we think are looking interesting, but we're keeping close eye on where the share prices are down 50 to 70 percent. You know, some financials look interesting as well. But and until until we get clarity on the interest rate cycle and where we're headed, that that typically has a really high three-year, the three-year bond is what you we watch. The three-year bond rate is what we think's got a high correlation to what the Australian small cap market does. And and and when we start to see that that bond curve inflect to start factoring in rate cuts, that's typically when you want you're close to the bottom.

SPEAKER_01 19:34

I'm just trying to think of in terms of growth, like it's one thing to say identify value or something that's underowned. Where, where, what, what do you see that's growing? Like, what industry is growing for you?

SPEAKER_00 19:46

Look, I think it's for us, it's on a on a sec, uh, sorry, a stock by stock basis. Yeah, we're we're looking at stocks that in some cases it's the grow in industries that are going backwards because they're taking market share that's got, I mean, I always talk about TPG Telecom, great case study. David Tio 20 years ago came in in the Australian internet ISP or internet market and just undercut the competition on price and just took market share off Telstra off Optus for many, many years and and carved out a really good business. We don't own TPG shares now, but that's it. What about two ads? Two as we own, no, we're for five years. And so we typically follow the people calendar. David is an A grader in the telecommunication space, and two AS, for those of you listeners that don't know, is essentially the TPG of Singapore. They're doing the same thing in Singapore in the mobile and internet space, and so they're doing doing it very, very well.

SPEAKER_01 20:40

Um that was one of the that was an absolute screaming bargain a couple of years ago when it got hammered in that bear market that we talked about, which is kind of typical of what you're saying, that these big market sell-offs do throw up these niche situations. But it takes a guy like you to go, oh, I know that who runs that and I I know what's going on there, and you can step in and take advantage of.

SPEAKER_00 20:59

Yeah, look at it, it's been a terrific stock for us. We still like the company, we we still hold the shares, continues to deliver and exceed expectations every six months on their results. So that's one we quite like. In terms of sectors that are growing, anything that's tapped into AI is growing. Although there's not many direct exposures or direct ways to play that domestically here in Australia, you have to go to the US for that, typically. The other key sector that is growing the fastest right now is we talk about the electrification of the economy. So anything that's tapped in to data centers is flying. And so there's a couple of you know, electrical contractors that we own, SKS Technologies, Southern Cross Electrical, which we think are very well positioned over the next three to five years to take advantage of the insatiable appetite for AI, for data, and therefore for data centers that we need to service this demand. And you know, the pipeline is enormous for those companies. And so their runway looks quite strong.

Data Centres And Electrification Tailwinds

SPEAKER_01 21:55

I'm gonna take a swing out. I'm gonna assume that you own mass group.

unknown 21:58

No.

SPEAKER_00 21:59

No, we don't. No, don't have a position in Mars Group.

SPEAKER_01 22:02

Did you have it before he did? Because I was going to ask about that move that he pulled of selling off the core asset to move into that space and what you thought about it.

SPEAKER_00 22:10

Yeah, look, I think it was a big surprise. You know, Mars floated four or five years ago as an East Coast exposure to the East Coast infrastructure boom, primarily in the form of their you know, construction businesses and materials businesses, quarries and the like. So they've got a real they've sold that business. They've achieved a really, really good price for it, a really good multiple.

SPEAKER_01 22:29

I feel like that's be the kind of guy that you would be interested in, though. Like previously successful.

SPEAKER_00 22:34

We're having a good look at it now because around half their market cap in the next few months will be in cash. Once they, if they sell this business, which we think they should. And then you've got to take a view on what what they're going to do with those proceeds. And one area, as you said, Carl, that they're looking to deploy money into that data center space to take an initial investment in Fermist. So yeah, once we get some more clarity on the strategy, that will give us a bit more confidence on you know, charging the outlook for that business.

Avoiding Profitless Hype And Memes

SPEAKER_01 22:59

I'm trying to think this small caps has a mix of like established businesses, specy miners, and then you get the ones where nobody can be quite sure. I'm gonna drop like drone chill, which is very, you know, like it goes on these massive rallies, and then you know, it has these massive collapses because everyone's like, no, it's it's it's you know, it's too expensive and it's a it's a thematic, it's a it's a meme. When it can would you do you invest in stocks that don't have profits? No. No, you wouldn't so you wouldn't consider that type of stock anyway.

SPEAKER_00 23:34

No, it doesn't. So we've got that filter in deliberately. We typically find stocks that are unprofitable struggle. Even we will look at some that are within six months of profitability, but always takes longer. It's always harder and longer than they think. So in the case of DroneShield, we haven't owned shares in DroneShield, and there's another company, EOS, which they're the two that have done really, really well in the last six months on the back of the geopolitical unstability we've seen globally.

SPEAKER_01 24:02

But I mean, I'm just you you know that like the small cap sector is famous for these sort of thematics that roll through them, and and the stocks go absolutely bananas. And I'm sure at times your investors go, hey, why don't we own that stock that's gone up 800%? I'm thinking of like IPX is another one that kind of fits that bill that's gone bananas lately. And it's like sometimes you must scratch your head and go, why is that so expensive?

SPEAKER_00 24:26

Yeah, no, we we do it all the time. And you know, it's very important to us that we stick to our process, stick to our unit, sell us in good stead over a very long time period. And the minute you start chasing that stuff, the minute you it it will start to it won't end well for you. In the case of Drone Shield, um yeah, fascinating case study, isn't it? You know, you've had the CEO sell 100% of his shares on the first at the first possible opportunity late last year. I think it was in November from memory. And then just today, the CEO and the chairman have both both announced that they're stepping off, stepping away from the company. So the CEO's resigning and the chairman's gonna step down. Um so and on the same day that a ceasefire is declared over in Iran. So I think we'll look back at this day in time and reflect in the next six to twelve months and let's see what happens. But yeah, they typically say actions speak louder than words, don't they? And so CEO sold 100% of his holding four months ago and now he's departing. So he's seen something that we're not, but Tom will, I think it will come out in time, whatever it is.

Consumer Stress Petrol Prices And Sentiment

SPEAKER_01 25:29

I was watching a webinar the other day, uh, Tim Carlton, who's a peer of yours, I know, not necessarily the same sector, but one manager. And he he generally made the case that the Aussie consumer was in reasonable shape. Do you share the same view, or do you think it's more stressed out there, or even better, perhaps?

SPEAKER_00 25:48

I think that was the case up until three weeks ago. As soon as you saw the spike in petrol prices and the uncertainty with Iran, the consumer has stopped. Sentiment's at decade, multi-decade lows. Consumer sentiment is at multi-decade lows now. When we're speaking to retail unlisted retailers, our channel checks is that in the last three weeks everybody's stalled, no one's spending anymore. When you talk to real estate agents here in Sydney, numbers are down, auction clearance rates are at multi-year lows again. Things have are tough. So, no, I'd suggest that the consumer in the very, very short term has taken a big turn down, and that's reflective of the moves in share prices. But time will tell. I think, as I said, interest rates with the key here. Consumers are nervous about interest rates going up further. They keep getting told by the RBA there's going to be more rate hikes this year, and you know, the concern about the price of petrol, like that's not insignificant. Um, so there's a few factors there that need to be addressed before I think the consumer starts to get back out there and spend again.

Cedar Woods And Macro Headwinds

SPEAKER_01 26:52

You mentioned CWP there, and that just triggers for me because I've followed that stock for years. So when now that's primarily in Southeast Queensland and Perth. So that's the their stronger housing market. Is that that a kind of position where you might like the company, you like what they're doing, but the macro things are building against them? And you'll you almost have to second guess, is the market really going to bid up this stock in this environment? So should we just jump ship kind of thing until it gets clearer? Or how do you manage that kind of it's a bit like the zip one when that you said alluded to zip, you sort of said, well, it it had sort of run its race anyway. What do you do when you still like what the company's doing, but the macro's building against you, if you like?

SPEAKER_00 27:36

Yeah, so we've reduced our position in Cedar Woods over the last six months, and we've owned it for three or four years, and we bought it in that 2023 year when you know no one wanted to own small caps and interest rates were going up. That's typically the time when you want to be buying things. And so, particularly this the companies that are most economically sensitive, like you know, property developer or retailer. So we've held Cedar Woods since then. Uh, we have been trimming it over the last six months. We still believe that they are flying, particularly they are in the two hottest property markets in Australia right now, being WA and Southeast Queensland. Southeast Queensland will be the strongest property market over the next five years, going into the Brisbane 2032 Olympics. The amount of activity infrastructure spend that's occurring up there is enormous and will carry you know that economy forward over the next similar to what happened in the Sydney 2000 Olympics here in Sydney. So yeah, in that case, you know, Cedar Woods, we think that's still in the sweet spot that they're gonna, we're very confident on their earnings this year. A lot of it's already locked in from pre-sales of properties and these are next year as well. But so certainly, you know, obviously lower interest rates help them, don't they, as you say? And we've just got to keep a close eye on what on that and and and how that evolves over the next six months.

SPEAKER_01 28:52

You won't know this, but in 2023, I wrote a presentation actually that was quite long-winded in the style of the company I was working at at the time, making the case for small caps. And I remember citing you because you had this quote like, I haven't seen sentiment this bad since the GFC or something like that type of thing. And anyway, we send it out, and of course, nobody was interested. Of course. Do you find that? I mean, even as you you you'll go like sentiment's terrible, the values are there, we know these are buying on that. Investors still do the wrong thing at the wrong, they go conservative when the the bargain's on the floor, and then when it's fine, they want to hand you all the money, you know. As it's risk adjusted for risk, it's getting worse. Do you do you still battle against that as a fund manager, even with your reputation and all this type of thing?

Buying On Panic And Bad Headlines

SPEAKER_00 29:36

Look, I think we get excited by sell-offs in a market quite crudely, and I, you know, it just creates opportunities. And the people always like, I remember the tariff tantrums last year from Trump. It was similar, it was April last year, and the market sold off. And then I remember people saying to me, I, you know, I always get asked, is now a good time to be buying? I said, like, I don't know, but there's a few things I look at. And you know, one of the things I always look at is, you know, watching the six o'clock news at home every night, the lead story is, you know, 100 billion wiped off the share market. If you look back in time, the correlate, but they are typically great buying days. Because they're the maximum panic for whatever reason, there's always something, but they are typically the times you want to be deploying capital and and and and have a five or 10 year view, and you'll you'll you know, generally your returns will be really, really, really, really strong. And and and we say that to our investors with a loyal investor base, they understand that. And we actually see more money come into the fund through our whole, we're a wholesale fund. More we typically experience more inflows, you know, in periods like we're seeing right now where where there's the markets are down and there's opportunities.

SPEAKER_01 30:43

You just said that you're a wholesale fund. That just did you set up deliberately to not take that kind of retail investor that might get spooked under that kind of environment? So they're not yanking their money out on you, or or was it just an easier to do a wholesale kind of fun?

SPEAKER_00 30:58

It was easier and cheaper, first of all. We did at the outset, we were going to do a listed investment company. We we seriously considered that. Obviously, a retail, a retail product. We decided not to for various reasons. The vagaries around licks trading at premiums and discounts over time was a was a big thing. And I think for us, uh having an unlisted unit trust the way we do, you know, the price is the price. The asset backing is there every month that we price it. So that doesn't needless to say that we could consider doing a retail product again in the future. There's nothing planned right now, but certainly a wholesale fund for us was a a much easier structure to manage from our perspective and a better, potentially a better strategy to to run from an investor's perspective as well.

SPEAKER_01 31:47

Uh just to circle back to where we were, I've I didn't conclude the thing. When it came to AI, did you do you feel like that sell-off has was it is gone too far then? All those stocks, whether it's Wise Tech or REA or Car Group. I know some of these are outside your bucket, but do you feel uh it's gone too negative? And they'll or are they still so expensive? It feels like they were so expensive that even getting cut in half, they're still expensive.

SPEAKER_00 32:15

Yeah, they are in some cases. I think have they been sold off too aggressively? I think the short answer is yes, in some cases. You know, real estate to come is a good example, great business market leader. They'll be around for a long time. And you know, if you speak to real estate agents, they can't live without it and they they won't ever cut them. So, yeah, so it's certainly I think as a general thing, as I said earlier, the stock market always overshoots to the upside, and you never know what the catalyst is going to be for it to fall over. And generally it's in this case, it was AI. You know, I think AI will impact a lot, you know, more companies, some companies more than others. I don't think AI is gonna impact someone like realestate.com as much because at the end of the day it comes down to the agents and the agents' relationships. And and as they say, where are the eyeballs? Well, the eyeballs are on their website, they're not they're not on Google, Google searching for a property because you know it's a trusted source, you're gonna get everything on there. So yeah, so I think there's definitely value appearing in some of those, in some of those things. But yeah, if you look at the last two or three, they had big runs, didn't they, as you say? And so it was a good excuse to sell them, more or less.

SPEAKER_01 33:24

And do you worry about AI's effects on the labor market? I mean, that has to, if there's absolutely, yeah.

SPEAKER_00 33:28

Look, that's the biggest threat, no doubt, about it. And you're gonna see workforce reductions over the next five or ten years in some sectors more than others. You know, there's companies that we've we speak to that they're removing their call center or reducing it by 90% because chatbots and what have you can take over that role of a human. Now, we've seen Atlassian lay off 10% of their workforce in the last couple of months. There's gonna be more of that, unfortunately, over the next little while. But so certainly, yeah, I say AI, yeah, the the biggest negative of all of it in a human sense is that it's gonna impact a lot of people's jobs.

2026 Outlook Timing The Bottom

SPEAKER_01 34:06

Right. Well, I don't want to tie you up for much longer. But so when we look out to 20 for the rest of 2026, you've already indicated you think it's gonna be a little bit tough. So in one way, you have to be offensive to buy the value when you see it. But is overall your positioning still kind of defensive, if that makes sense, if you know what I mean? Like aggressive when you see the opportunity, but you're still not expecting a massive rally to kind of do the work for you, as it were.

SPEAKER_00 34:34

Yeah, I think that's fair. I think I said the next six months is going to be tough for the Australian small cap market, primarily because of interest rates. And as I think there will be two or three more hikes. I just don't think the RBA has got any choice with inflation pushing well north of 4% and even five, could be five as we go forward in three, six months' time. But as we know, the share market is always forward looking. It moves six to nine months into the economy. So at some stage between now and Christmas, I think is gonna be a great time to buy. It's not yet.

SPEAKER_01 35:02

Um actually you're indicating then then that it could get worse.

SPEAKER_00 35:06

Oh, absolutely, yeah, no doubt. I think, I think people could be underestimating the impact that a boat a quick succession of interest rate hikes could have on the economy. And so, yeah, I think there's certainly more downside than upside right now. But as I said, at some stage between now and probably Christmas, there'll be a great buying opportunity. And this we think there'll be a shakeout potentially again. You know, watching a three-year bond is critical, I think, from our perspective. But you know, from a you're probably gonna get the best buying opportunity over the next six months the year you'll have for the next five years. That's sort of how we how we see it. And once we get clarity on the outlook for interest rates, that will that will be the key.

Fund Access And Closing

SPEAKER_01 35:43

Hmm, interesting. Well, definitely want to do it again then. Maybe we'll I'm gonna have to keep an eye on that three-year bond when I when I see a major move. I'm gonna have to call you off and say, hey, I need an update. Chris, it's been an absolute pleasure speaking to you, buddy. We'll do a summary of this and and uh send it out to the members, and I'm sure we'll get some great feedback. And definitely I can forward through anything they said and next, and hopefully we can do it again and generate some questions. Of course, if you're watching this and you're interested in the fund, they can go to your website. Is it even can you even invest in the fund? I think you closed it, didn't you?

SPEAKER_00 36:12

Or is it it it is soft closed at the moment, it's only open to existing investors. It's been that way for five years now. We we we filled up quite quickly in the space of 18 months.

SPEAKER_01 36:21

So if you saw a massive opportunity, would you open it up to oh absolutely, yeah, exactly.

SPEAKER_00 36:26

If there was a big fall in the market, big drop in the fund, we would open it back up again. But there's no no plans to do at this point in time. Uh well, thanks. Great to chat to you, Callum, and thanks for the opportunity. Yeah.

SPEAKER_01 36:37

Pleasure, buddy. Have a good day. Cheers, thank you. Bye-bye.