Big News: We filed our constitution with ASIC last week, which means we now have a much firmer handle on the launch of the Lakehouse Small Companies Fund.
I’m pleased to say that we plan to begin accepting funds from investors in mid-November. Between now and then you can expect us to share a product disclosure statement (PDS) that will distil down all the key points about the fund.
In the meantime, though, here’s a brief Q&A about the fund and our approach based on the most popular questions we’ve received from the 1,900 of you who have registered your interest.
What is the Lakehouse Small Companies Fund?
An unlisted managed fund that will be managed by Lakehouse Capital, which is owned by The Motley Fool. The fund will focus on small-cap shares in Australia and New Zealand.
What’s the big goal of the Lakehouse Small Companies Fund?
We’re going into the funds business to solve problems for our investors. The fund will take the weight off members who would just like us to manage their money for them, plus provide access to investments such as pre-IPOs that are usually reserved for the wealthy and well connected.
And, of course, we aim to outperform over the long-term. Namely, our goal is to outperform our benchmark, the S&P/ASX Small Ordinaries Accumulation Index, over rolling five-year periods.
What kind of companies will the fund buy?
The Lakehouse Small Companies Fund will do what it says on the box. We’re looking at companies outside the ASX 100 — think market caps smaller than $2.5 billion — as they tend to be underfollowed and overlooked. That gives us a universe of around 2,000 potential investments in Australia and New Zealand, which is exciting as few of these smaller companies are on the radars of big institutions and the mainstream press.
The fund will also be able to invest up to 10% of its capital in private companies that we expect to list within the next year. Pre-IPOs are even less picked over than small-caps, which is very compelling.
What’s inside our model portfolio right now probably says it best. The model portfolio holds 21 companies at the moment with an average market cap about $750 million — far smaller than the smallest member of the ASX 100 and in the ballpark of our benchmark average, which is $950 million.
Will the fund pay distributions?
That’s the plan. We expect to pay out distributions twice a year.
What qualities do you look for in potential investments?
Very briefly, we zero in on companies with strengthening competitive advantages in growing markets. They’re selling for attractive prices and run by aligned, experienced management teams. They also boast strong pricing power, diverse customer bases, and prudent balance sheets.
Again, I’ll turn to the positions in our model portfolio as a window into our process. All 15 of our largest positions are growing, most of them growing well into double-digit rates. 14 of the 15 have no long-term debt, and 12 of the 15 have businesses built on proven subscription models. 9 of the 15 even still have founders engaged with the business.
Bigger picture, we’re looking to invest in companies for three, five, and ten-year stretches. Such a long-term outlook underscores why we’re focused on buying quality, well run companies in growing industries. To that end, we’d rather buy a young thoroughbred at a modest discount than a broken-down old nag for a big discount.
How many companies will the fund hold at a time?
We plan to hold 15 to 30 high-conviction investments at a time. We believe in backing our best ideas and I’ve never seen much appeal in putting capital behind my, say, 31st best investment idea. Too much water ruins a Scotch and, as study after study has demonstrated, more concentrated portfolios tend to outperform those watered-down with low-conviction ideas.
Contributing to our mindset is: 1) our long time horizon, and 2) that very few companies meet our high standards. We also prefer to know our companies very well — for example, we’ve met with the CEOs of the 10 largest companies of the model portfolio we’ll soon spring to life — which better suits a concentrated strategy.
One more thing: We like to keep turnover at a minimum, which will save our investors on unnecessary brokerage, reduce tax drag, and fits snugly with our more concentrated approach.
How much cash will the fund typically hold?
We take the view that, while we think it’s smart to keep some dry powder so that we can stay nimble in the illiquid realm of small-caps, our investors are counting on us to put their money to work for them. That’s why we expect to typically hold between 5% and 15% of the fund’s asset in cash, so the lion’s shares of our clients’ money will be working hard for them.
Motley Fool Pro members will notice that’s a lower cash allocation than we held when I led the service. It’s not that my world view has changed — it’s that a managed fund gives me more flexibility to put capital behind a wider range of small companies.
Who should not invest in the fund?
Investing in the fund is a personal decision and the best people to make such a call are you and your financial advisor. I can describe my preferred investor, though.
We prefer investors who share our long time horizon. Like us, they measure success over years, not months. They know that trends come and go but that proven, repeatable investment processes win out over time.
Our preferred investor also has a meaningful stake in the fund, not a punt. Lakehouse Capital is a big commitment and exciting opportunity for us and we want to share that same sense of enthusiasm with our foundational investors.
Expect more details on the fund, including a product disclosure statement (PDS) and how to invest, in the coming weeks. Meantime, our team continues to race towards the starting line as we’ve met with 5 companies each of the past two weeks.
Joe Magyer, CFA
Chief Investment Officer
The above article contains general investment advice only (Lakehouse Capital Pty Ltd is the Corporate Authorised Representative of The Motley Fool Australia Pty Ltd AFSL 400691).