Emerging Companies Fund
Hannah: I'm Hannah Jardine, Business Development Manager at Australian Ethical. Today I'm joined by Nathan Parkin, Head of Australian Equities and our Portfolio Manager for our Emerging Companies Fund. Good morning Nathan.
Nathan: Morning Hannah, great to be here.
Hannah: There's been a real shift in the local share market this year, which has seen smaller companies outperform the better-known larger caps. Can you talk us through that and what's driving it?
Nathan: Yeah, sure. So, advisors would have noticed in the past few months the rising up of smaller companies. So looking at the market in a bit more detail, the top 100 companies in the year to October, we're up an impressive 10.4% but smaller companies have more than doubled our return to 22.8% for the small ordinaries over the same period. Now we think there's a few factors at play. You can buy smaller companies at the moment for lower earnings multiples, but they're delivering higher earnings growth, which we think is a good equation, and the lowering of global interest rates is also helpful in the short to medium term.
Hannah: So what's happening here is this a short-term trend or something that you expect to continue?
Nathan: There's a couple of factors at play. Over the past four or five years, as we've had market volatility and uncertainty, investors have really paid with the larger companies in the market, and so a lot of weight of money is pushed into those companies, and now the multiples that investors have paid for them really justifying the earnings growth that's been delivered. So, you can see companies like Woolworths and CommBank over reporting season actually start to underperform because investors have realised they paid a very high multiple for very low earnings growth going forward, we do think that the economic growth that's been delivered around the world is pretty solid. Inflation is more benign than it was, and there's a lowering of interest rates, which is pretty supportive for equities, and in particular, small cap stocks over medium term, yeah.
Hannah: And can you describe some of the opportunities in the portfolio at the moment?
Nathan: Yeah, there's always a good range of opportunities in the emerging companies fund. Here, about 65% of the fund is invested in high quality industrials and financials right now. They're producing a high level of free cash flow. They've got good, solid balance sheets. The growth part of the portfolio, there's about 25% of the fund invested in companies that are in the scaling up mode, and so what that says is, there's good revenue growth there, but they're at the point of inflection point of free cash flow, and that provides the growth opportunity for investors in the fund.
Hannah: Can you talk to us about some of the companies that we're investing in?
Nathan: Yeah, I'd love to, there's two that I'd highlight. Sims Metal, which is a recycling company, and SomnoMed, which is a sleep apnea device company. Interestingly, we've held both companies in the portfolio for over 10 years. So firstly, I'll discuss Sims Metal, the company processes about 8 million tons of steel every year, and that's about the weight of 9 million cars. So recycled steel is a crucial input for manufacturers and steel mills, helping power the circular economy, but by reusing materials, Sims not only boosts its own earnings, it also helps investors back a more sustainable future. Steel making itself is responsible for about 9% of global carbon emissions, but by using scrap metal, steel makers can contribute to cutting those emissions by investing in Sims. We're not only investing in a company we expect to grow revenues and generate returns. We're also supporting smarter resource use, lower emissions and a cleaner manufacturing future.
So next up, we'll discuss SomnoMed, and it's hard to believe a small Aussie company like SomnoMed delivered a million oral devices for sleep apnea treatment worldwide. We see SomnoMed as a strong investment. It operates in a high margin, scalable medical device niche with recurring demand and a growing customer base, plus it benefits from us tariff exemptions under the Nairobi protocol. So, the sleep health industry is booming, driven by rising obesity aging populations and growing awareness of the risks of untreated sleep apnea, which affects nearly a billion people globally. So, by investing in SomnoMed, we're backing a solution that helps patients swap bulky CPAP masks for more comfortable oral devices, improving compliance, quality of life and long-term returns as a company expands.
Hannah: That's great. Nathan, thank you so much for your time.
Nathan: Thanks Hannah.
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Interests in Australian Ethical Managed Funds are issued by Australian Ethical Investment Ltd (ABN 47 003 188 930, AFSL 229949) the Responsible Entity of the Australian Ethical Managed Funds. The information is of a general nature and is not intended to provide you with financial advice or take into account your personal objectives, financial situation or needs. Before acting on the information, consider its appropriateness to your circumstances and read the Financial Services Guide, relevant product disclosure statement (PDS) and Target Market Determination (TMD) available on our website. You may wish to seek financial advice from an authorised tax or financial adviser before making an investment decision. Past performance is not a reliable indicator of future performance.
Investing ethically and sustainably means that the investment universe will generally be more limited than non-ethical, non-sustainable portfolios in similar asset classes. This means that the portfolio(s) may not have exposure to specific assets which over or underperform over the investment cycle, and so the returns and volatility of the portfolio(s) may be higher or lower than non-ethical, non-sustainable portfolios over all investment time frames.
This transcript may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, Australian Ethical accepts no responsibility for the accuracy or completeness of, nor does it endorse any such third party material. To the maximum extent permitted by law, we intend by this notice to exclude liability for this third party material.
The information contained in this transcript is believed to be accurate at the time of compilation.
Equity market sentiment has stabilised since the beginning of the year as markets have become more immune to geopolitical headlines, allowing a return to company fundamentals as the primary focus. The continued lowering of global interest rates and stable economic growth and lower inflation has assisted market sectors outside of the large blue-chip stocks to perform positively.
The Emerging Companies wholesale fund outperformed its ASX Small Industrials benchmark (12.9% vs 11.2%), over the 3 months to 30 September 2025.
The Fund’s holdings in the Information Technology sector were the strongest contributor to relative investment performance with vehicle fleet monitoring company EROAD (+77%) getting a boost from likely favourable legislation change in NZ, hotel room management company Siteminder (+63%) and digital education software group Janison Education (+47%) all performing strongly on good results and positive outlook over the August reporting period.
The sectoral laggards included utilities with electricity generator-retailers Contact Energy (-4%) and Meridian (-11%), both underperforming the Small Industrials as they reported subdued results due to major droughts affecting electricity generation in New Zealand and uncertainty over the outcomes of a regulatory review weighed on the sector. Conditions have improved, regulatory risks are manageable and we retain positions in both companies due to a better outlook.
The consumer discretionary sector also detracted from relative performance due to digital hotels marketplace operator WEB Travel Group (-11%) still fine tuning its organisational momentum after its de-merger last year and had also seen some subdued travel demand across Europe. We see the company representing compelling value and have increased our position.
Outlook for the Fund
Current macro settings are positive for markets, albeit valuations for larger companies remain high in a historical context. The lower volatility of equities is providing an opportunity for investors to look for emerging companies that might provide a better risk/reward tradeoff and higher earnings growth. We expect that corporate and private equity interest in Australian micro-cap companies will remain a feature in coming months.
Emerging Companies (Wholesale) Fund Performance
As at 30 September 2025*
| fund | benchmark^ | |
|---|---|---|
| 3 months | 12.9% | 11.2% |
| 6 months | 19.6% | 20.6% |
| 1 year | 12.8% | 12.9% |
| 3 years p.a. | 14.4% | 14.7% |
| 5 years p.a. | 8.5% | 7.1% |
| since inception p.a. | 13.2% | 7.7% |
Source: FE fundinfo.
^Benchmark: S&P ASX Small Industrials Index.
*Past performance is not a reliable indicator of future performance. Fund returns are net of fees.
Inception date: 30/06/2015.
Emerging Companies (Retail) Fund Performance
As at 30 September 2025*
| fund | benchmark^ | |
|---|---|---|
| 3 months | 13.0% | 11.2% |
| 6 MONTHS | 19.4% | 20.6% |
| 1 year | 12.2% | 12.9% |
| 3 years p.a. | 13.9% | 14.7% |
| 5 years p.a. | 8.0% | 7.1% |
| since inception p.a. | 12.5% | 7.7% |
Source: FE Fundinfo
^Benchmark: S&P ASX Small Industrials Index. Past performance is not a reliable indicator of future performance. Fund returns are net of fees.
Inception date: 30/06/2015.
Contributors and detractors
Top 3 contributors to Fund return
76.8%
EROAD Limited (ERD)
+62.8%
SiteMinder Limited (SDR)
+33.8%
Nuix Ltd. (NXL)
Top 3 detractors from Fund return
-21.2%
Gentrack Group Ltd (GTK)
-48.8%
Mach7 Technologies Ltd (M7T)
-18.7%
MedAdvisor Limited (MDR)Contributors
- EROAD (ERD) was a strong contributor to performance over the quarter driven largely by a positive regulatory development on electronic road user charging (eRUC) from the NZ government which expands EROAD’s market opportunity to an additional 3.5m light passenger vehicles as they transition onto the eRUC system. With EROAD currently the market leader for existing vehicles subject to eRUC, we view the company as best positioned to capture the leading share of this segment as it is implemented in 2027.
- Siteminder (SDR) had a strong FY25 result with higher than expected underlying ARR growth of 27% which was high quality based on the solid 6.2x LTV/CAC ratio with minimal churn. The FY26 outlook implies a continuation of this strong growth trend, driven by the ongoing rollout of the new Smart Platform products which have been gaining traction since their launch. We remain positive on the long-term investment thesis of expanding its share and take rate of the large addressable market.
- Nuix (NXL) had a solid share price recovery during the period as new deals signed in FY26 particularly with the German tax authority of the Rhineland-Palatinate state for forensic analysis software overshadowed the lower ACV growth in FY25. This suggests that the timing of deals in the sales pipeline is showing signs of improvement from the previously elongated sales cycle.
Detractors
- Gentrack (GTK) announced in July that a key Australian customer had not renewed with the company and will be transitioning to a competitor due to lower pricing and the fact that Gentrack’s G2 product was not live yet. As these transitions take time, there is limited impact on earnings in the short term though it puts increased pressure on the company to win new deals to offset the loss. The company remains well positioned for further growth over the medium term and a beneficiary of the structural energy transition thematic.
- Prophecy International (PRO) experienced a significant decline in its share price over the quarter as their annualised recurring revenue (ARR) had declined due to customer churn in the Emite and Snare businesses along with a reduction in their sales pipeline. This has led to a cost cutting program to align the cost base to the lower revenue base in order to target free cash flow neutrality which culminated in the CEO’s exit. The company is continuing to navigate a transformational merger with AI decision optimisation software provider Complexica of which there is uncertainty whether this will complete given Prophecy’s financial position.
- IPH Ltd (IPH) underperformed during the period as its FY25 result pointed to a mixed outlook. While Asia presents genuine growth opportunities, with strong filing momentum across several markets, this was offset by declining filing volumes in Australia. IPH offers compelling value, benefiting from positive exposure to increased investment from a declining global interest rate environment, while trading at an attractive 7.5x P/E and delivering a robust 10% yield.
We added bulk grain handling company Graincorp to the portfolio as we believe the market is underestimating the earnings outlook for the stock in FY26 driven by favourable crop conditions on the East Coast of Australia.
Portfolio changes
Additions to the Fund
- Graincorp Limited Class A (GNC) is vertically integrated bulk grain handling company with high quality infrastructure assets and a strong market position, servicing the domestic and international markets. It also has nutrition and energy business producing a range of oils, meals and food products. We added GNC to the portfolio as we believe the market is underestimating the earnings outlook for the stock in FY26 driven by favourable crop conditions on the East Coast of Australia. We see compelling valuation upside, while a strong balance sheet also provides management with flexibility to pursue growth opportunities, while also returning capital to shareholders.
Reductions from the Fund
-
We exited the position in 3P Learning Ltd. (3PL) following the FY25 result which highlighted that the lack of sales growth remained a core issue despite an improvement in earnings. Without meaningful growth prospects and better defensibility against AI disruption, we viewed that it would be difficult for the stock to re-rate from current levels.
- Domain Holdings Australia Ltd. (DHG) was acquired by CoStar in August 2025 following approval of the transaction by shareholders.
- We exited the position in Kinatico Limited (KYP) following a period of strong share price performance as we viewed the re-rated valuation as fair for a business with some execution risk in the midst of transitioning its revenues to SaaS whilst investing in its new compliance solution.
- Macquarie Technology Group Limited (MAQ) has been a successful investment for the Fund over many years, led by a strong founder and management team that has seen the business grow from a small telco into a fast growing business leveraged to the growth in cloud and AI. While we continue to admire what MAQ has become, this evolution into a capex hungry data centre business has altered the investment thesis, with dividends not likely to be a feature for the foreseeable future. We have therefore chosen at this time to take profits and monitor the progress that MAQ makes over the coming years.
- We initially invested in Praemium Ltd (PPS) as a lower-priced alternative to peer challenger platforms such as Netwealth and HUB24, attracted by its valuation discount and potential for operating leverage. However, several developments have led us to reassess the investment case. Despite strong headline growth in FY25, PPS has continued to lag larger peers in terms of platform flows and market share gains. The loss of Asgard as a portfolio services client represents a material revenue headwind and undermines confidence in PPS’s competitive advantage in the non-custodial segment. Further to this Netwealth announced its intentions to invest in this space. Given these factors we chose to exit the position.
Sector allocation
Sector overweights
Cash, Financials, Health Care, Information Technology, Utilities (renewables)
Sector underweights
Communication Services, Consumer Discretionary, Consumer Staples, Industrials, Materials, Real Estate
The lower volatility of equities is providing an opportunity for investors to look for emerging companies that might provide a better risk/reward tradeoff and higher earnings growth.
*Total returns are calculated using the sell (exit) price, net of management fees and gross of tax as if distributions of income have been reinvested at the actual distribution reinvestment price. The actual returns received by an investor will depend on the timing, buy and exit prices of individual transactions. Return of capital and the performance of your investment in the fund are not guaranteed. Past performance is not a reliable indicator of future performance. Figures showing a period of less than one year have not been adjusted to show an annual total return. Figures for periods of greater than one year are on a per annum compound basis. The current benchmark may not have been the benchmark over all periods shown in the above chart and tables. The calculation of the benchmark performance links the performance of previous benchmarks and the current benchmark over the relevant time periods.
Interests in the Australian Ethical Managed Funds are issued by Australian Ethical Investment Ltd (ABN 47 003 188 930, AFSL 229949), the Responsible Entity of the Australian Ethical Managed Funds. The information in this summary is of a general nature and is not intended to provide you with financial advice or take into account your personal objectives, financial situation or needs. Before acting on the information, consider its appropriateness to your circumstances and read the Financial Services Guide, relevant product disclosure statement and Target Market Determination available on our website. You may wish to seek financial advice from an authorised tax or financial adviser before making an investment decision. Past performance is not a reliable indicator of future performance.
This commentary may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, Australian Ethical accepts no responsibility for the accuracy or completeness of, nor does it endorse any such third-party material. To the maximum extent permitted by law, we intend by this notice to exclude liability for this third-party material.
Investing ethically and sustainably means that the investment universe will generally be more limited than non-ethical, non-sustainable portfolios in similar asset classes. This means that the portfolio(s) may not have exposure to specific assets which over or underperform over the investment cycle, and so the returns and volatility of the portfolio(s) may be higher or lower than non-ethical, non-sustainable portfolios over all investment time frames.
The information contained in this document is believed to be accurate at the time of compilation.