Category: Letter to Investors

Idea Bonanza!

In another good month for equity markets, January saw all of the Ophir funds outperform, with gains of at least +4% each, driven by good early Q4 earnings results for our Global Funds.
The Mag-7 took a back seat in performance during the month, and many investors are asking whether DeepSeek’s AI has turned their once-powerful moats into mere puddles.
Investors are focused on what could spark small-cap outperformance, but they should also be judging small caps on their superior reward-to-risk ratio relative to large caps which, in our opinion, should deliver outperformance over the next 5 years.
While small-cap performance has been hampered by sluggish earnings growth, there are promising signs this could be about to change.
In January we made the trek to the Needham Growth Conference in New York, leaving with a record number of fantastic ideas which should serve to significantly strengthen our portfolio.

At Ophir, we have notification alerts set up on our phones with many of the major news outlets including The Australian Financial Review, The Australian, The Wall Street Journal, The New York Times, Bloomberg News … the list goes on.

This year it has felt like almost every time a notification has popped up, in the headline has been the word ‘Trump’ or ‘Musk’. We don’t expect that to change much over the next four years. We just have to get used to it.

For investors, though, it helps to remember that, over the long run, almost the only thing that matters for a company’s share price is its earnings.

Not tariffs, interest rates, inflation, immigration policy, DOGE spending cuts, how many ‘illegal aliens’ are getting deported this week from the U.S., or whether a new ‘Riveria’ is being created in the Middle East.

Of course, some of these things will matter for some companies’ share prices, but mostly in the short term.

At a portfolio level, over the longer term, politics and government policy runs a distant second (or third or fourth) behind the idiosyncratic drivers of a company’s earnings.

Overwhelmingly, the things that have always mattered the most in investing will continue, such as:

The size of a company’s addressable market
The value the company offers its customers compared to its selling price
Its ability to scale cost effectively
The size of any moats that protect it from competition
The strength of its balance sheet
Its bargaining power with suppliers, and
The gap between current and assessed value of the business

It’s easy to forget this when the volume of Trump or Musk articles goes stratospheric.

January 2025 Ophir Fund Performance

Before we dive further into the Letter, we’ve provided a detailed monthly update for each of the Ophir Funds below.

The Ophir Opportunities Fund returned +5.2% net of fees in January, outperforming its benchmark which returned +4.6%, and has delivered investors +23.0% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned +6.6% net of fees in January, outperforming its benchmark which returned +5.1%, and has delivered investors +14.1% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +2.0% for the month.

The Ophir Global Opportunities Fund returned +5.1% net of fees in January, outperforming its benchmark which returned +3.1%, and has delivered investors +18.0% p.a. post fees since inception (October 2018).

🡣 Ophir Global High Conviction (Class A) Fund Factsheet

The Ophir Global High Conviction Fund (Class A) returned +4.5% net of fees in January, outperforming its benchmark which returned +3.1%, and has delivered investors +13.9% p.a. post fees since inception (September 2020).

The Ophir Global High Conviction Fund (Class B) returned +4.3% net of fees in January, outperforming its benchmark which returned +3.1%, and has delivered investors +28.1% p.a. post fees since inception (June 2023).

🡣 Ophir Global High Conviction (Class B) Fund Factsheet

The Mag-7 finally takes a backseat

Putting aside some of the noise, it was a good month for equity markets overall in January, and for the Ophir Funds.

Each of the Ophir Funds were up +4% or more, and all outperformed for the month. A pleasing result, particularly for the Ophir Global Funds where the performance was driven by good Q4 earnings results for some of our stocks.

After a muddle through the first half of January, major equity indices put on solid, to- in some cases great, returns in the second half of the month.

What was most interesting was that U.S. exceptionalism and Magnificent-7 led outperformance over the last couple of years, took a back seat.

While the S&P 500 was up +2.7%, the Mag-7 actually underperformed, rising just +2.5%. The equal weighted S&P 500 (where all 500 stocks get a 0.2% weight) rose +3.4%, which highlights that smaller large caps did better than the behemoths.

The perennially underperforming European equity market (Euro Stoxx 50) put on a whopping +8.0% – eclipsing that index’s all-time high from way back in the year 2000!

It also reverses, albeit for just a month, a little of the 25-year underperformance of the European versus the U.S. share market.

The question for investors is whether this the start of a rotation in leadership for this current bull market in shares that started back in October of 2022?

Space Race redux

Undoubtedly the big news in January that put a chink in the armour of some of the Mag-7, and particularly U.S. chipmaker Nvidia, was Chinese firm DeepSeek.

We won’t go into the details here because it’s been thoroughly covered by the press. But many were calling it a ‘Sputnik’ moment for the U.S. – that is, the U.S. might not be as far ahead in the AI ‘arms race’ as previously thought. This had echoes of the USSR’s 1957 launch of Sputnik, the first earth-orbiting satellite, a development which shocked Americans and helped trigger the space race between the U.S. and Russia.

This raises several questions:

Is DeepSeek’s R1 – China’s new open sourced ‘reasoning’ AI large language model (LLM) – close in performance to the best U.S. models like Open AI’s ChatGPT? It appears so.
Is it significantly cheaper to build and train than the best U.S. models? That’s what is being claimed, with some saying R1 was built for only 5% of the cost of U.S. models, though others argue that figure is understated.
And has DeepSeek made some significant advances in software architecture that helped provide great performance at low cost? It seems the answer here too is yes, with U.S. competitors acknowledging the smarts behind DeepSeek’s code.

What is undeniable, though, is the meltdown that Nvidia’s share price suffered. After the DeepSeek announcement on the 27^th January, Nvidia fell -17.0%, wiping out US$593 billion in market cap from the then-largest listed company in the world.

To put that in perspective, below are the 30 largest listed companies in the U.S. below $US500 billion in value at the time.

Source: Jefferies.

So, in other words, Nvidia’s market cap loss was the equivalent of McDonalds and Coca Cola being wiped from the face of the earth. (New Secretary of Health and Human Services RFK Jr has assured us he’s not taking away McDonald’s, one of Trump favourite foods!)

Source: X (Donald Trump Jr)

Moats or puddles?

All eyes during the recent U.S. reporting season were on the big capex plans of the hyperscalers, such as Meta, Google and Microsoft. Given DeepSeek’s seemingly cut-price AI LLM build job, investors wanted to know the hyperscalers weren’t wasting that big capex spend.

Investors have given them the benefit of the doubt for now.

As Microsoft CEO, Satya Nadella, said: “Jevons Paradox strikes again! As AI gets more efficient and accessible, we will see its use skyrocket, turning it into a commodity we just can’t get enough of.”

The logic of the ‘Jevons Paradox’ is that a lower cost to produce = lower cost to consumers = higher demand from consumers as AI is built into all sorts of products.

But while the news from DeepSeek seems good for consumers and demand for AI applications more generally, the question now is whether the ‘moats’ for Meta, Google, Microsoft, and Co, are now more like shallow puddles in AI – that is, easier to be attacked by smaller upstarts?

What could spark small-cap outperformance?

Speaking of smaller upstarts, as small-cap investors, probably the most frequent question we get asked is: “We get small-cap valuations are very cheap versus large caps globally, but what might be the catalyst for small-cap outperformance?”

It’s an excellent question.

While small-cap valuations are very cheap globally versus large caps – and particularly in the U.S. where they really haven’t been this cheap in 25 years – small caps, in our opinion, will likely outperform large over the next 5-10 years.

It’s trickier to identify when that outperformance may start.

Firstly, we’d say don’t try pick the start. It’s better to focus on the fact that ultra-cheap relative valuations provide an asymmetric return payoff in small versus large caps. That is, should mean reversion in valuations occur like it has historically, small caps have more limited relative downside (it’s hard for them to get much cheaper in a relative sense) but much larger upside than large caps. This is why we are personally putting more money into our Ophir Global Funds now.

Earnings growth set to broaden out to small caps

One thing that’s likely been holding back small-cap outperformance is that for much of the last two years aggregate earnings of U.S. small caps (which make up almost 2/3’s of the global small cap market) have been stagnant. (Side Note: this is not the case for our Ophir Global Funds where through stock picking we have continued to be able to find companies growing earnings significantly).

This stagnant aggregate U.S. small cap earnings can be seen in the chart below with the yellow line of U.S. small cap earnings-per-share growth moving sideways, whilst mid, large and mega-cap earnings have grown.

Source: Bloomberg, Ophir

Why?

The Fed’s rate rise cycle has basically caused a bifurcated U.S. economy. Large caps earnings have been boosted by very strong Mag-7 earnings. But small caps, which hold disproportionately shorter-term floating-rate debt, have suffered under the weight of higher interest costs.

This may be about to change though.

Interest rates, not just in the U.S., but globally, are now being cut (yellow line below). That should lead to a cyclical upswing in the U.S. economy – as measured by the Institute of Supply Management’s New Orders Index – a key leading index of manufacturing activity in the U.S. (red line below).

Source: Piper Sandler

Historically, as seen in the below chart, upswings in manufacturing activity have tended to see a broadening out of earnings growth in corporate America.

Never before have we seen more than two years in a row of flat or negative aggregate earnings growth across U.S. small caps. So there is some hope that 2025 represents a return to growth and leads to further liquidity flowing into and supporting the cheap small-cap valuations.

Source: Piper Sandler

Big conference conversion

In last month’s Letter to Investors (read here) we spoke about how the election of Donald Trump has given a shot in the arm to U.S. small business optimism.

Over November and December, the NFIB Small Business Optimism Index jumped the most in any two-month period in the Index’s 50-year history!

The percentage of small business owners expecting the U.S. economy to improve in the next year also recently reached near record levels.

With this background we were very excited to head one of our favourite small-cap conferences globally in January, the Needham Growth Conference in New York.

Over a few days, we had 28 one-on-one company meetings.

Normally at conferences like this we would have 2 or 3 high-quality ideas that result in 1 or 2 investments.

This year we had 9 ideas! And we think 4 or 5 investments might come from it.

High grading the portfolio

Small-cap businesses are definitely more bullish heading into the New Year, with a new market and US-economy-friendly administration in place, and major central banks cutting rates (ex the Bank of Japan who is doing its own thing!).

On one hand our cautious nature has the team asking: have we lowered our threshold for great ideas?

But for us (Andrew and Steven), who have seen this movie before, our muscle memory would tell us it’s more likely that, overall, the businesses we have seen are indeed more confident that they can grow earnings faster than last year and faster than the market expects.

This is great news for our Global Funds because it keeps pressure on the portfolios and increases the quality of ideas.

If we do have 5 new stocks come into the Global Funds, the threshold for getting in usually means they are at least an average weight stock of say 3-4%.

This in turn means the bottom 5 get pushed out, and the strength of the overall companies in the portfolios gets high graded.

That is exactly what we want. New year, new ideas and high pressure for only the best companies to remain in our Funds.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior Portfolio Managers

Ophir Asset Management

16 Jan, 2025 Letter To Investors - December

27 Feb, 2025 Keeping you in the AIR

16 Jan, 2025

Letter To Investors - December

Letter to Investors • 11 mins read

Ho Ho Ho… Hum

2024 saw the fifth best year in the U.S. share market in the last quarter century, led by large caps, with material underperformance (albeit still positive) for small caps
Last year all Ophir Funds delivered strong outperformance and met their long-term investment objectives
We’re particularly pleased that our outperformance in 2024 was driven by our investment process, which focuses on stock selection, rather than other investing “factors”
The outlook for further U.S. interest rate cuts may be diminishing, but there is renewed optimism in small businesses and a continuing strong U.S. economy should finally deliver the anticipated earnings growth (and share price performance) of small caps

We hope Santa delivered what you wanted under the tree because he didn’t deliver what investors were hoping for – a Santa share market rally in December.

Perhaps it was too much to ask for after November’s generally stellar gains across the major bourses.

The cause of December’s weakness?

The most obvious was the U.S. Federal Reserve. Despite cutting rates by 0.25% during the month, the Fed signalled there may not be many more cuts (with a non-zero chance of no more cuts!) in 2025.

Most share markets fell in December, with the S&P 500, Russell 2000, MSCI Europe and MSCI Australia Indices down -2.4%, -8.3%, -0.5% and -3.1% respectively (local total returns).

Fortunately for unhedged investors, including those in our Global Funds, much of the fall in the U.S. share market was offset by a falling Australian Dollar, which helped protect returns when converted to the domestic currency.

But, overall, 2024 was still a great year for the global share market. Though, admittedly, this was mostly because U.S. large caps had such a stellar year … again!

The S&P 500 ended up +25.7% (total return) in 2024 – the 5^th best calendar year return in the last 25 years. You know what beat it out for 4^th spot? 2023 – with a return of +26.8%.

And when you consider 2019 (+31.3%) and 2021 (+30.6%) hold first and second place over the last quarter century, it’s hard to escape the conclusion that being invested in the biggest companies from the biggest economy in the world has been a great place to be recently.

Share markets rose in 2024 because of several factors:

U.S. macro risks, like recession, high inflation and employment worries, generally fell;
The Fed started cutting interest rates;
Trump was elected, raising economic and market hopes; and
The AI train rolled on, boosting the Magnificent 7’s earnings and share prices.

December 2024 Ophir Fund Performance

Before we jump into the Letter, we’ve provided a detailed monthly update for each of the Ophir Funds below.

The Ophir Opportunities Fund returned -2.5% net of fees in December, outperforming its benchmark which returned -3.1%, and has delivered investors +22.7% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned -5.4% net of fees in December, underperforming its benchmark which returned -3.4%, and has delivered investors +13.5% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +0.0% for the month.

The Ophir Global Opportunities Fund returned -0.9% net of fees in December, in-line with its benchmark which returned -0.9%, and has delivered investors +17.4% p.a. post fees since inception (October 2018).

🡣 Ophir Global High Conviction (Class A) Fund Factsheet

The Ophir Global High Conviction Fund (Class A) returned -1.3% net of fees in December, underperforming its benchmark which returned -0.9%, and has delivered investors +13.0% p.a. post fees since inception (September 2020).

The Ophir Global High Conviction Fund (Class B) returned -1.2% net of fees in December, underperforming its benchmark which returned -0.9%, and has delivered investors +26.3% p.a. post fees since inception (June 2023).

🡣 Ophir Global High Conviction (Class B) Fund Factsheet

Small cap struggle

Last year small caps continued to underperform large caps, and nowhere was this more evident than in the U.S.

In fact, in 2024, U.S. small caps (Russell 2000) lagged large caps (S&P 500) by +13.3% – the most since 1998.

A good chunk of this came in December just gone, where the almost 6% underperformance delivered the 5^th worst monthly underperformance by U.S. small caps to U.S. large caps this century.

Longer term, as seen in the chart below, U.S. small caps have now underperformed for four years in a row.

Source: Ophir, Bloomberg. Calendar year returns are provided for the S&P 500 (US Large Caps) minus the Russell 2000 (US Small Caps) from 1980 to 2024.

But Ophir Funds provided great returns and outperformance in 2024

Whilst one-year returns are too short a period to get overly excited about, we are happy that, despite the small-cap underperformance, the Ophir Funds provided returns between +21% to +45% over 2024:

Starting off with our Ophir Opportunities Fund. Despite operating for more than 12 years now, we’ve been able to continue with the good results, returning +42.8% last year.
Not as strong but still a great outcome, our Ophir High Conviction Fund provided an investment portfolio return of +21.2%. But based on its ASX listed price, it returned an even higher +26.7%, as its discount to Net Asset Value shrank over the year.

Ophir Australian Funds – Performance to 31 December 2024

Turning to our Global Funds, given their high level of stock overlap, they provided very similar returns at +45.1% and +44.7% each for the Global Opportunities Fund and Global High Conviction Fund.

Ophir Global Funds – Performance to 31 December 2024

Source: Ophir. Bloomberg. Data as of 31 December 2024.

These numbers mean that the Ophir funds even outperformed the Australian and global large cap Indices in 2024.

While we would never want investors to extrapolate those sorts of one-year numbers into perpetuity, or think we are going to repeat them year in and year out, they have comfortably met our long-term goal of 5% outperformance versus our market benchmarks, and the 15% absolute return per annum we target over the long term.

It was stock picking that drove Ophir’s 2024 outperformance

So what drove the outperformance in the Ophir funds last year?

As we highlighted in our Investment Strategy Note last month (link) it has continued to be stock picking.

We show this below for our Global Opportunities Fund (which is mirrored very closely with outperformance from our Global High Conviction Fund).

When we look at the ‘factors’ (see article linked above for further details) or common characteristics that might have caused this outperformance, we see things like our allocation to different countries, the market sensitivity of the companies we held in the portfolio (‘beta’), or the size of those businesses, amongst other things, made very little contribution to our outperformance.

Source: Ophir. Bloomberg. Data as of 31 December 2024. Benchmark is the MSCI World SMID Cap Index NR (AUD). Factor analysis uses proxy of Bloomberg Global Developed Mid Small Index.

Ultimately, it was good old fashioned stock picking (here formally called “selection effect”).

This is great news because that is what our investment process targets.

If it was exposure to some other factor – like being overweight U.S. stocks when the U.S. share market did well (which would show up as a positive “Country” factor attribution) – we’d be worried (and so should you!) because it’s not a sustainable way to outperform with our investment process. We don’t try to invest based on factors other than stock picking because a) it’s very difficult to do; and b) we have no skill in it.

We are happy our hard work finding mispriced companies that are growing faster than the market expects has been rewarded in 2024.

Of course, the work doesn’t stop. We need to keep “pounding the rock” (see link to this great motto from the NBA San Antonio Spurs Hall of Fame coach Greg Popovich here).

We are acutely aware new investors are coming on board all the time and for you our very long-term returns are just numbers on a page, not tangible results.

U.S. small business gets excited about Trump 2.0 from 2025

Returning to U.S. small caps, one thing holding back the relative performance of U.S. small caps over the last few years is that their earnings have not been growing as fast as their larger brothers and sisters, such as the Magnificent 7.

When may that change?

We were encouraged in December when the NFIB (leading U.S. small business association) Small Business Optimism Index – closely followed by economists – jumped 8 points in November after Trump’s election win.

This was the third-biggest monthly jump in U.S. small business optimism in the last half century! It also took the reading back above its 50-year average of 98, a level it had been below for the last almost 3 years.

Source: Bloomberg. Data to 31 December 2024.

As NFIB Chief Economist Bill Bunkelberg wrote at the time:

“The election results signal a major shift in economic policy, leading to a surge in optimism among small business owners. Main Street also became more certain about future business conditions following the election, breaking a nearly three-year streak of record high uncertainty. Owners are particularly hopeful for tax and regulation policies that favor strong economic growth as well as relief from inflationary pressures. In addition, small business owners are eager to expand their operations.”

*At writing the December data for the NFIB Small Business Optimism Index was released, showing another gain, and the highest reading since late 2018. Interestingly, the net percent of owners expecting the economy to improve rose to a net 52%, the highest since the fourth quarter of 1983!

We are hearing this from the coal face from our portfolio companies too. Optimism is up. Hiring and capex intentions have increased. We’ll be keeping a keen eye on how this translates to company guidance for revenues and profits this year that will be provided at full-year 2024 results in late January and February.

This optimism needs to be tempered with the more recent news that potentially little further rate cut relief is ahead in the U.S., which may limit further valuation increases.

But here too we may have a silver lining.

U.S. rates may not come down much from here, simply because the U.S. economy is in such strong health. And that bodes well for small cap earnings too – especially if we see a friendly Trump 2.0 policy mix for domestically orientated U.S. small-cap businesses.

We are excited about the new year ahead having returned from a brief break and raring to go. The investment team is in a great place, and we can’t wait to get stuck into reporting season for our portfolio companies that starts later this month. We think we own some great businesses that should pleasantly surprise the market and help build on 2024’s investment returns.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior Portfolio Managers

Ophir Asset Management

11 Dec, 2024 Letter To Investors - November

20 Feb, 2025 Letter To Investors - January 2025

11 Dec, 2024

Letter To Investors - November

Letter to Investors • 14 mins read

Why we Trust this Pilot to take off

November didn’t disappoint share market investors. A Trump-led rally shot the S&P500 (U.S. large caps) up +5.7% and the Russell 2000 (U.S. small caps) up +10.8% — the best monthly return for each index this year.

That was nothing compared to Bitcoin, which exploded +38.5%. Trump is seen as a ‘BFF’ (Best Friend Forever) to the crypto market.

Aussie large-caps followed the U.S. up, adding +3.2%, though Aussie small caps lagged somewhat, rising +1.3%.

The big monthly return in U.S. small caps captured the headlines though, as the market has started to price in the potential benefits of Trump’s proposed tax cuts, as well as his more protectionist policy agenda. Both should disproportionately benefit smaller and more domestically orientated U.S. businesses.

We have been delighted at the recent surge in small-caps and in this month’s Letter to Investors we lift the lid to see just what’s driving the recovery. So far, it’s largely been a story of improving valuations. But could an earnings recovery kick in and help propel small-cap share prices even higher?

We also take a close look at Trustpilot, a stock that is bringing credibility and trust to internet reviews. We watched the company for some time before buying in October this year. As you’ll see, the company and its share price have huge upside potential and it’s a stock we’re particularly excited about.

U.S. large cap Santa rally is set to continue

It’s been a banner year so far for the heavyweight U.S. share market with returns year-to-date the strongest in at least 25 years.

Source: Piper Sandler. Data to 26 November 2024.

About 17% of the 27% rise in the S&P500 this year to the end of November – or in other words a little more than half – has been expanding valuations (price to earnings ratio) as macro risks have been priced out.

The market has more comfort that U.S. inflation is under control, no recession is imminent, and election uncertainty has now been resolved.

Seasonally, we are also in the best two-month stretch for the U.S. share market (November and December), and there seems to be little that could get in the way of the Santa rally into year end.

Historically, PE re-rating is usually the precursor to a market rally as the market is forward looking despite declining or anaemic profit growth. So, the question on everyone’s mind is – will history repeat as it has done many times before?

November 2024 Ophir Fund Performance

Before diving into this month’s Letter, we’ve provided a detailed monthly update for each of the Ophir Funds below.

The Ophir Opportunities Fund returned +4.2% net of fees in November, outperforming its benchmark which returned +1.3%, and has delivered investors +23.1% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned +7.5% net of fees in November, outperforming its benchmark which returned +3.5%, and has delivered investors +14.3% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +9.6% for the month.

The Ophir Global Opportunities Fund returned +11.9% net of fees in November, outperforming its benchmark which returned +6.8%, and has delivered investors +17.8% p.a. post fees since inception (October 2018).

🡣 Ophir Global High Conviction (Class A) Fund Factsheet

The Ophir Global High Conviction Fund (Class A) returned +12.6% net of fees in November, outperforming its benchmark which returned +6.8%, and has delivered investors +13.7% p.a. post fees since inception (September 2020).

The Ophir Global High Conviction Fund (Class B) returned +11.5% net of fees in November, outperforming its benchmark which returned +6.8%, and has delivered investors +29.1% p.a. post fees since inception (June 2023).

🡣 Ophir Global High Conviction (Class B) Fund Factsheet

A ray of light in small-cap earnings?

While U.S. large caps have seen earnings rise 10% this year (+17% valuation increase = the 27% S&P500 return), it’s been tougher in U.S. small-cap land where earnings (earnings per share or EPS in the chart below) have gone slightly backwards. Small businesses there have been suffering through more recession-like conditions.

The +16% return in the S&P600 index this year (another U.S. small cap index along with the Russell 2000) has been all driven by expanding valuations that still remain very cheap at around 19x forward earnings versus U.S. large caps at around 26x forward earnings.

Valuation increase drives all the return for U.S. small caps this year

Source: Piper Sandler at as 26 November 2024.

Valuation increases, though, are not a sustainable way to generate investment returns and do have an upper limit. Ultimately, earnings per share (EPS) growth is needed to drive the market higher over the long term.

As seen in the chart above, declines in annual earnings for U.S. small caps (S&P600) have been relatively rare. Yet it looks like both 2023 and 2024 will see U.S. small-cap earnings decline in aggregate.

The last time a decline occurred two years in a row was during the GFC in 2008 and 2009, though earnings fell much more back then, before surging strongly in 2010.

This gives some more hope that we may be nearing the end of the lengthy earnings falls or stagnation for U.S. small caps we have seen recently.

Our Funds’ portfolio companies are generating superior earnings growth

Certainly, the share market appears willing to give the new Trump administration – combined with the dialling back in monetary policy restriction from the U.S. Fed – the benefit of the doubt at present that better times are ahead for small-cap earnings.

We maintain a keen eye on small-cap earnings revisions and a handful of other key leading indicators for small-caps’ earnings to see if this is playing out.

Anecdotally, we are seeing an increasing number of our portfolio companies in the U.S. appearing more confident in their end markets given the current political and monetary policy setup. We’ll be watching closely whether this translates into increases in company guidance at their fourth-quarter results due in late January and throughout February early next year.

If it transpires, we will likely become even more positive on cyclically orientated businesses, and those that are leveraged more to the economic cycle.

Regardless, given the huge opportunity set at our disposal in our Global Funds at Ophir, and despite the slower broader backdrop for U.S. small-cap earnings this year, we still have not had trouble keeping average earnings growth in these Funds from our portfolio companies in the +20-25% range.

Trustpilot: Good things come to those who wait

“Trust is like the air we breathe – when it’s present, nobody really notices; when it’s absent, everybody notices.” Warren Buffett

Trustpilot (LON: TRST) is a London-listed, Danish-founded consumer business operating a review website, which hosts reviews of businesses worldwide. Around 1 million new reviews are posted each month.

Reviews are written by any consumer with a Trustpilot account who has had a recent buying or service experience, as long as they follow the Guidelines for Reviewers, and don’t have a conflict of interest with the business they’re reviewing.

Consumers who’ve had an experience with a business can create a Trustpilot account and write an unsolicited review (“organic reviews”). Businesses can also ask their customers to leave a review by invitation. There should be no bias in the way customers are invited to review, with no offer of payment or incentive.

What sets Trustpilot apart is their commitment to transparency and neutrality. They ensure the platform is a trusted space where customers feel heard, and businesses can demonstrate their integrity.

A commissioned study conducted by Forrester Consulting on behalf of Trustpilot found that organisations deploying Trustpilot achieved a remarkable 401% return on investment over three years. These organisations experienced significant benefits, including improved customer acquisition and operational efficiencies.

Additionally, Trustpilot helped increase web traffic by 25% in the first year, 30% in the second, and 35% by the third year. These metrics underscore Trustpilot’s pivotal role in enhancing business performance through trust and transparency.

Trustpilot’s business model has strong network effects. As more consumers use Trustpilot to review more businesses, more domains and businesses are added to the platform. More businesses claim their profiles, and over time become customers.

As the flywheel keeps spinning – this drives organic growth, strengthens the brand and market position, while simultaneously and creating high barriers to entry.

Trust follows the adage of “goes up the escalator and down the elevator” demonstrating barriers/ time to build adequate consumer reviews yet easy loss of confidence in website if reviews aren’t honest. If the business can overcome this dynamic, then it should build adequate moat to monetise model as difficult for competitors to replicate.

Lofty initial expectations came back towards earth

We first met Trustpilot management during the 2021 IPO process. Despite evidence of good early momentum across the business, we passed on valuation grounds. At the 265p IPO price we were being asked to pay too much for potential success in the U.S. where there was limited penetration at the time.

Patience pays off

Source: Ophir, Bloomberg. Data to 30 November 2024.

This was a good decision because Trustpilot’s share price declined materially after peaking towards the end of 2021 and tracked broadly sideways from mid-2022 and much of 2023 due to macro factors.

Stock-specific factors also impacted the share price. The initial roll-out in the U.S. was ‘scatter-gun’ and lacked focus. That was a key element holding us back from buying the stock.

Yet because of its unique business model and significant market opportunity, we continued to follow the company.

But during 2023 we noticed Trustpilot’s approach to the U.S. became much more focused. The company homed in on a few core verticals (e.g. financial services, education).

This improved growth and more specifically net revenue retention (another way to describe customer retention). That was the evidence we needed to see before re-engaging with the company.

So in early 2024, we met with management in their U.S. headquarters in Denver. We were impressed with the ongoing execution in the UK, as well as the momentum that was building in other jurisdictions globally, including the U.S.

We subsequently caught up with the company on a handful of occasions over the next few months, after which we invested in the company. Our patience and valuation discipline allowed us to see the company execute for several years and, ultimately, we initiated our position below the IPO price.

We see big upside for the company and its share price for several reasons:

The UK and other markets remain underpenetrated

The UK is Trustpilot’s most penetrated region. However, with 1H24 bookings of US$47m in a serviceable addressable market (SAM) of ~US$1.7 billion this equates to only ~5% penetration.

Source: Ophir. Company Financials.

This provides a meaningful growth runway; while also providing a reasonable blueprint for what the terminal/mature economics of the business may look like for the group.

Trustpilot continues to show strong network effects

Since 2018 UK bookings have grown at a ~20% compound annual growth rate (CAGR), while sales and marketing dollars have remained broadly stable, based off our internal estimates for the UK division. This demonstrates the strong network effects when consumer awareness hits a tipping point.

Source: Ophir. Company Financials.

The company is still seriously undervalued

Our comparative analysis shows that businesses with a similar growth and margin profile to Trustpilot’s UK business trade on 8-9x annual recurring revenue (ARR).

This results in a UK valuation of ~US$1 billon and implies we are paying ~US$500 million (or 3x ARR) for Europe & the Rest of the World (RoW) and North America, which combined are 10x the SAM of the UK.

Data shows strong momentum globally

We think near-term momentum will show acceleration in the U.S. and EU/Row based off our data tracking, calls with regional experts and tracking of onboarded and paying companies.

For key markets and verticals, we closely monitor Google search visibility, the quality and volumes of reviews as well as engagement and conversion. We also track corporates who are signed up and paying them.

Our data tracking shows Trustpilot’s robust performance in established markets such as the UK. It also demonstrates the critical U.S. market is accelerating alongside Germany, France and Italy, which are core to the Europe/RoW segment.

Source: Ophir, Google Trends.

Trustpilot’s U.S. position continues to strengthen

When compared to competitors in the U.S., such as Stamped, Yotpo, Bazaarvoice and Birdeye, Trustpilot has demonstrated more consistent performance and a positive trajectory. This suggests a strengthening of its position in the U.S. market. The strong interest levels against a backdrop of competitor volatility suggests Trustpilot is on the path to becoming the pre-eminent platform in the trust and review ecosystem.

Source: Ophir, Google Trends.

A significant runway for growth

Given their large markets, significant upside to penetration, high long-term margins and limited competition due to high barriers to entry, as well as strong network effects, we see significant upside for Trustpilot.

As management continues to execute, the market will get more comfortable with the long-term growth opportunity in North America, Europe and the Rest of the World.

This is a great example of how being patient and waiting for a better entry point can pay off. By applying our GARP (growth at a reasonable price) investment philosophy at the time of the IPO, we were effectively given a free look at how the business executed for the following 3 years.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior Portfolio Managers

Ophir Asset Management

11 Dec, 2024 What’s caused the recent outperformance in our Global Funds?

16 Jan, 2025 Letter To Investors - December

18 Nov, 2024

Letter To Investors - October

Letter to Investors • 14 mins read

No one else wanted to look here, but we found a bargain

After a hot streak of five months, the global share market took a breather in October. The MSCI World Index (in USD) fell -2.0%; the S&P500 got off a little lighter, down -0.9%. It was a surge in the U.S. 10-year Treasury bond yield, which rocketed up +0.5% in the month to 4.3%, that weighed on share market valuations across the world.

Not only did long-term interest rates in the U.S. move sharply higher over the month, but so too did expectations for short-term rates. Only four 0.25% Fed cuts are now expected this cycle (at writing), down from eight 0.25% expected at the start of October.

Why such a sharp move higher in short and long-term interest rates in the U.S.? In short there are two key reasons:

U.S. economic data has continued to surprise on the upside. The unemployment rate has dropped back to 4.1%; inflation has continued to moderate back towards the Fed’s 2% target; and real GDP growth is running above trend at just a shade under 3%.
In October polls showed momentum was swinging towards Donald Trump and a Republican win in the November U.S. election (which, unless you’ve been hiding under a rock has subsequently been proven right with a big win earlier this month). Trump’s policy platform of tariffs, reduced immigration and tax cuts are all inflationary, so markets started pricing in higher rates. The day after the election, November 6, when it was clear Trump had won, the U.S. 10-year jumped 0.16%. Most of this rise came from higher inflation expectations (10-year breakeven inflation expectations).

A natural hedge

For Australians invested in unhedged global shares (such as those in Ophir Global Funds), October’s pullback in global share markets, and more specifically the U.S. share market, was totally offset by a big fall in the Aussie Dollar versus the U.S. Dollar.

The benchmark for our Global Funds, the MSCI World SMID Cap Index posted a negative total return of -2.6% in October. But when converted to $AUD, it rose +3.1%.

Being unhedged for your global shares is usually a positive for Australian investors during declining markets. When global shares fall, the Australian Dollar often (though not always) also falls.

October 2024 Ophir Fund Performance

Before we jump into the Letter in more detail, we have included below a summary of the performance of the Ophir Funds during October. Please click on the factsheets below if you would like a more detailed summary of the performance of the relevant fund.

The Ophir Opportunities Fund returned +5.1% net of fees in October, outperforming its benchmark which returned +0.8%, and has delivered investors +22.9% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned +3.7% net of fees in October, outperforming its benchmark which returned -0.8%, and has delivered investors +13.6% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +0.0% for the month.

The Ophir Global Opportunities Fund returned +3.4% net of fees in October, outperforming its benchmark which returned 3.1%, and has delivered investors +15.9% p.a. post fees since inception (October 2018).

🡣 Ophir Global High Conviction (Class A) Fund Factsheet

The Ophir Global High Conviction Fund (Class A) returned +3.3% net of fees in October, outperforming its benchmark which returned +3.1%, and has delivered investors +10.7% p.a. post fees since inception (September 2020).

The Ophir Global High Conviction Fund (Class B) returned +3.2% net of fees in October, outperforming its benchmark which returned +3.1%, and has delivered investors +21.3% p.a. post fees since inception (June 2023).

🡣 Ophir Global High Conviction (Class B) Fund Factsheet

Two charts you should know about

Before we get into our stock in focus for the month, we wanted to highlight two quick charts we think you should know:

1. Ophir Global Funds: A strong year driven by stock picking

The Ophir Global Opportunities Fund and the Ophir Global High Conviction Fund had a tough late 2021 and early 2022 when interest rates ripped higher and small-cap growth valuations got torched. But over the last year their performance has surged. While their benchmark, the MSCI World SMID Cap Index NR (AUD), was up about 26% in the last 12 months to the end of October, both Funds were up about 46%. That’s about 20% outperformance!

So what drove that outperformance?

Source: Ophir & Bloomberg. Data as of 31 October 2024.

In the chart above we show how $100 invested a year ago into the Ophir Global High Conviction Fund has grown versus the same investment into our official benchmark. We’ve also included different size (mid, SMID, small, micro) and style (growth & value) indices.

It’s clear that the last year’s outperformance was not due to size factors – as you can see mid, SMID and small caps all performed similarly and were lagged by microcaps. Growth and Value styles of investing also provided very similar results.

So Ophir’s small-cap growth company bias didn’t generate the outperformance.

What was it then?

It was good old-fashioned stock picking.

All the top contributors to performance beat the markets expectations on their earnings results and raised guidance for future results. That’s exactly what our investment process targets and that – rather than size or style – is the most sustainable form of outperformance for our funds.

2. The valuation ‘catch up’ still hasn’t happened

Some investors might have been wondering if the Ophir Global Funds’ strong performance over the last year was because small-cap valuations simply caught up with the stocks that have led this bull market since 2022 – ie. large caps and the Magnificent 7?

Source: Ophir and Bloomberg. Data to 31 October 2024.

But as you can see in the chart above, both small (gold line) and large (grey line) caps have both benefited from valuations (here price to earnings ratios) increasing. Yet the gap (shaded area) has not closed.

So, it’s still highly likely there is a period ahead in the next five years where small caps will catch up and outperform large caps due to their much cheaper starting valuations.

On a relative basis, small caps are the cheapest they have been in a quarter century and to us they represent a once in a generation relative opportunity to large caps. This year’s strong performance in the Ophir Global Funds has not changed that.

Stride: The company no fundie wanted to see

In January 2021 vaccines were rolling out, people were starting to travel again; and the share market had flipped back from ‘stay at home’ stocks to the ‘re-opening trade’. That was when we attended the Needham Growth Conference in New York and found one of our best stocks of the last few years.

The Needham Conference is one of the biggest small-cap investment conferences. Fund managers were lining up to meet the management of companies primed to capitalise on the tidal wave of services spending as consumers emerged from hibernation.

So, what did we do?

We asked the conference organisers: “What are the companies at the conference with the least requested number of meetings by fundies?”

The company that no one wanted to see was Stride (NYSE:LRN). Stride provides online education solutions to kindergarten through Year 12 students in the U.S. and their solutions are used in the classroom. But originally and still, they are used by students homeschooled for various reasons including bullying, parental preferences; even for child actors.

When we were all going to ‘work from home’ during COVID, students were going to ‘learn from home’. Stride’s share price rocketed from around US$20 to over US$50 between March and August 2020 as demand, and expectations of demand, for their products and services ballooned.

But by January 2021, the time of the Needham Conference, the balloon had popped. As students returned to school, investors thought there’d be no durable increase in demand, so Stride’s share price returned to US$20. In any case, fundies had turned their attention elsewhere.

What we found when we decided to dance with the ‘wallflower’ Stride

Stride was the proverbial ‘wallflower’ at the prom. But we decided to dance with Stride and we found:

A company structurally benefitting from increasing adoption of virtual schooling more generally (despite schools having been reopened), which could lead to sustained growth in a market in which Stride was a leader.
Defensive revenue growth of 8-10% revenue, underpinned by state government budgets that fund the 70 schools across 35 US states in which Stride had solutions.
This was flowing through at high incremental profit margins, driving what we expected would be 20%+ earnings growth.
A depressed EV/EBITDA (Enterprise Value to Earnings Before Interest Tax Depreciation and Amortisation) valuation multiple of just 5x.

Of course, we never just take what the company says at face value, so we got to work. We checked data around individual school’s login traffic; called enrolment centres for intel, including the number of open enrolment applications; spoke to public and private school peers around market share changes; and spoke with school district budget allocators to ensure funding was rock solid.

We initially bought Stride later in January 2021 between US$22-25. And we have held ever since, building our conviction and knowledge around the business.

And boy has it delivered. From financial year 2020 through to 2024 it has:

Doubled revenue from US$1.04 billion to US$2.04 billion
Improved EBITDA margins from 11% to over 18%, and
10x’ed profit from US$24.5 million to US$240 million (12 months to Sept 2024)

Fuzzy Panda tests our conviction

But then last month our conviction was really tested.

Fuzzy Panda (FP) – no not a Sesame Street character, but a well-known short-selling organisation – released a report on the 16^th October dubbing Stride “the last COVID over earner”.

The stock tanked over -9% on the day, but Stride was down -24% if you include the falls leading up to the report, when FP was clearly putting on their short position.

FP was essentially claiming that Stride was a big beneficiary of the US$190 billion in Federal emergency relief funding program for U.S. schools during COVID. The funding was ending in September 2024 and FP warned Stride’s profits were about to “fall off a COVID cliff”.

Australian investors in ASX listed companies probably aren’t that used to “short reports” as they’re not that prevalent domestically. However, they are big business in the U.S. and par for the course if you’ve been investing there long enough. The playbook is simple.

Take a short position, put out a scary short report questioning the company’s profits, many investors shoot first dumping the stock (regardless of the merits of the short report), the shorter closes the short by buying back the stock at the now lower price, pocketing a tidy profit. Sometimes there is merit to the short report, sometimes it’s just hot air.

Over the last three years we have owned the stock we have spoken with Stride’s management on multiple occasions each quarter. We have found them diligent, trustworthy and conservative.

But we also did more work.

We already knew from the publicly available individual school budgets that the federal COVID funding was used to offset funding from the states during COVID. But we also went through the corresponding publicly available state budgets in detail that showed the states were increasing their education spend to offset the federal grant funding that was ceasing. So, this gave us comfort there was no big looming funding shortfall from state schools for Stride’s offering. This gave us the conviction to hold through the short report.

When Stride reported its September quarter results aftermarket on the 22^nd of October, it blew the market’s expectations away. both at a revenue and profit level.

The next trading day the stock popped around +40%!

Source: Ophir & Bloomberg. Data as of 31 October 2024.

The future of Stride

So where to next for Stride?

Even though they are the largest online education provider in the U.S. by enrolment, they are still very underpenetrated across schools. They can also fuel growth by entering or expanding into education verticals including:

Experiential learning: Through extended, augmented and virtual reality modes; AI voice and chat learning software; and games and simulation teaching solutions.
Learning support: Building out their tutoring business which we think could add 30-40%+ to today’s earnings over the medium to longer term, given their existing relationships with students and teachers.
Workforce and talent development and acquisition: Providing certifications to the increasing number of U.S. high school leavers who are shunning four-year college degrees and opting instead to directly enter jobs. Stride already owns a business called Tallo, which connects students from Stride-powered schools to opportunities (the Tallo app has 1.7million users already!).

A long career ahead

Today, Stride is still growing earnings at 20%+. That’s two to three times the market’s growth. Yet it operates in a defensive end market with a large share of its revenues underpinned by state government education budgets. It’s a great all-weather stock.

But its valuation is lower than the market. Stride trades on a still cheap 13x price to earnings ratio. Most of the share price move since we have owned has actually been driven by earnings growth and not valuation expansion. We think it could still be a 20x P/E business.

So while it’s been a great performer for our Funds, we still think there is a long ‘career’ ahead for Stride.

…the hard work pays off

It would have been easy to crack during the Fuzzy Panda short drama and sell Stride.

The only way to know whether to ‘keep the faith’ or to ‘fold’ is to put in the work and back yourself. It won’t always work out on your side, but if you go the extra mile, it will more often than not.

We are proud of the team and the work they have done which allowed us to keep our conviction in Stride.

We’re also glad we took that meeting that no one else wanted back in 2021!

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior Portfolio Managers

Ophir Asset Management

18 Nov, 2024 How will Trump’s epic win affect the share market?

11 Dec, 2024 What’s caused the recent outperformance in our Global Funds?

17 Oct, 2024

Letter To Investors - September

Letter to Investors • 16 mins read

NextDC – where Nvidia’s chips live

September.

For some it’s their favourite song – a funky and joyful classic by Earth Wind and Fire, released back in 1978.

“Do you remember
The 21st night of September?
Love was changin’ the minds of pretenders
…
As we danced in the night, remember
How the stars stole the night away, oh, yea”

But for share market investors, September has historically been the worst-performing month of the year. If you were going to leave your brokerage account alone for a month to “dance in the night”, September was the one to take off.

As we show below, on average over the last quarter century, the global share market (MSCI World Index) has fallen -1.5% in September. No other month comes close to being as bad, with a -0.3% fall the next worst.

September – the worst month of the year (MSCI World Index)

Source: Ophir, Bloomberg.

It’s not been because the market always falls in September, though – only 12 of the last 25 Septembers have lost money.

It’s because September has had some of the biggest stinkers for shares. 2022 (recession worries on higher rates/inflation), 2008 (peak GFC fears) and 2002 (Dot.com bubble bursting) all clocked up falls of around -10% or more.

It came as a welcome relief, though, that this September didn’t fall prey to history, with gains extending for the fifth month in a row.

In fact, to the end of September, the S&P 500 had its strongest first nine months of the calendar year since 1997! (Can I hear Earth Wind and Fire singing?)

During September in total return terms the S&P 500 rose +2.1%, while the Nasdaq gained +2.8% and the ASX 200 was up +3.2%.

September 2024 Ophir Fund Performance

Before we jump into the Letter in more detail, we have included below a summary of the performance of the Ophir Funds during September. Please click on the factsheets below if you would like a more detailed summary of the performance of the relevant fund.

The Ophir Opportunities Fund returned +4.6% net of fees in September, underperforming its benchmark which returned +5.1%, and has delivered investors +22.5% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned +2.6% net of fees in September, underperforming its benchmark which returned +4.1%, and has delivered investors +13.2% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +2.3% for the month.

The Ophir Global Opportunities returned +0.8% net of fees in September, outperforming its benchmark which returned -0.1%, and has delivered investors +15.5% p.a. post fees since inception (October 2018).

🡣 Ophir Global High Conviction Fund Factsheet

The Ophir Global High Conviction Fund returned +0.1% net of fees in September, outperforming its benchmark which returned -0.1%, and has delivered investors +10.1% p.a. post fees since inception (September 2020).

Un-inversion concern

September’s share market gains occurred despite the yield curve in the United States ‘un-inverting’ during the month. Historically, that’s been an ominous sign for the US economy and corporate earnings.

The un-inversion happened as the Fed kicked off its interest-rate-cutting cycle with an outsized 0.5% cut in its short-term interest rate, the Fed Funds Rate.

As we show in the bottom panel of the chart below, the yield curve ‘inverts’ – that is short-term interest rates (in this case two-year Treasury yields) rise above long-term interest rates (in this case 10-year Treasury yields) – with the purple line going negative when the Federal Reserve is raising short term rates to cool the economy and lower inflation. This is what happened in 2022.

Source: Ophir, Bloomberg.

Historically, when the yield curve un-inverts (green circles) it’s because the market expects the Federal Reserve to cut interest rates as the inflation fight is done – the market now starts worrying about the other side of the Fed’s mandate: maintaining full employment.

That is where we are today, as witnessed by the Fed’s 0.5% cut in September.

Naturally, some are worried that when the un-inversion happens, as seen in the middle chart above, that historically it has meant the Fed is too late and the labour market softens too much. The unemployment rate goes up (yellow line rises) and a recession (grey bars) and its attendant economic and earnings contraction ensues.

During the recession, the fall in corporate earnings typically sees the share market fall, as shown in the top chart by the drawdown (peak to trough fall) in the S&P500 index. Sometimes these falls are more mild (less than 20%), and sometimes they are very severe (greater than 30%).

Is history repeating?

But, pleasingly, the latest data in the US shows the labour market, while cooling, is holding up ok, at least for now. That’s reduced the probability of a recession in the US. In fact, the US unemployment rate, at writing, has just dropped back to 4.1% from 4.3% a couple of months ago.

What, despite higher interest rates, is providing support and helping avoid mass layoffs?

The US economy so far is being kept afloat by several things: continued jobs growth in non-cyclical areas like healthcare, education and the government sector; solid (though not spectacular) company revenues and household income growth; big government spending; and not-too-tight-for-not-too-long monetary policy.

But all eyes, including ours, will remain on the employment picture to see if the softening seen over the last year or so morphs into something more sinister.

China rockets

The other big news in September was the People’s Bank of China (PBoC) finally coming to the party with some meaningful stimulus. Calls have been loud for some time for big stimulus with China mired in slowing growth, a property sector overhang, rock bottom consumer confidence and deflation.

In the last week of September, the PBoC announced a stimulus program that included an interest rate cut, a reserve requirement ratio cut for banks, lowered mortgage downpayments, and support programs for the property and share market.

The Chinese share market loved it!

The MSCI China Index was up over 21% (!) over the last five trading days of September and the rally continued into early October*. Commodities that China voraciously consumes also rocketed on the news, as seen in the chart below of exchange traded funds (ETFs) that follow commodity miners.

*Though just at writing in the second week of October the Chinese share market has given back some of its September gains as the announcement of government fiscal stimulus has come up short of expectations.

Source: Ophir. Bloomberg.

In response, the ASX 200 Materials index in Australia rose over 12% in those same last five trading days of September.

In a relative sense this created a performance headwind for the Ophir portfolios versus their benchmarks, given we are structurally underweight the Materials sector.

(As a reminder, we prefer more industrial-type businesses that can structurally grow into big-end markets over time, rather than businesses who earnings tend to be more cyclical because of short term swings in – to us at least – largely unforecastable movements in commodity prices).

This was more of a headwind for our Australian Funds where the Materials sector makes up a greater proportion of our benchmark than our Global Funds.

The influence of Materials alone took our Ophir Opportunities Fund from outperforming its benchmark in the first three weeks of the month to underperforming by the end of the month.

As always, we are happy to wear the swings and roundabouts of relative performance due to short-term moves in commodity prices. If we get the earnings right long term in our typically industrial type businesses, investment performance will look after itself.

NextDC – from Microcap to Midcap – where Nvidia’s chips live

Ever since ChatGPT entered the public domain in November 2022, demand for anything artificial intelligence (AI) related has seen computer chip maker Nvidia skyrocket to become, at one point this year, the most valuable listed company in the world.

Naturally, Australian investors have been looking for an AI play on the ASX.

Enter NextDC, Australia’s leading listed data centre operator.

The company is not some ‘Johnny-come-lately’ here just to capitalise on the AI scene. It was founded by wildly successful Australian serial tech entrepreneur, Bevan Slattery – Australia’s answer to Elon Musk – back in May 2010.

NextDC listed on the ASX not long after in December 2010 when it IPO’d at $1 a share, giving it an $80 million market cap. IPO investors got a nice bump on day one with the stock closing at $1.52 a share! But it was definitely still in microcap territory.

Today it’s the 49^th largest stock on the ASX with a market cap of $11.2 billion and scratching on the door of the ASX Large Cap Index.

But wait a sec, what’s a data centre anyway, and doesn’t it all seem very mysterious what goes on inside these big data centre ‘boxes’ you might have seen around Australia? And how and why do they benefit from AI?

You’re about to find out.

What’s in the box?

No this is not like the movie Seven! But today’s modern data centres do resemble big boxes, or even mini-Westfield shopping centres in many ways.

Put simply, a data centre – a term born in the 1980s – is a computer room. In fact, some companies still have on-premises data centres/computer rooms where their IT infrastructure, including servers, are kept.

A data centre is the central, physical hub of an organisation’s digital operations. It’s the secure home with the power and cooling essential to operate the network of computer systems that house a business’s data. It is the beating heart of a business’s day to day operations.

Many businesses these days don’t store their IT infrastructure on premises, but rather use external providers like NextDC in what are called Colocation data centres that reduce redundancy and downtime at cheaper cost. You co-locate your IT infrastructure in NextDC’s ‘boxes’ along with that of other companies.

In this way NextDC is like Westfield, the landlord, and you are the tenant, renting space inside the box for your business’s equipment.

But what’s in the box, exactly?

There are really four main categories of ‘things’ you will find inside a NextDC data centre:

Computing infrastructure: mainly servers, rackspace, cages, and dedicated private suites (sounds like a fancy airline right)
Storage: your hard drives and solid-state drives
Network infrastructure: such as cables, switches, routers, and firewalls
Ancillary items: backup generators, ventilation and cooling equipment, fire suppression systems, and security and monitoring systems

Who uses the box?

NextDC has over 1,800 customers and they include

Enterprise customers (like Alibaba or any business that wants to move their IT infrastructure out of the office)
Telcos (like AT&T or Aussie Broadband), and importantly
So-called Cloud providers (like Google, Amazon and Microsoft), often called ‘hyperscalers’ because of their fast growth

Cloud providers deliver computing services, such as servers, databases, networking, software, storage and intelligence, via the internet. That allows them to offer faster and more flexible resources, high-performance capacity, as well as scalability.

Basically, any services that don’t require physical proximity to the IT hardware in use can be considered candidates for cloud delivery. Don’t have or want your own IT infrastructure? You can use Amazon Web Services, Microsoft Azure or Google Cloud.

But those cloud providers have IT hardware too … and they need to store it somewhere. NextDC provides the data centres for cloud providers to store their hardware. (They even have names for data centres where only cloud providers are in there – they are imaginatively called Cloud Data Centres.)

Which leads us to NextDC’s marketing tagline: “Where the Cloud lives”. Sorry to crush the dreams of those of you who thought it was all happening in satellites in the sky. At least they can get a private suite for their gear at NextDC!

AI turbocharges demand

But perhaps more appropriately for why AI investors have been attracted to NextDC is that it’s also where Nvidia’s chip live. Those servers and racks and cages are stuffed with silicone chips. And AI tools like Generative AI models such as ChatGPT are some of the most chip hungry software applications out there.

The impact of A.I. on data centre demand is not just about increasing capacity, which is clearly does through increased hardware and data storage needs. A.I. workloads often require special hardware called graphic and tensor processing units (GPU/TPUs) which consume more power and generate more heat than traditional servers. Specialised cooling and power distribution systems have had to be designed, along with new network infrastructure to support the low latency (read speed critical) needs of A.I. applications.

Westfield needs more land

A.I. needs are only adding to existing demand of enterprises moving to the cloud and by some estimates is increasing that demand by four to five fold!

Hyperscalers are therefore battling it out to secure the supply (tenancies) of new data centres. They have the hottest product in town, cloud services, and they need somewhere to sell their goods from.

Australia, so far, is behind the US in terms of AI deployment but it’s running hard to catch up.

This is seeing NextDC increasingly move from providing colocation services for businesses’ private IT infrastructure, to hyperscalers.

Like any good landlord, when your building is full, NextDC is searching for more land.

Today, NextDC operates in all the major Australian cities (sorry Hobart) and also some regional areas too, with New Zealand and parts of southern Asia in the works. Sydney has the most, with four operational and another four in the pipeline or under evaluation.

NextDC Data Center locations

Source: NextDC company website

The next AirTrunk?

Historically it’s taken three years to fill a NextDC data centre with tenants. Today it still takes three years, but the size of the data centres is now roughly three times that of the old ones.

The landscape is also changing.

Many of NextDC’s big competitors aren’t publicly listed, but instead are in private hands. Most public data centre providers have been taken over and taken private. The amount of capital they need to grow is well suited to ownership by big global pension funds that are accumulating inflows.

This represents an opportunity for NextDC.

Deals are happening. Australian competitor, AirTrunk, was recently taken over by a big global pension fund at 20x contracted EBITDA giving an AUD$24 billion valuation.

Takeover or not, the opportunity remains ripe for NextDC. It currently sits in an oligopoly in Australia competing against AirTrunk and CDC (partially owned by New Zealand based and listed company Infratil).

Asia looks to be the next big regional growth leg, with Google eyeing that region and looking for data centre partners.

NextDC is also prioritising so-called Edge Data Centre investments. They’re the next stage in data centre development, where smaller centres are strategically located physically close to the edge of a network, and the populations they serve, to provide low-latency high-performance computing for latency sensitive applications like virtual reality, financial systems, gaming or the Internet-of-things (IoT).

This 14-year-old company might still be in its teenage years, but like most teenagers, it still has a lot of growth ahead.

A big winner for Ophir

We first bought into NextDC in the Ophir Opportunities Fund on the 28th of November 2013 at $2.01 when it was a $415 million market-cap company.

As the company grew, we then bought it in our Ophir High Conviction Fund on the 18^th of April 2016 at $2.80 when it was a $700 million market-cap company.

We have held NextDC ever since and it now trades at over $17 with a market capitalisation of around $11.2 billion at writing.

Source: Ophir. Bloomberg.

It has been one of our longest-held positions in our Australian Funds, and we have gotten to know the company very well over our more than decade of ownership.

Of course, like most great growth stories, it’s not been all smooth sailing. The bottom chat shows the drawdowns (peak to trough falls) of its share price since IPO. (20%, 30% and even 40% falls have been seen over the journey and some of them quite regularly.)

Doing the work and staying the course has certainly paid off, though, with the share price rising at a 22.0% per annum clip since we first purchased in 2013.

NextDC is and remains a classic Ophir stock. A fast growing business, growing into a big end market, with long term company and industry tailwinds. And A.I. is only just starting to put a big gust behind that tailwind.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior Portfolio Managers

Ophir Asset Management

17 Oct, 2024 Should investors be joining the gold rush?

18 Nov, 2024 How will Trump’s epic win affect the share market?

18 Sep, 2024

Letter To Investors - August

Letter to Investors • 14 mins read

Thinking Rate Cuts, Fast and Slow (+ a portfolio addition surprise)

You’ve probably heard of Daniel Kahneman – the recently deceased psychologist who won the Nobel Prize in Economics in 2002 for his groundbreaking work on behavioural economies.

Kahneman summed up much of his life’s work in his wonderful 2012 book, “Thinking, Fast and Slow”. (For those who haven’t, it’s a must read.)

Kahneman divided our brains and our thought processes into two characters:

System 1: Fast, automatic, intuitive and often subconscious, but prone to biases and errors.

System 2: Slow, deliberate, analytical, effortful and conscious. Our ‘slow’ brain is often used for complex decisions and calculations that require logical reasoning.

Things can, of course, go wrong in both brains. But it is System 1 that is most prone to cognitive biases like overconfidence, anchoring, framing effects and loss aversion.

Kahneman taught us that we are not the perfectly rational beings that economics once assumed. Yes, quick rules of thumb can help us get through life easier and quicker, but they can also get us into trouble.

What does this have to do with investing?

Well, plenty. If you fall prey to these biases in investing, you can lose serious money. (Way before Kahneman, even Warren Buffett’s teacher Ben Graham knew this when he said: “The investor’s chief problem, and even his worst enemy, is likely to be himself.”)

But the ‘fast’ versus ‘slow’ dichotomy has major relevance to investing today.

After being on hold since July last year, the US Federal Reserve is almost certainly going to start its rate-cutting cycle this month. You’d remember that global share markets sold off when talk of Fed rate hikes began back in 2021; and they sold off again then when the Fed actually raised rates in 2022. So does that mean that when the Fed starts to cut rates, it will be good for shares?

Well not so fast.

August 2024 Ophir Fund Performance

Before we jump into the Letter in more detail, we have included below a summary of the performance of the Ophir Funds during July. Please click on the factsheets if you would like a more detailed summary of the performance of the relevant fund.

The Ophir Opportunities Fund returned +1.9% net of fees in August, outperforming its benchmark which returned -2.0%, and has delivered investors +22.3% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned +0.9% net of fees in August, outperforming its benchmark which returned +0.0%, and has delivered investors +13.1% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +2.3% for the month.

The Ophir Global Opportunities returned -0.4% net of fees in August, outperforming its benchmark which returned -2.1%, and has delivered investors +15.6% p.a. post fees since inception (October 2018).

Be careful what you wish for

Just as fast ‘System 1’ thinking can sometimes get you into trouble, fast rate cuts by the Fed can also be a worry.

ND Research broke up the last 17 Fed rate-cutting cycles dating back to the 1950s into ‘fast’, ‘slow’ and ‘non-cycles’. (Fast cycles are those with at least five cuts in a year; slow is fewer than five cuts; and non-cycles are those with just one cut.)

As you can see in the chart below of the cycles, slow rate cut cycles (in blue) are the best for the share market (here the S&P500 index). Fast rate cut cycles (in orange) are the worst. (Non-cycles – in green – while technically the lowest performer, aren’t really rate cutting cycles at all with only one cut registered in 1967 and 1968 in a sideways moving market).

1954-8/30/2024. The chart and table shows S&P 500 Index performance around the start of Fed easing cycles. Y-axis is indexed to 100 at start of first rate cut. An index number is a figure reflecting price or quantity compared with a base value. The base value always has an index number of 100. The index number is then expressed as 100 times the ratio to the base value. A fast cycle (orange line) is one in which the Fed cuts rates at least five times a year. A slow cycle (blue line) has less than five cuts within a year while a non-cycle (green line) is case with just one cut. Black line represents all first cuts. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Why?

As we saw in the 2001 Dot.com bust-related recession, and the 2007-2009 Great Financial Crisis, when the Fed acts aggressively via ‘emergency’ rate cuts, it is usually responding to a recession or financial crisis characterised by falling corporate earnings. Investors become risk averse and slash the valuations they place on those now-reduced earnings.

Our friends at Charles Schwab have taken this data a step further and looked at the maximum drawdown (that is peak to trough fall) in the 6 and 12 months after the Fed’s first cut.

Again, it’s clear that fast cycles tend to see bigger sell offs. (It also looks like fast cutting cycles have become more common in more recent decades.)

Source: Charles Schwab

So, what is the market expecting today?

Fixed income markets have priced in between nine and ten 0.25% rate cuts over the next year, with at least one 0.25% cut priced at each of the next six Federal Reserve meetings. If that eventuates, it will put this cycle in the ‘fast’ cutting camp.

At writing, however, equity markets don’t seem nearly as worried about a fast rate-cutting cycle as fixed-income markets – as witnessed by many major share market indices trading near all-time highs.

That might be because, while a sharp rate-cutting cycle is expected, it will only take the Federal Funds Rate back to a ‘normal’ level of around 2.75-3%. At those levels, rates won’t fall into the ‘stimulatory’ (below 2.5%) or ‘ultra-low’ levels near 0% that you might expect if a recession was forecast.

The positive news

The bottom line: share market investors should hope for a slow rate-cutting cycle because that means economic growth and corporate earnings are likely holding up well, providing support to share prices.

If fast rate cuts are on the cards, just like our errors in System 1 thinking, things are more likely to go awry in the near term in share markets.

There is positive news, however: on a 12-month horizon, both slow and fast cutting cycles have, on average, seen positive S&P500 returns.

For the rest of this month’s Letter to Investors, we wanted to give you some insight into a company that has been recently added to our Global Funds but that has been around literally for ages.

You’ve probably read one of their books!

Time to hit the books

It’s 1807. Thomas Jefferson was the US President. It’s the year Robert E Lee, the Confederate General during the American Civil War, was born. The Napoleonic Wars were raging. And it’s the year Charles Wiley opened a tiny print shop in Manhattan.

When Charles died in 1826, his son John took over the business. Like any good son, he put his name on the business as if he were the founder(!). It became John Wiley. Eventually, when his kids joined the business, the company adopted its current name: John Wiley and Sons – though today many just call it Wiley (NYSE: WLY).

Wiley is now one of the world’s largest publishers, with products ranging from academic journals and articles, to textbooks and professional assessments.

If you went to university, chances are you read a book with ‘Wiley’ on the cover.

At its heart, Wiley enables the creation of new knowledge at the frontier of thinking in such diverse areas as science, medicine, technology, engineering, business, economics and finance.

The business is broken up into two key segments:

1. Research

Wiley has one of the world’s leading portfolios of journals and operates the Wiley Online Library. It is the home to some of the most prestigious academic journals in the world, including the Journal of Finance.

Source: AppAdvice – The Journal of Finance

2. Learning

Learning includes academic publishing and courseware for higher education students, as well as books and assessments for professionals. The content is increasingly valued for GenAI models, a topic we’ll touch on later. Learning also includes books such as the well-known ‘For Dummies’ series – books that probably provide investment advice a little more accessible to the average punter than the wonky Journal of Finance!

Source: for Dummies – A Wiley Brand

Wiley’s competitive advantage lies in a number of things:

its massive content library which includes circa 2,000 journals and over 40 million published articles;
its relationships with some of the brightest minds in the world as authors;
its incumbent category leadership; and
its brand and reputation that has spanned centuries.

Ok, but why does Ophir own it, you ask?

Doesn’t Ophir only invest in new up-and-coming, fast-growing companies?

4 reasons why we own Wiley

We invest in companies that we believe are growing faster than the market thinks; and we don’t overpay for that growth. Sometimes that is a new business; and sometimes, as in the case of Wiley, that can be an old business that for whatever reason is experiencing new, accelerating growth.

Essentially, there are four key reasons why we like Wiley today:

1. It’s easier to find bargains where no one is looking

Despite Wiley being around $A3.5 billion in market cap and generating over $A2.5 billion in revenue, only one broker analyst covers the stock: the previously-unknown-to-us CJS Securities. If Wiley was listed in Australia, its market cap would put it in the ASX mid-cap universe, for which the median number of broker analysts for a company is 13!

Talk about under researched.

It’s easier to find $100 bills still lying around on the street when you are the only one walking down it.

Our investment process is all about getting an edge on a company over the market. The fewer the analysts ‘doing the work’, the more likely we’ll be able to get an edge and find a company outperforming the market’s consensus. Just one broker, CJS Securities, is in effect the ‘market consensus’ for Wiley.

2. Earnings acceleration through digitisation

We expect the business to grow earnings 15-20% pa over the next few years. Revenue has been accelerating after research submissions for journals rebounded post COVID and because Wiley has been digitising its back catalogue of journals/articles over the last few years. Revenue from its digitised back catalogue is dropping through to its bottom line at higher incremental gross profit margins (over 80%). A cost-cutting program, including divesting three non-core business, now just complete, is also helping its bottom line.

3. Competitor IPO shows Wiley’s valuation is attractive

Over in Europe, their big German competitor, Springer Nature, has just announced its imminent IPO and listing on the Frankfurth Stock Exchange. We have met the company multiple times and one of our team very recently travelled to the UK to meet them as part of the pre-IPO “testing the waters” and to gain more intel as a part of our Wiley holding. We think it’s likely Springer’s team of Tier 1 bulge bracket Investment Banks (JP Morgan, Morgan Stanley and Deutsche Bank) will seek a valuation multiple of around 20x 2025 earnings. Wiley, which is growing at a similar rate, is trading on a much cheaper 13x 2025 earnings. We think its likely that the Springer Nature listing will bring significant interest to the space, and Wiley, given its similar growth and business model, but much cheaper valuation.

4. Free optionality: GenAI

You might not think a company that has been around for over 200 years would be at the forefront of artificial intelligence (AI). But Wiley just closed its second licencing agreement with a business customer so they can utilise its content to train their Generative AI (GenAI) models. Most this initial interest is relates to book content in the Learning Division. We can also see this broadening out in the future to the Research division’s academic journal and article content.

So far, Wiley’s GenAI agreements have been for back catalogue content three years or older. But, again, this could become a more recurring revenue source if Wiley provides access to its latest content on an ongoing basis. With around 40 million published articles, Wiley is sitting pretty as a prime source of information to train these models now, and into the future.

For investors in Wiley, this is a completely unpriced and free option. We have seen Shutterstock and Getty Images, whom we have spoken to, recently cash in on the opportunity to use their catalogue of images for training GenAI models. Reddit, the social media forum, also recently signed a deal with Google to use content for its AI training models. Its March IPO has been a success.

All up, Wiley ticks the three key investment selection criteria for us:

Earnings beating expectations.
Margin of safety through a cheap valuation.
Free or cheap growth optionality in the future.

Source: Ophir

So, though Wiley’s been around a while, this is definitely a case of an old company that has some new tricks.

While the small cap market overall waits for its catalyst to start outperforming large caps again, we remain focussed on finding businesses like Wiley that have their own unique catalysts to drive growth and fund performance today. No matter the broader interest rate or macroeconomic backdrop.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior Portfolio Managers

Ophir Asset Management

18 Sep, 2024 Is your fund manager skilful or just lucky?

17 Oct, 2024 Should investors be joining the gold rush?

23 Aug, 2024

Letter To Investors - July

Letter to Investors • 13 mins read

What we think could be the next 10 bagger on the ASX

The share market party kept rolling in July, with little to indicate August’s looming ‘flash crash’. The story of July was the massive rotation from the Magnificent 7 (Apple, Microsoft, Nvidia, etc) into US small caps.

The Russell 2000 US small-cap index was up a whopping +10.2% (in USD) for the month. The S&P 500 eked out just +1.2%, with the Mag7 actually falling -0.6%.

The small-cap surge provided a big tailwind to our Global Funds’ performance during the month.

Small caps globally have had to play second fiddle to large caps since late 2021. As far as the US share market is concerned, there have only been two periods since then where small caps have had some time in the sun. One was back in December last year; the other July just gone.

What do they have in common?

Essentially, during those two periods the market started to price in a higher chance the US Federal Reserve would cut rates (see chart).

Source: Bloomberg. Ophir.

Higher interest rates, starting in late 2021/early 2022, caused small caps to underperform. Lower rates may be their saviour.

The one complicating factor? Whether the long-discussed US recession will eventuate or not.

Like a manic depressive, the share market in recent times has been lurching from ‘soft landing’ rate-cut hopes (good for markets and small-cap outperformance) … to recession and emergency rate cut fears (bad for markets and potentially small-cap underperformance).

While the economic consensus, if there is one, remains in the soft-landing camp, views are wide and outcomes uncertain.

July 2024 Ophir Fund Performance

The Ophir Opportunities Fund returned +5.2% net of fees in July, outperforming its benchmark which returned +3.5%, and has delivered investors +22.2% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned +2.8% net of fees in July, underperforming its benchmark which returned +3.8%, and has delivered investors +13.1% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of -1.1% for the month.

The Ophir Global Opportunities returned +9.3% net of fees in July, outperforming its benchmark which returned +8.0%, and has delivered investors +15.9% p.a. post fees since inception (October 2018).

Great risk/reward in small caps

We like the asymmetry for small caps; that is, they have big upside performance potential but limited relative downside to large caps if things get rough.

We think cheap valuations versus large caps (especially in the US) are likely to be the kindling for small-cap outperformance in the US, with soft-landing rate cuts likely to be the spark. (Based on market pricing, those rate cuts will almost certainly start from next month at the Fed’s September 17-18^th meeting.)

But if a US recession happens, along with supersized emergency rate cuts by the Fed, small caps will almost undoubtedly fall. However, given the chasm in valuations, those falls will likely be less – or at least not much more – than large caps.

The US small cap price-to-earnings (PE) ratio is currently at 16.5x versus 24.3x for large caps. US small caps have not been as cheap versus large caps since the Dot.com bubble 25 years ago. When the bubble burst and recession followed, large caps fell more than small caps because their valuations had to drop from nose-bleed levels.

When US recessions have ended, across all the major share markets in the world, small caps have then significantly outperformed in the first year of the market rebound.

In our view, the relative case for global small versus large caps over the next 5-10 years has not been as compelling as it is today for at least a quarter century. We don’t know the exact catalyst, but as Warren Buffett says, “price is what you pay, value is what you get”.

For the rest of this month’s Letter to Investors we wanted to give you a deep dive on the ‘Who Am I’ company that we flagged in last month’s Letter to Investors – ASX listed company Life360. We think Life360 has the best chance of any ASX-listed company of being a ‘10 Bagger’ (increases in value 10 times over) over the next 5-10 years.

Facebook for friends … LinkedIn for business … and Life360 for family?

When travelling in the US for work there is a lot of down time in the back of an Uber travelling between meetings.

You inevitably start talking to the driver about their families and, of course, America’s favourite topics: crime, homelessness and gun laws.

From the hundreds of these uber rides we can tell you three things:

No one feels safe in America;
Many of these drivers work incredible hours (often in multiple jobs) to give their family a better life; and
The number of drivers that use Life360 with their families has grown exponentially over the last five years.

Life360 is a ‘freemium’ app. The app provides real-time location services for families. You can set up notifications to get an alert when your child arrives at school, leaves school and then arrives home.

If you want to pay for a subscription, you get driver reports, which show how your child is driving (are they speeding? using their mobile phone? etc), roadside assistance, towing, and crash detection with emergency response.

Today, there over 70 million users worldwide, 40 million of those in the US, and two million paying a subscription for the app (think US$15/ month).

Incredibly, on Apple’s ubiquitous mobile operating system (iOS), Life360 now has the fourth-highest daily active users of any social networking app in the US … and the 13^th highest of any app! (You’ve obviously heard the names of all the other big-use apps, like YouTube, Facebook, TikTok, Instagram, Snapchat and Spotify.)

Why we own Life360

We have owned Life360 since mid-2020 when it traded at around $3.50 per share (Ophir owns the stock in all our Australian equity funds including the Ophir Opportunities Fund and the Ophir High Conviction Fund (ASX:OPH).

We were attracted to the growing subscriber base, the ability to move to a tiered subscription model and the free optionality inherent in their user base.

The stock has certainly taken us on a rollercoaster ride. At one stage, it fell close to $2.50. At writing, it was trading at just over $18 per share.

Essentially, there are three key reasons we own Life360:

1. Life360 is going viral in the US and has an ultra-low cost of acquiring customers

Life360 has been spreading like wildfire through the US, especially in the South. Some 13% of Americans are now using Life360 regularly, up from 6% just four years ago. In the Southern States, like Texas, up to a quarter of people are using the app.

Source: Life360 Presentation

The Southern States are still the fastest-growing States in the US. Could Life360 go from 40 million to 100 million users in the US? There is no evidence growth is slowing.

Now it is starting to spread globally.

Importantly, Life360 reported that between 70% and 80% of users sign up because of word of mouth. Recently, the number of users downloading the app has accelerated, despite the company spending less on marketing and advertising.

To help make its app even more viral in the next couple of years, Life360 is set to release its ‘Pet’ product, which will allow pets to be tracked with GPS live in the app. Life360 will also release elderly care, where an elderly parent can have a wearable device integrated with the app. The wearable could feasibly detect a fall and automatically send an emergency dispatch, as well as notifying family members. Life360 is becoming a ‘cradle to grave’ business targeting a huge global end market.

2. The potential to be a powerful ‘Facebook-like’ ad business

Life360 has the potential to become like Facebook and become a marketing business. Like a newspaper, Facebook uses content to attract a crowd and sell adverts. But with Facebook, the user creates content for friends for free. Facebook then targets the best ads to users consuming the content. This creates a very valuable loop: low cost to acquire customers through free content; ultra-low cost to create content; and the ability to target ads algorithmically .

We view Life360’s location services as the ‘content’ created by the family unit. Family members are always creating content for other family members to consume. Moreover, Life360 uses that content to target ads using algorithms and achieve high conversion on those ads. Why might they have the best algorithms to target advertising? For the app to work, they always need to know your location. What other app can claim this? That data is a goldmine for advertisers.

In February this year Life360 announced that it will launch advertising on its platform. From the first second of that day Ophir were buying more stock, even when the stock was up over 20%.

We estimate there will be over 100 billion views on their app over the next 12 months. We have spoken to many people in the digital advertising industry. Their insights suggests that Life360 should be able to charge advertisers somewhere between $3 and $6 per 1,000 views in three to five years’ time on the app in the US.

Interestingly, Life360 included the Uber example (below) in their latest chart pack to illustrate the potential of advertising for the company. This suggests they are thinking along the same lines.

In five years, we believe advertising will likely generate more revenue than Life360’s subscription business. However, the true excitement comes from their margins. In our view the subscription business has the potential to get to 30% profit margins in 2029. But given the content is free and acquiring the customers is free, we think digital advertising can deliver 80% plus profit margins for Life360.

3. Even more opportunities from add-on products like auto insurance

But we don’t see the business stopping there. Life360 has other ‘free options’ – products with massive upside potential that aren’t being valued by the market – embedded. Like auto insurance. Given Life360 knows who is speeding, and the generally good versus bad drivers, they have the ability to price risk better than the standard insurer. Could they offer discounted car insurance to the best drivers who drive infrequently through safe areas at low-risk times? Again, they will have no cost to acquire customers given they are existing users of the app.

Teenage debit cards are another latent opportunity. Parents can pay pocket money through the app and watch how their children spend it in real time. From the days of the Dollarmite account through Commonwealth Bank, signing up kids has been a great way to win long-term customers for a bank. Greenlight is a private US operator in this space, and we estimate it makes well over $100 million of ongoing revenue at high incremental margins on revenue growth.

Importantly, you are not paying for any of these potential businesses where Life360 will have a huge comparative advantage in the cost of acquiring customers and data collected from location services.

Source: Life360 Presentation

The key risk

The key risk for us, of course, will be Apple’s ‘Find My’ app.

It allows Apple users to do many (but not all) of the same things the free Life360 app does. It is conceivable, especially in an AI world, that Find My becomes a lot better and Life360 is not able to stay meaningfully in front of Apple.

While we don’t know what Apple will do here, it’s important to note that Android and Google have been moving away from location services.

Importantly, over 50% of families using Life360 have at least one family member on an Android phone. Given the inoperability between Android and Apple’s iOS, the Find My location services will not be effective for those entire family units.

A rare Aussie 10-bagger opportunity

It is not every day you come across a business listed in Australia that is growing globally above 20% per annum and has 70 million active customers. In the next few years, we will watch and see if Life360 can flex its free product offering to grow to become a truly global platform business.

The hard work has already been done in building the crowd. While Apple will always remain a risk, the potential to make 10x your money in Life 360 means that, to us, there is bigger risk not owning Life360 than worrying about what Apple will do next.

There are no certainties in investing, but Life360 is a company that has us pretty excited. A small cap company growing fast, into a big global end market, with lots of free options for business expansion. Now that’s the type of company we love at Ophir.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior Portfolio Managers

Ophir Asset Management

24 Jul, 2024 Letter To Investors - June

18 Sep, 2024 Is your fund manager skilful or just lucky?

24 Jul, 2024

Letter To Investors - June

Letter to Investors • 12 mins read

Welcome to the June Ophir Letter to Investors – thank you for investing alongside us for the long term.

Immaculate disinflation to the small cap rescue?

Investors have had to contend with inflation, the start of rate cutting cycles, a bifurcated US economy, and wars in Europe and the Middle East. If that wasn’t enough, another force has been thrown into the blender: politics.

Snap French and UK elections started things off. Joe Biden’s woeful first presidential debate performance saw the US get involved. Then, spectacularly and tragically for the innocent victim in the crowd, former President Donald Trump narrowly survived an assassination attempt at a rally in Pennsylvania. And just now President Biden has withdrawn from the race.

Most relevant for June’s performance in our Funds was the risk aversion the French elections injected into the Paris stock market, a market where Ophir has a number of portfolio holdings. French stocks dropped just shy of -14% during the month!

Sacre Bleu!

Source: Bloomberg. Data from 31 May 2024 to 30 June 2024.

In this month’s Letter to Investors, we’ll look at how we manage exposure to individual countries, like France. Then we’ll touch briefly on three key important topics:

The US presidential election and what it might mean for the outlook for inflation, bonds and stocks.
Whether ‘immaculate disinflation’ is alive and well again in the US. Is this the rocket small caps need?
And, finally, we’ll play a quick game of ‘Who am I?’ We ask you to guess this ‘family friendly’ high conviction stock we hold in our Australian Funds. We think this stock is a potential 10-bagger! (Read or scroll to the end of this Letter to play!)

June 2024 Ophir Fund Performance

Before we jump into the letter in more detail, we have included below a summary of the performance of the Ophir Funds during June. Please click on the factsheets if you would like a more detailed summary of the performance of the relevant fund.

The Ophir Opportunities Fund returned +2.8% net of fees in June, outperforming its benchmark which returned -1.4%, and has delivered investors +21.9% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned -0.8% net of fees in June, outperforming its benchmark which returned -1.4%, and has delivered investors +12.9% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +1.2% for the month.

The Ophir Global Opportunities returned -2.2% net of fees in June, unperforming its benchmark which returned -2.1%, and has delivered investors +14.4% p.a. post fees since inception (October 2018).

Quelle horreur! This is why we don’t bet the farm on one country

By far the main contributor to underperformance in our Global Funds during the month was our overweight exposure to France. Without this, we would have outperformed.

Why are we overweight French listed companies?

It is certainly not from any particular view on the French economy or political risks. Rather, from a bottom-up perspective we have found some great ideas in France.

The political uncertainty around a hung Parliament, however, triggered indiscriminate selling in June, and the four French companies we hold fell around -10% to -13% during the month in Euro currency terms.

Ultimately, this volatility doesn’t change our investment thesis on any of these businesses and they have, in general, recouped some of June’s falls in July at the time of writing.

From a portfolio management perspective, though, it does raise an important point: We will never bet the farm on a certain geography versus our Global Funds’ benchmark – the MSCI World SMID Cap Index.

We are bottom-up stock pickers, not macro allocators. We don’t make large, active (over- or under-weight to benchmark) geographic allocations based on a belief that a certain country’s share market will deliver superior risk-adjusted returns.

Typically, we do not go more that plus or minus 20% overweight or underweight a certain country in our benchmark. Most often it is 10% or less.

We don’t want an event like what happened in France in June to be the major determinant of whether we out or underperform over the medium to long term. We want performance to be based on getting the fundamentals of individual companies we own right – that is, identifying businesses with superior growth prospects that are underappreciated by the market.

Historic US market calm before the political storm?

Making money in your large-cap share portfolio has been easy of late with lots of return, yet very little volatility.

The S&P 500 just put on another 3.6% in June, and the Nasdaq added a further 6.0%. The VIX – the so-called ‘fear index’ in the US – has been plumbing lows at the 12-13 times range. This signals the market has very little concerns about a bumpy road ahead.

Another, far simpler, method of looking at recent market calm is the number of days the S&P 500 has gone without a 2% fall.

We have just eclipsed 350 days – the longest streak without a 2% pull back since 2007, just before the GFC. That’s quite an auspicious record to now hold.

In fact, a stretch of calmness by this measure has only occurred 11 times in the last 100 years!

Source: Bloomberg. Data to 22 July 2024

3 things investors can expect from a second-term Trump

However, we know from history that the months right before a US election tend to be more volatile times for share markets.

Will this time be different?

After Biden’s poor showing in the first presidential debate, and the attempted assassination attempt on his debating partner and challenger, Trump, it has become much more likely ‘The Donald’ will add to his title as the 45^th President of the United States by becoming its 47^th.

There is still time between now and November for things to change, but the market has been starting to price in the greater odds of a Trump victory. (At writing, President Biden has stepped aside from challenging the 2024 election with Kamala Harris the likely Democratic candidate as highlighted in betting markets – see chart)

Source: Bloomberg: PredictIt odds for who will win 2024 U.S. Presidential Election

From what we know so far, a Trump presidency will likely focus on four main policy initiates, including:

Limiting imports and reshoring economic activity
Curbing migration
Extending the Trump era tax cuts, and
Repealing the Inflation Reduction Act (IRA).

Given this, what should investors expect from a Trump Presidency? Here’s what we think is likely:

Higher-for-longer inflation

Import and migration restrictions, as well as extending tax cuts, are all inflationary. All else being equal, this could mean inflation remains above the Fed’s target of 2% for some time, at least the next two years.

Higher bond yields

The combination of higher inflation, rising government debt and stronger economic activity will likely put upwards pressure on bond yields. We could see US 10-year bond yields in the range of 5-6%.

Higher equity prices

Extending corporate tax cuts will provide a shot in the arm for US profits and margins. Trump, as he was during his first Presidency, is a market-friendly leader and we expect he will want to continue that in his second term. A key caveat is whether rising bond yields become a headwind to equity market performance. The speed of any rise will be the key here. We know that, initially, rising bond yields weren’t a headwind to share market gains during Trump’s first term in office.

Overall, we expect the market to like anything that increases the odds of a Trump presidency.

But history suggests we should still expect the share market to get more volatile as we approach election day, and that, if Trump wins, higher inflation, bond yields and equity markets become incrementally more likely.

Will ‘immaculate disinflation’ rate cuts rocket smalls caps?

As regular readers and many investors would be aware, since the latest equities bull market started in late 2022, there has been little market breadth. Small caps have dramatically underperformed, and a small handful of mega-cap tech companies have driven the market.

One of the few times market breadth has widened during this bull market was in December last year. That’s when the US Federal Reserve first indicated they were likely done raising interest rates this cycle, and that rate cuts were likely in 2024.

As of writing in July, we have just seen another big signal that indicates that small caps are poised to outperform on the back of so called ‘soft landing’ rate cuts by the Fed.

US inflation data for June, released on the July 11, was notably softer than expected. US annual Core CPI is still 3.3%, but on a three-month basis is annualising at 2.1% – virtually bang on the Fed’s 2% target.

Fed Chair Powell appears to be getting the “further evidence” that inflation is softening that he needs in order to cut rates this year. At the same time, unemployment remains relatively low.

Global Small Caps reacted by posting their second-largest outperformance over Global Large Caps in history! (see chart for outperformance of 3.03% on the 11^th July 2024).

And for good measure the Russell 2000 – the small-cap index – had its largest outperformance versus the Nasdaq ever!

Source: Bloomberg. Data to 11 July 2024

This was a MAJOR market rotation day.

It gives investors some idea of where market positioning and demand is likely to move if a soft-landing rate-cuts scenario continues to play out. This rotation of small cap outperformance, at the time of writing, has continued in the days after the 11th July.

For those wondering what might the catalyst be for small caps to catch up their monumental underperformance versus large caps and mega cap tech, it’s clear: soft CPI and impending Fed rate cuts.

The market has now fully priced in (i.e. a 100% chance) a Fed rates cut of at least 0.25% in September.

Is this the starter’s gun small caps have been waiting for?

If the economy holds, and the rate-cutting cycle starts on the 18^th September as predicted by markets, it is looking increasingly likely based on recent market behaviour.

Who am I? – The Ophir Company guessing game

Now, let’s play a game.

I am US tech company listed on the ASX. Earlier this month I listed on the NASDAQ.

My product is a smartphone app that families use to share their locations.

That app lets me know if my teenager, who has just gotten their drivers licence, is speeding or, God forbid, has crashed the car.

I have 25 million daily users. They use my app at least 5 times per day (that’s a lot of worried parents!!).

In February, on the day I announced I would introduce advertising to my free users, my share price soared nearly 40%.

We think Duolingo is a good ‘comp’ (comparative company) to assess the potential upside to revenues and valuation for this company from introducing an advertising income stream.

I am a top holding and top performer in the Ophir Opportunities Fund and Ophir High Conviction Fund (ASX:OPH).

My share price is up over 125% in the last 12 months.

Who am I?

I am Life360 (ASX:360) and if you want to know why Andrew Mitchell thinks I could be a 10 bagger in Ophir’s portfolios … click on the link here to listen to Andrew’s interview with Murdoch Gatti on The Rate of Change podcast.

As always, thank you for entrusting your capital with us.

Kindest regards,

Andrew Mitchell & Steven Ng

Co-Founders & Senior Portfolio Managers

Ophir Asset Management

17 Jun, 2024 Letter To Investors - May

23 Aug, 2024 Letter To Investors - July

17 Jun, 2024

Letter To Investors - May

Letter to Investors • 14 mins read

Welcome to the May Ophir Letter to Investors – thank you for investing alongside us for the long term.

Earnings matter longer term. Are they starting to again?

We often get asked, “who are your investment heroes?”

Many might think the obvious answer is Warren Buffett.

But that award actually goes to Peter Lynch.

Lynch managed Fidelity’s Magellan Fund from 1977 to 1990, generating remarkable returns. Magellan averaged a 29.2% annual return, nearly twice the S&P500’s 15.8%.

Lynch’s strategy is closely aligned with ‘GARP’ (Growth At a Reasonable Price). The strategy looks for companies growing faster than average (growth), but with a strong focus on not overpaying for that growth (reasonable price).

GARP, of course, is the general approach we use here at Ophir.

Lynch popularised “investing in what you know”: focusing on insights from everyday life, such as the products you buy at the supermarket, to get a market edge. On weekends, the Ophir investment team’s text chat group pings with investment ideas to investigate inspired by things we’ve seen in everyday life.

Lynch also coined the term ‘ten bagger’, the rare feat where an investment rises ten times its original purchase price. We’ve been lucky to bag a few ten-baggers and a handful of stocks in our portfolios definitely have ten-bagger potential.

Lynch’s two most famous books are ‘Beating the Street’ and ‘One Up on Wall Street’, both must-reads for any share market newcomer.

But perhaps our favourite Peter Lynch investing dictum of all time is:

“Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or a few years. In the long term, there is 100 percent correlation between the success of the company and the success of its stock.”

(For proof of this, check out the ‘Key drivers of stock performance’ chart from our last Letter to Investors (https://www.ophiram.com.au/letter-to-investors-april-5/).)

As you probably know, our portfolios have weathered one of those short-term periods where share prices become disconnected from earnings.

In late 2021 through mid-2022, small-cap growth companies, in which we invest, got hammered as interest rates increased. Yet at the same time, their underlying earnings continued to grow.

But is that beginning to change?

During the recent reporting season, in our Global Funds at least, earnings momentum and ‘beats’ finally looked like they are being rewarded by the market again to a degree we haven’t seen for some years. This is good news for investors as earnings growth and positive share price reactions to it are the most sustainable form of performance generation in our funds.

We’ll explore this theme further in this month’s Letter to Investors, using a core stock holding, Zeta, as an example of a stock where the share price is finally catching up with stellar earnings beats.

And we’ll also look at what the current bearishness of Wall Street strategists can and can’t tell us about what lies ahead for markets.

May 2024 Ophir Fund Performance

Before we jump into the letter in more detail, we have included below a summary of the performance of the Ophir Funds during May. Please click on the factsheets if you would like a more detailed summary of the performance of the relevant fund.

The Ophir Opportunities Fund returned +3.1% net of fees in May, outperforming its benchmark which was flat, and has delivered investors +21.8% p.a. post fees since inception (August 2012).

The Ophir High Conviction Fund (ASX:OPH) investment portfolio returned +2.5% net of fees in May, outperforming its benchmark which returned +0.2%, and has delivered investors +13.1% p.a. post fees since inception (August 2015). ASX:OPH provided a total return of +1.2% for the month.

The Ophir Global Opportunities returned +5.8% net of fees in May, outperforming its benchmark which returned +1.2%, and has delivered investors +15.0% p.a. post fees since inception (October 2018).