Microcap masterclass: Yarra's Joel Fleming on making the most of the small end of town

"Liquidity is starting to come back down," he says. "People are prepared to look a little bit further down to drive some of those gains. Valuations look pretty interesting at the moment. You've got really good growth profiles in a lot of cases, and you've got valuations that don't look utterly ridiculous when compared to that forward growth profile."

Against a decent economic backdrop, Fleming expects what has been a fairly narrow rally (driven mostly by miners) to broaden out, presenting investors with the "opportunity to find great companies that could be bigger in the future. There's a lot of choice and a lot of optionality for us. And that gives us a lot of confidence."

On the unique attraction of microcaps

The fundamental opportunity in the microcap space can be summed up in one word: inefficiency.

As one of the market's few dedicated microcap specialists, Fleming says his team's edge is in finding tomorrow's market darlings before they're even on the radar of other investors. 

"There's a whole heap of companies out there that people really don't take notice of until they start to move," he says. "If you can bring a disciplined and focused investment process to these companies, that's a competitive advantage, because there aren't a hundred other fund managers in there trying to find the same idea."

"We are fishing in a really big pond, but there aren't many people doing the same thing."

Given where many microcaps find themselves in the business cycle, proactive investors like Yarra can get genuine access to companies and identify inefficiencies in valuations early. 

"We can touch and feel it. We can get on a plane and within five hours and meet with any company that we're invested in."

"[As investors], you can go in and try and really understand: what's happening in this industry, how are you positioned and what does the path look like here for you to actually take advantage of something that looks really, really exciting?" 

"It's the road less travelled. We do a lot of our own work. We can't lean on consensus information, but that's our competitive advantage because we can identify these companies and say, 'I think that this can really take advantage of a thematic out there that we have a great level of confidence in.'"

On finding the right companies

One of the challenges of the microcap space is applying the right lens when assessing a company's prospects, says Fleming. 

"Every fund manager has a good story to tell, every company has a good story to tell. How do we go and validate what they are telling us?"

While there are some similarities to how a large-cap manager may approach prospective stocks, for Fleming, it's about finding sustainable, long-term growth stories. 

Ultimately, Fleming says, it's about finding those companies that can prove their worth over the long-term and reward early conviction. 

"We want them to be those compounding stocks that you comfortably hold in the portfolio and every single year they deliver for you."