The fundies who survived launching late last year - and five of the top small caps they are backing

Imagine you have served your apprenticeship and you’re ready to go out on your own. You're ready to start your own fund with a partner who shares your vision. You’ve both done it all - working your way up the ladder - from analysts to portfolio managers, to heads of equity departments.  

You’ve seen all the market has to offer: GFC, the Euro debt crisis, a pandemic, and bull runs. You have worked across different clients: institutional, high net worth, and family office. You’ve built the connections. You have your strategy.

Across every dimension, you’re ready. 

It’s late 2021. You pull the trigger, launching your fund focused on ASX small caps, called LSN Capital. At the time, small caps are fully valued, at best. More like overvalued. The easy money has been made and the asymmetry of risk is to the downside. 

And you know that something is coming. Not exactly what, but something. Then, 2022 begins and the market gets smashed in January. Growth assets take a hammering as central banks try to stuff the inflation genie back into the bottle. Breathe. 

That’s the situation that has befallen Nick Sladen and Nick Leitl. The aforementioned colleagues who have seen and done it all launched LSN in December 2021. Lesser investors might have taken their ball and gone home. Not these guys. Their discipline, their aligned goals – with each other and their investors, and their aforementioned experience have them excited by the opportunity ahead, even if the launch of LSN has been a baptism of fire.

“We look at it and say our investment process has been really, really tested through the first nine months of this year.” 

It’s that sort of thinking that sets the tone for the rest of the conversation. Rather than backing down from challenges, the two Nick’s are stepping up to them.

The story so far

The LSN Emerging Companies Fund offers investors a portfolio of 30-60 quality emerging companies and is available to wholesale investors. The Fund is built using a robust stock selection process with a strong risk management framework, which we will discuss below. 

When asked about their path to launching LSN, both speak of their wealth of experience and the extremely talented people that they worked with over the journey, who helped to shape their approach and style. When asked why they chose the style that they did, the answer was both candid and refreshing.

Their focus has always been on Australian equities, and the best investment and returns that they have made have been in small caps. The data also supports the fact that the best returns and the best outperformance for investors are delivered in that space. So they have stuck to their knitting. But it’s more than just the money.

These guys are genuinely curious. To hear Leitl speak, the passion for emerging companies is visceral, “These are the most under-researched companies. Access to management is one key component of that. Getting out there, seeing companies, meeting management, and having access to businesses is exciting."

Leitl notes that researching these companies means you are at the forefront of new industries. 

"You're at the forefront of companies that are disrupting industries that are quite settled. That in itself is exciting. And following the journey from these businesses, from small cap companies into large cap companies, is something that exciting to be a part of.”

Problem Solvers

I asked Sladen and Leitl how hard it was, when they launched the fund late in 2021, not to simply pull the trigger on lots of stocks amid the excitement of finally putting their stake in the ground. Without missing a beat, the reply came back “not hard at all.”

“We've both been around long enough to see different upturns and downturns and there was a clear valuation bubble for zombie-type companies – companies that were not self-funding. They needed the support of equity markets to deliver the funding capacity, to deliver their growth going forward. And we knew that capital market support would not be there forever and those valuations would not stand the test of time," says Sladen. 

The guys pride themselves on their alignment of interests with their investors. They own 100% of the management company. They are highly incentivised to deliver outperformance. They have skin in the game, and they win when their clients win. 

A winning formula

The LSN investment process is built on valuation discipline. They simply won’t overpay for companies. Outside of that, exceptional return on capital, healthy margins, significant growth, and balance sheet strength are important, in companies with incentivised management teams and the ability to self-fund their growth.  

In talking to the slide above, Sladen highlights that LSN is looking for businesses “in that emerging growth phase", saying that they want to invest and watch them grow up the return curve and mature into the quality growth phase. 

"And that's really where you generate a lot of returns, identifying those businesses at an early stage in their life cycle and, and growing with them into that quality bucket.”

Whilst highlighting quality growth names is key, equally important is rejecting businesses that are too expensive. Coming back to late last year when they launched the fund, through August and September 2021 the market was providing messages that certain stocks were ‘cheap’ on EV to sales relative to global competitors. The boys weren’t buying it, with Leitl saying, “many of these companies had limited prospects in the short to medium term of self-funding their growth and needed the support of capital markets to grow. And for us, that was just a simple red flag, and we avoided these companies.”

Coming back to their aligning of interest with their clients, Sladen and Leitl won't invest in a business that they wouldn’t own themselves.

As for the macro environment, whilst they are bottom-up stock pickers at their core, they’re mindful of the environment in which they are operating. But again, this comes back to their process of looking for businesses that will enjoy structural growth, irrespective of the cycle. 

Stockpickers at heart

It would have been remiss not to ask them for a stock or two that they like right now, that fits the LSN mould. They mentioned Hub24 (ASX: HUB), Netwealth (ASX: NWL), IPH Limited (ASX: IPH), and Atturra Limited (ASX: ATA) throughout the interview but the one they highlight is Life360 (ASX: 360) – a name which they have been buying recently.

“It's a high-growth SaaS business, exposed to an addressable market of over $12 billion. The company is rapidly expanding its subscriber base, leveraging its pricing power. It's just recently put its prices up. It has over 40 million monthly active users. And it's in the top 20 downloaded apps in the US. It's well-funded. And we expect that to really do well as they move to positive cashflow in FY23.”

The bottom line

Pressure creates diamonds and LSN Capital was launched through an intense period for global markets. Rather than wilt, Sladen and Leitl have survived and thrived, handily outpacing their benchmark to this point via a combination of incredible discipline, market nous, and a healthy dose of humility. Far from content, they believe they are in a strong position to capitalise when markets normalise.