High-flyer one year, 'avoid' rating the next

Morningstar has issued an ‘avoid’ rating to one of 2009’s best performing investments, the EQT/SG Hiscock Smaller Companies fund.

The research house said despite the fund’s “monster” return of more than 120 per cent in 2009, it could not encourage investment on a forward-looking basis.

The fund is managed by SG Hiscock’s Adrian Di Mattina and John Thompson on behalf of Equity Trustees. Morningstar described Di Mattina and Thompson as an “experienced pair” who were invested in their boutique employer and the fund they managed, positively aligning them with the fund’s investors.

However, Morningstar is concerned the portfolio construction employed by Di Mattina lacks rigour, while the research house also has concerns about the stock-specific risks that come from investing in the “small and illiquid segment in which Di Mattina and Thompson hunt”.

“We’re not prepared to back a process where the performance depends on one or two calls coming right,” the research report stated.

Morningstar said the fund’s micro-cap focus failed to boost its performance during the bull market, with poor performance between 2004 and 2008 seeing all but the most loyal of supporters withdraw their money. The fund then lost 65 per cent in 2008.

And while the fund’s performance in 2009 was “up with the very best in the market”, the research house said on a forward-looking basis the strategy lacked conviction, including a lack of focus on risk controls in addition to portfolio construction concerns.

“We therefore suggest that prospective investors in EQT Small Companies search among the alternatives in the large and high-quality field of Australian small-cap strategies,” the report stated.