When it comes to picking small cap companies to invest in, K2 Asset Management’s Stephen Scott turns to Scotland Yard’s interrogation tactics to find potential winners.

Mr Scott, portfolio manager for K2’s Annapurna Microcap Fund, said he likes to take an almost forensic approach to researching businesses before putting money behind them – taking the time to question managers, and listening intently to their answers.

And when the opportunity presents itself to test a possible investments’ products or services, he rarely passes it up.

“We don’t invest conceptually,” he noted.

“We like to see companies with a particular product or software commercialised and being sold into the market live.”

This hands on approach is how Mr Scott, in his former role heading up Contango’s Microcap Fund, identified the opportunities presented by the likes of Pro-Medicus and Hub24.

The latter of those two, now a $1.5 billion company trading between $19 and $26 this calendar year, he bought in infancy for around $1.20 per share.

And under the guidance of Mr Scott and fellow Annapurna manager Bill Laister (also a Contango alumni) delivered an annualised return of 16.5% for the Contango Microcap Fund – which was the largest and longest-running microcap fund in Australia at the time.

Speaking to Reach Markets, Mr Scott listed the two questions he believes are the most important to ask when speaking to a business’ leadership team.

The burning questions

In his spare time, Mr Scott listens to podcasts about Scotland Yard – the headquarters for London’s Metropolitan police force – and the interrogation tactics used by its officers.

These discussions have helped him refine his own line of questioning when speaking with the CEOs and managing directors of small and microcap businesses – notably, they reinforced the importance of keeping questions open-ended.

And the first open-ended question investors should be asking, according to Mr Scott, is….

What is your specific competitive advantage, as you see it?

This question will often require follow up questions, such as who they see as the business’ competitors.

This is an important question because investors can glean so much from the answers – a business that lists 10 or more possible competitors, for example, might not really have (or understand) a distinct competitive advantage in the market.

Looking at a business’ product or service, and who they see as their competitors, also gives you a sense of how easy they think it will be for rivals to copy their solution, what kind of lead time they have over competitors – there are a multitude of ways to dig into the answer.

The second question Mr Scott likes to ask is one most investors will already have up their sleeves, but by asking it differently, those same investors will get far more detailed answers.

The question in question: Where does your business want to be in three years’ time?

The trick, however, is to frame it in a way that taps into a CEOs personal relationship with their business. For example:

When you go home and speak to your wife or your kids, in three years’ time what do you tell them, what do you say to them that means you’ve had a good day or that the business is successful?

Mr Scott says this approach helps him to fill in the gaps and better analyse prospective investment opportunities.

Stephen Scott will be joining us for ‘The Insider: Meet the Fund Manager’ on Friday 9th of April at 12 pm (AEST) where he will provide an overview of his favourite stocks, market themes, trends and insights, followed by an interactive Q&A. Book here.

‘The Insider: Meet the Fund Manager’ is a free webcast series which gives you direct access to prominent fund managers. This session is live and interactive and includes a live Q&A. Spots are limited, so please book into this session as soon as possible.

Past performance is not a reliable indicator of future performance.

Reach does not assume responsibility for the accuracy or completeness of any information provided, and the views expressed are not reflective of Reach Markets position.

Any advice contained within this presentation is general advice and does not consider your personal circumstance, you should consider whether it’s appropriate for you. The information we are giving you is for educational purposes only. “Investing is about understanding your risk” and every time you invest in the share market there is a risk of loss.

Sources:

• ASX, HUB24 Limited (ASX: HUB)
• K2 Asset Management, Microcap Fund Launch, Annapurna