It was the start of 2012 and James Dougherty was handed the keys...

It was the start of 2012 and James Dougherty was handed the keys to Macquarie's flagship Australian small-caps fund.

Macquarie's former small-caps portfolio managers had left to head up IFM Investors' new equities team, and Dougherty had his chance after eight years in the bank's funds management team.
The bloke sitting next to him was surf lifesaver Liam Donohue.
"It was then that we pretty much committed to each other, for life," Dougherty says, with a smile.
The rest is history. The pair's Macquarie Australian Small Company Fund returned 12.85 per cent a year on average over the next five years, while the benchmark small ordinaries accumulation index gained 2.8 per cent a year.
Along the way Dougherty, a keen surfer, caught the eye of industry veteran Chris Cuffe, who he says he "chased down" for an initial meeting and would end up as a friend and mentor.
So after five years running money for Macquarie, and armed with a good set of performance numbers, Dougherty and Donohue have set up their own firm, Lennox Capital Partners.

People game

And which outside investor seeded their new Lennox Australian Small Companies Fund, which started investing last week?
Cuffe's Third Link Growth Fund.
"They've clearly got the results of the past and often managers do pretty well when they are small and I find that is a good time to support if you believe in them," Cuffe says.
"I follow the people rather than the brands. Managing money is a people game. The brand doesn't manage money. And I have no doubt they will very quickly attract a very significant amount of money."
It's an interesting time to set up a small caps fund. After a multi-year period where almost all small caps funds beat the benchmark, most managers have struggled.

Goldman Sachs equity strategists reckon the past year has been the most challenging in the history of most Australian small caps investors. The market is expensive – with only 20 small caps trading on a forward P/E of less than 10-times on – with prices pushed up by large-cap investors scouting small caps in search of the next big thing.
And there are also the "fallen angels", as Goldman Sachs calls them – the high-flying small caps that have crashed, such as Vocus group, Bellamy's Australia, Aconex and Slater & Gordon.
"One of the forgotten skills sets in small caps is you can be an OK manager if you can identify the winner," Dougherty says.
"But the really great small cap managers identify the disasters, can avoid those and don't let those disasters dilute the rest of their portfolio."

Lennox Capital says it is keeping an eye on Aconex and its founders Leigh Jasper and Rob Phillpot to see whether it will re-invest in the company.

Dougherty and Donohue say some of their best decisions have been when to sell. For example, the pair sold Slater & Gordon at $4, when it no longer passed the pair's first test: a quality screen.
So, too, selling SurfStitch when chief executive Justin Cameron left. And Aconex, which they sold after its 2016 financial year result, when they felt its investment thesis had broken down.
"The small-cap market has been very tough for six months – but you could argue it has been tough for 10 years," Donohue says.
"What we have seen in the past six months is more of those losers than in a normal six-month period. And that's what our process is designed to do."
"We are very diligent – and almost obsessed with sticking to our process," Dougherty adds.
"We should always be able to look to our investors, hand on heart, and say we stuck to our process. If we put a stock in our portfolio, we want to be able to front our investors and say we stuck to our process."
And what does the process say to buy at the moment?

Infrastructure boom
One of the stocks in Lennox Capital's new fund is engineering company RCR Tomlinson, which has morphed from a heavily resources-linked company to focus on the east coast infrastructure boom.
"The business has done an absolute about face, it is a credit to the MD Paul Dalgleish – he has refaced that business and now we all know about the infrastructure spend coming down the pipeline," Donohue says.
"The stock looks cheap ... and following on from that infrastructure spend is that the business has a good record of turning contracts into profit, which is also important."

Donohue also likes Australian body, hair and skin-care products producer BWX, and the pair have been backing it since before the company's ASX-listing in 2015.
"Once you start to look at the trends in the industry, the move towards skin-care brands, it really was a compelling proposition," he says.
"The business is still growing really strong, they are dominating Australian pharmacy sales and now the opportunity is offshore expansion. Initially it was seen as a diagou expansion story, but we think of it more about the UK and North America."
Dougherty likes data centre owner NEXTDC and ferry operator Sealink Travel Group.
"They seem like simple businesses but data centres are complicated," Dougherty says of NEXT DC.
"[CEO] Craig Scroggie has always been able to articulate his growth strategy really well and if you look back in the past three years, he has done an excellent job executing it."
Lennox Capital Partners are also backed by Challenger Ltd's Fidante Partners, which has a minority stake in the manager.