Finding undervalued opportunities
Taking a small-cap approach to investing can provide access to a diverse range of opportunities while allowing investors to avoid exposure to the largest sectors such as fossil fuels.
The Australian Securities Exchange (ASX) is one of the most concentrated global stockmarkets with the top 10 companies including BHP and CSL making up 50% of the market. This is a factor some investors might want to avoid, particularly from an environmental, social and governance (ESG) perspective as they may prefer avoiding exposure to these large-cap companies from an ethical perspective. In particular, this mood has driven the demand for Ex-20 funds, those active funds which exclude the largest 20 firms on the ASX.
Small and mid-cap funds also gave investors the opportunity to get in at an early stage on companies which large-caps avoid which could go on to big successes. A large-cap fund will tend to ignore a company until is over $50 billion in size. This makes small and mid-caps an under-researched area with the potential to find good opportunities, if managers can find reliable and transparent data. Early small-cap successes include A2 Milk, Afterpay and Aristocrat Leisure which have all since seen significant growth since listing on the stockmarket.
According to FE Analytics, within the Australian Core Strategies universe, there are 99 Australian small and mid-cap funds in the Australian equity small/mid cap sector.
There is no strict definition of what is classed as a ‘small and mid-cap’ company but most funds would invest in small-cap companies between $500 million and $2 billion while mid-cap is $2 billion to $10 billion. Within the sector, there are also micro-cap funds which are usually highly concentrated and consider companies with a market cap below $500 million.
The largest fund in the sector was the Bennelong ex-20 Australian Equities fund which has $2.4 billion in funds under management (FUM) followed by Allan Gray Australia Equity which has $1.6 billion. In total, there were only nine funds in the sector which were over $500 million as small and mid-caps tended to deliberately be kept at a small volume of AUM for liquidity purposes.
With this in mind, there were also many funds which were significantly smaller including 8IP Australian Small Companies which was $10.4 million, Ausbil Australian SmallCap at $4 million and Eiger Australian Small Companies at $5.4 million.
This was one of the downsides of these types of funds as small or mid-cap companies are usually less liquid than large or mega-caps which meant the funds could be riskier and/or more volatile than their large-cap counterparts. The companies do not have the same capital or resources which make them more vulnerable to negative events but, at the same time, they may be able to pivot and move their businesses quicker than larger ones.
PERFORMANCE
The Australian small/mid cap sector has returned 22% over three years to 30 June, 2020, compared to returns of 14% by the large-cap sector. Over one year to 30 June, 2020, it has lost 0.3% but this was a smaller loss than the large-cap sector which lost 5.8%.
From an index perspective, the S&P ASX Small Ordinaries has returned 19.4% over three years, lost 6% over one year and lost 9.2% since the start of 2020 compared to returns of 16.3% by the ASX 200 over three years, 8% losses over one year and 10% losses since the start of the year.
Small and mid-cap funds have also fared better than large-caps during the pandemic, losing 7.9% since the start of the year to 30 June compared to losses of 9.5% by the large-cap sector. The best-performing fund since the start of the year was Hyperion Small Growth Companies which returned 5.9% followed by DMP Australian Small Caps Trust Wholesale which returned 2.3%. The sector average was losses of 7.94%.
There were two further funds, Perennial Value Microcap Opportunities Trust and Ophir Opportunities which returned 1.9% and 1.5% since the start of the year.
While only four funds had seen positive returns since the start of the year, this was a larger percentage at 4% of the sector compared to the Australian equity sector which saw just 2.6% of its funds reporting positive returns over the same period.
Looking over a longer three-year time period to 30 June, the best-performing fund was the aforementioned Perennial fund which returned 23% and Ophir fund which returned 20.2%.
AUTHOR
Laura Dew
Recommended for you
As thematic ETFs gain popularity among advisers, research houses have told Money Management of their unique challenge to rate these niche products and assess their long-term viability.
Count CEO Hugh Humphrey is keen for the firm to be a leader in the new world of advice as the industry generates valuable businesses post-Hayne royal commission.
Money Management explores what is needed for a successful fund manager succession plan as a generation of managers approach retirement and how firms can mitigate the risk of outflows.
As ESG and sustainable funds continue to suffer outflows and the regulator cracks down on greenwashing, there has been a notable downturn in the number of launches and staff hires in this area.
