Micro-caps offer big potential despite size

Micro-capsare continuing to out perform the ASX 100, but investors are still running shy of the sector.

In the 12 months to March this year, the micro-cap benchmark achieved returns of 22.8 per cent, compared to the All Ords return of 12.29 per cent.

Australia’s only micro-cap manager, Acorn Capital, achieved returns of 36.97 per cent during the same period.

Acorn managing director Barry Fairley says the returns for micro-caps have been consistent. His company has achieved a return of 27.60 per cent since its inception in late 2000.

“We have stuck to our investment philosophy and we haven’t had to change the investment process,” he says.

Acorn invests in about 70 of the 1,100 stocks that make up the Australian micro-cap index.

Retail investors can access the micro-cap manager through Australian Unity’s Freedom of Choice master trust or the friendly society’s wholesale funds product.

Acorn is 50 per cent owned by Australian Unity and four per cent by JB Were. To date, Acorn has $28 million of funds under management.

Fairley says while there was a drop in performance of the micro-cap sector in September last year, the same as all the other global indexes, micro-caps have come back stronger.

However, investors are still flocking to the major stocks, he says.

“Acorn has calculated that for every dollar invested in the top five per cent of Australian stocks, less than half a cent is invested in the bottom five per cent of the Australian Stock Exchange (ASX),” Fairley says.

“Investors seem to have more than $20 billion invested in News Corp, but less than $50 million in micro-caps.”

Fairley says this investment split between the two sectors cannot be argued on value reasons.

“We believe there are three principal reasons behind investors’ asset allocation decisions,” he says.

“During the past five years there has been a movement towards passive portfolios and this has lead to capital being withheld from stocks outside the ASX 300.”

Fairley says the lack of research outside the top 300 stocks has also created poor liquidity in small and micro-caps, and that has been a barrier to investing in these areas.

“Finally, there has been no group promoting the micro-cap sector and no body of research into the investment merits of the sector,” he says.

Independent research would reveal the sector’s potential, Fairley argues, especially in picking future winners on the ASX.

“All the future stars on the ASX tend to come from the micro-cap sector and they create a lot of performance,” he says.

“Because we are sector-neutral in our investing, we have the ability to pick more of these future star performers.”

Acorn visited 300 companies last year as part of its investment strategy. Acorn’s analysts rates a company’s management team as one of the signs of future performance potential.