Small cap stocks ride out market weakness
As the returns from ASX200 stocks appear to be moving ever more in unison, having the ability to pick stocks outside of the mainstream market is more important than ever, according to new research by Macquarie Group.
Tracking the correlation of each stock's return using a year of weekly returns, the study found that the correlation has moved from 0.25 to almost 0.40 in less than a year, with a correlation of one indicating that stocks move up and down together perfectly, and zero suggesting there is no linear relationship. Correlations also tended to increase during periods of increased market volatility, Macquarie stated.
"Looking across the Australian Securities Exchange - rather than just large caps - is now even more important because smaller companies have the capacity for above average growth in weak economic conditions, and often deliver higher returns when markets rebound," Prime Value Asset Management senior investment analyst Fiona Clark said.
She said investors should consider investment in smaller companies, which are often overlooked by larger managers, hedge funds and high frequency traders.
Their valuations are often a better reflection of the basic fundamentals, allowing for normal pricing irregularity, she added.
According to Clark, the risk profile of small cap companies has remained stable, while the profile of larger companies has increased substantially.
"There may be opportunities to buy large caps when they get dragged down with every other average run-of-the-mill enterprise," she said.
"When volatility eases then the true value of your investment may be appreciated,"Clark said.
The key to success with a large cap investment is timing, and Clark said finding opportunities outside of ASX200 universe is still an extra advantage for any investor.
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