Over recent months the microcap and small cap end of the ASX has been pummeled, by what has been termed the “great rotation” or "silent crash", more phrases to add to your investing lexicon. This is largely where large cap managers who had meandered down into the smaller end of the market looking for EPS growth and alpha have been largely divesting (some would say indiscriminately) out of small and microcap names since about September 2016 back into more familiar large caps names. This “great rotation” out of small and microcap names back into large cap names has lead to a real de-rating in microcaps and small caps. This has precipitated some poor short term performance results from a number of professional active managers in the space. My own recent microcap picks it must be said have not been immune.
However Microcaps should not been seen as a short-term, 6 month investment, like all equity investments they should be judged over a longer time period. I note the latest SPIVA report for the Australian equity market came out in the middle of reporting season and many probably overlooked it. However given the angst currently faced by microcap and small cap investors, professional or otherwise, I believe it is worth reviewing some of the salient data points from the report.
Unfortunately the report doesn’t cover microcaps, however I will use mids and small cap results as a general proxy. Firstly over 1 year the benchmark or a simple passive index fund would have outperformed over 80% of professional active small and mid cap managers. However when looking out over a 10 year time horizon the benchmark or passive index fund only bested active small and mid cap managers a little over 30% of the time. Comparing the results over the same 10 year time horizon for Australian large cap managers, international equity managers or AREIT managers we see these managers were bested by the index at least 75% time! Or looking at it another way large cap, international and AREIT managers were bested at least twice as much by a simple passive index fund compared to small cap managers over the same period. Thus the small end of the market is a fertile hunting ground for active managers. As a group over the long term small cap managers have an excellent record of delivering alpha and outperforming their relevant benchmarks. Indeed the outperformance over ten years according to SPIVA has been +3.41% annualised. Even adjusting this outperformance for the higher fees charged by active managers the difference is still meaningful.
If we look at some specific funds for example such as the Wilson Asset Management's flagship small cap fund WAM Capital Ltd it has underperformed its benchmark by 1.1% on a 1 year basis, however over the nearly 18 years the fund has been running it has outperformed its benchmark by +9.6% on an annualised basis. Similarly looking at microcaps in particular, fund manager Microequities Deep Value Microcap Fund has underperformed its benchmark by 2.67% on a 1-year basis, but again looking at the 8-year track record of the fund it has delivered a very generous +12.82% annualised outperformance to its investors.
My own 5 picks of Microcaps to watch in 2017 have also not been protected from the general aversion to the smaller end of the market. Some of the picks have also provided somewhat disappointing results in the February reporting season to compound their underwhelming share price performance in recent times. This has also not been a forgiving market, even small and microcap stocks, which delivered in reporting season, got sold off, partly I believe by large cap managers trying to capitalise on the volume available surrounding results announcements in effort to try and exit their positions. Thus even my picks that did report inline or slightly ahead also suffered. However as we are only 3 months into the year and while acknowledging I am well behind the 8 ball I still believe there are quiet a few catalysts that can still turn things around and my mini portfolio should still perform well.
Stepping back and looking at performance through a long-term lens shows us that the performance of microcaps and small caps has been robust and rewarding for investors in the space, something we must not lose sight of given the current turmoil.
Hi Mark. thx for the report. I look forward to hearing more of your picks.
Thanks James hopefully have a few more coming through later in the year.
Recently I've seen lots of articles attributing the decline in small caps to large cap fund managers selling. At some earlier point these same managers must been buying small caps. I'd be interested if anyone recalls seeing articles at the time attributing the small cap rise to this. Or was it a case of small cap managers 'owning' good performance then, while looking for someone else to blame for poor performance now?