Why add small caps to your portfolio
If I were to characterise the domestic small cap market in just one word, it would be ‘dynamic.’ It is truly dynamic in the sense that it is constantly changing and evolving which creates exciting opportunities for astute investors.
Driving forces of this constant change include global growth themes that have some years to play out, such as the falling costs of deploying technology and the rise of the Asian consumer, as well as dynamic entrepreneurs with advantaged business models disrupting the larger often established incumbent players.
Smaller companies are generally defined as those sitting outside the ASX100 index. In general, they tend to be at an earlier stage of their business life cycle relative to their more mature counterparts (‘big caps’ in the ASX100). The upside here is small caps can have quite significant growth potential.
Importantly, realising this growth potential may be less reliant on general macroeconomic conditions because these companies are earlier-stage, benefiting from structural tailwinds and/or employing disruptive business models.
A key to success
Management execution is a particularly important success factor when it comes to small companies. Indeed, many small companies are a direct reflection of their management teams, who are often entrepreneurial founders with substantial ‘skin in the game.’ Their strategic decisions strongly shape and define the outcomes of these businesses so understanding how management think can be a key contributor to making money as an investor in the small cap market.
Our process involves us spending a lot of time getting to know the management teams of the companies which we invest in because we see investing as a partnership built on trust and delivering on expectations.
Many of the higher growth companies within the ASX100 index were once small caps – household names like realestate.com.au, carsales.com, Flight Centre, Domino’s Pizza and Cleanaway, and more recently, Altium and Afterpay.
This highlights the exciting potential of investing in the small cap market. By seeking out structural growth companies lead by dynamic management teams, we are essentially investing in tomorrow’s leaders, today.
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Dominic is Portfolio Manager of the Montgomery Small Companies Fund – a small-cap Australian equity fund investing in 30 to 50 high quality, undervalued small and emerging companies with strong growth potential. The fund invests outside the ASX100.