Small and micro cap companies – on the tear ?

By Alistair Francis - December 5, 2017

Global equity markets continue to remain well supported in response to an increasingly positive backdrop of improving economic data and accommodative central bank commentary.

Read: The full Investment Month in Review December 2017 Newsletter

Along with an encouraging US corporate earnings season, recovering global commodity markets and increasing optimism around potential US tax reform, Australian equities have rebounded after a period of subdued relative performance.

As a share market heavily weighted to domestic facing, older-world businesses (banks, insurance, traditional retail and resources), we are again seeing capital being recycled out of the lower growth larger-capitalised space (ASX Top 100) and deployed into higher growth opportunities either offshore or further down the market-capitalised curve (ASX Small Ordinaries). 

Source: Iress; Pitcher Partners Investment Services

Diversity

One of the true benefits of being a small or micro capitalised equity investor is the diverse range of businesses and industries on offer to allocate capital to at any one time. These are typically either domestic-facing businesses that are exceptionally high quality and/or unique in their industry or business model, or businesses that are growing their scale and opportunity set through expansion into higher growth international jurisdictions. Another feature of the Australian market that supports micro capitalised investing in particular, is the relative small scale of the competing domestic venture capital industry, with listed markets providing investors with the added benefits of a greater level of transparency, scrutiny and liquidity.

Smaller capitalised growth-orientated businesses have continued their recovery from the selloff experienced in late 2016 and the more recent performance (3 months) has been nothing short of spectacular. This support for the space can be attributed to the positive macro-economic environment (per above), an encouraging reporting period, a more benign AGM season compared to 2016, strong net capital inflows and hyped thematic investing into China, electric vehicles and resource stocks. While one would expect this small company outperformance to mean-revert at some juncture, it is difficult to pinpoint a catalyst near-term given the relatively more subdued outlook for the large capitalised stocks.

While the index performance has been strong, it hasn’t been across the board and stock selection continues to remain critical across the small and micro-capitalised spectrum. While overall market returns for the quarter were exceptional, a lot of the heavy lifting came from a relatively concentrated group of businesses ie A2 Milk (+50.6%), Blackmores (+53.1%) & Mineral Resources (+31.2%) to name a few.

The chart below highlights the Small Companies strength (+11.6%) over 3 months versus the Large Caps. (ASX 100 +5.2%) over the last quarter with a strong contribution coming from Small Resources (+17.9%) with the Small Industrials (+10.0%) lagging.

On the other side of the equation, whilst the AGM season so far has proven to be relatively benign, it hasn’t been without incident ie Fletcher Building (-17.7%), Webjet (-16.1%) and the iSentia Group (-25.3%) to name a few. Elevated share prices create a greater risk that a business will miss market expectations.

At Pitcher Partners Investment Services we have traditionally left the management of this segment of the market up to our diversified list of approved specialist small and micro capitalised managers. These managers can all be characterised as having:

  • an experienced team with a proven track record;
  • a consistent investment process; and
  • a disciplined risk management focus given the inherent volatility of this space.

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