Don’t meddle with your small caps

FILE PICTURE: The JSE in Sandton. Picture: Desiree Swart.

FILE PICTURE: The JSE in Sandton. Picture: Desiree Swart.

Over the last decade, three of the top twenty local unit trusts have been small cap funds.

The Nedgroup Investments Entrepreneur Fund, the Momentum Small/Mid Cap Fund and the Investec Emerging Companies Fund have all delivered annualised returns of over 20.5% over that time.

Three funds might not sound like a lot, but proportionally, it’s significant. Small cap funds make up a tiny portion of local collective investment schemes – there are currently just nine of them in a total of more than a thousand available funds. That means that a third of all small cap funds are within the very cream of top performers over the last decade. No other category comes close to being able to boast that kind of success rate.

Over the last ten years, the mean fund in the SA equity general category returned 18.17%. For the same period, the mean fund in the SA equity small cap category gave investors 20.34%.

But this out-performance is noteworthy, not remarkable. If anything, it should be expected. Since the start of 2002, the

small and mid cap index on the JSE has delivered 78.6% more than the All Share index, and 58.2% more than the SWIX 40.

“Over the last ten years, small and mid caps have massively outperformed large caps,” says Richard Middleton, fund manager of the Investec Emerging Companies Fund. “The same holds true internationally.”

The small cap story is based on the ability of smaller companies to grow their sales and earnings growth more aggressively than larger counterparts. One expects small caps to be the potential growth stocks that can generate the sorts of returns big counters no longer can, since they’re coming off a much lower base (and growing faster).

Vanessa van Vuuren, manager of the SIM Small Cap Fund says: “Your fund manager should also be picking stocks that grow faster than the market.”

Although their overall growth’s been exceptional, during the 2008 crash small caps fell much harder than anything else. This not only caused many investors to abandon small caps at the time, but has made many others unwilling to buy into them since.

“People are quite reluctant to get into small caps after crashes, because they tend to crash

dramatically,” Investec’s Middleton says.

“This is because liquidity dries up, so selling a large number of shares in a small company could drive the share price down 20%.”

But while this short-term volatility can be alarming, it shouldn’t distract investors from the bigger picture.

Investing in small caps comes with some extreme ups and downs, but one can accept this more easily when one’s time horizon is well into the future.

“That’s why … an investor who invests in small caps must take a long term view,” Middleton says. He suggests investors buy into a fund manager who they believe will do a good job and buy in for the long term.

“Over the long term, small cap companies massively outperform larger cap companies.”

Making a conscious decision to stay invested for ten or fifteen years, no matter what happens in the interim, also reduces the chances of trying to time the market and getting it wrong. Because with the volatility of small caps, one can get it exceptionally wrong.

“It’s a fairly risky space to take a short term view,” SIM’s Van Vuuren warns.

“So I always encourage our investors to have a longer investment horizon because the down cycles can be quite deep and protracted, and small caps are by their nature more cyclical and more sensitive to the local economy than larger businesses. But you should make a better return if you can sit through that.”




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