Boutique manager Avoca Investment Management says that while smaller caps have traditionally been perceived as a higher-risk investment, they may provide investors with a risk management tool.
“The oligopolistic big four Australian banks have been a great long-term investment and self-managed super funds in particular have been a major beneficiary. However, with ever increasing capital requirements, increasing government and APRA oversight, likely softening in mortgage lending and the spectre of encroaching fintech, it seems less likely that the returns of the past will be emulated going forward,” Avoca managing director John Campbell said.
“Financials represent around 40 per cent of the ASX S&P 100 benchmark, providing a worrying level of concentration risk.”
Instead, investors would be wise to carefully consider their index composition.
“Conversely, the composition of the S&P/ASX Small Ordinaries is much more balanced and aligned to the Australian economy,” Mr Campbell said.
Small caps’ previous under-diversification should serve as a cautionary tale for those overly invested in their larger counterparts, he added.
“Five years ago, with its absurd resources skew of 48 per cent, the S&P/ASX Small Ordinaries benchmark bore little resemblance to the Australian economy. This skew was completely at odds with the Australian economy and was a clear warning signal.
“It caused massive pain for investors when the inevitable happened in 20100-11 and the China economy started to slow, creating a knock-on effect to commodity prices.”
Now that smaller caps have diminished their concentration risk, they can be a promising opportunity for investors.
“Our view is that small caps are a good place to invest going forward given the better opportunity to grow that small companies, with generally smaller market shares, have over large companies ... the breadth of opportunity in stock selection and the greater likelihood of M&A activity benefiting smaller companies than top 100 companies,” Mr Campbell said.