Being selective with IPOs delivered for this small cap expert

In a year of bushfires, cheap money, a US Presidential election and a global pandemic, investors were exposed to a rollercoaster ride of mixed emotions, panic selling, and dizzying bouts of volatility. Reflecting back on the calendar year 2020, it is interesting to see which group of companies outperformed. Large or small caps? Tech or healthcare?

It was a clear win for the smaller end of the market, which quite convincingly outperformed the bigger end. The MSCI Australian Shares Microcap Index returned 14.71% and the MSCI Australian Shares Small Cap Index returned 14.58% whereas the MSCI Australian Shares Large Cap Index managed only 1.42% for the year, roughly a 13% difference.

Without question, both micro-cap and small cap stocks outperformed the top end of the market, which in itself is a rare occurrence. Usually after a black swan event, fear and panic sweeps through markets and investors offload the riskier micro-cap/small-cap stocks first to reduce overall portfolio risk. Yet the pandemic was very different: it exposed the large-cap universe for what it is; mainly a group of old-fashioned, growth-challenged companies.

This led to an outperformance in a number of small cap stocks that were able to benefit from the COVID outbreak. When it comes to small-cap investing, old-fashioned active management still delivers. The OC Micro Cap Fund was the best performing fund in the country, delivering a whopping 43.1% in the calendar year (December 2020) The result demonstrates the resilience of the micro/small-cap sector last year.

The OC team has more than 50 years of investment management experience, with Robert Frost successfully managing small and micro-cap Australian equities since 2001. He is responsible for the portfolio management of the OC Premium Small Companies, Dynamic Equity and Micro-Cap Funds. It’s his skill and experience, together with that of his team of four, that has contributed to the fund’s success. Virtually all small-cap funds have beaten the benchmark in the last 12 months, and Frost attributes OC’s result to its avoidance of Australia’s challenged resources and mining companies, which comprises a significant chunk of the index. The top 10 list of small-cap stocks recorded massive gains well in excess of 100%.

While the small-cap sector outperformed, it was the team’s specific selection of “direct COVID-19 beneficiaries” and subsequent selection of “vaccine beneficiaries” that tied a skyrocket to the overall portfolio’s fund performance.

November was the fund’s third double-digit monthly return since the March lows and the fFund remains well ahead of the S&P/ASX Emerging Companies Index over the calendar year having returned +38.1% (versus +23.8% for the index).

The fund’s success is also attributable to its IPO opportunities and selection of high-quality names such as:

Duratec (DUR; +20%), which provides building and infrastructure maintenance and remediation solutions to government. Other IPOs include Doctor Care Anywhere, Booktopia and GenusPlus.

The team’s outlook: “Investors have continued to take a ‘glass half full’ approach in recent months casting aside record daily COVID-19 cases in the US and parts of Europe. A confluence of significant events has created a risk-on investment environment for equities which is good news for short-term investment returns. Some of these events include:

• record low interest rates domestically and the adoption of a quantitative easing strategy by the RBA;
• an election outcome in the US which ought to be supportive of equity markets;
• stunning early successes on the COVID-19 vaccine front (in the West) with preliminary Phase 3 efficacy
• data from both Pfizer/BioNTech and Moderna and later Oxford/AstraZeneca extremely promising.

In summary, the team at OC say the “domestic small-cap market may continue to grind higher in the coming months with the wave of positive investor sentiment continuing to support risk appetite and as the Australian economy enters 2021 with a recovery tailwind.”

A list of the best-performing small cap stocks in the ASX based on share price returns for the 12 months to December 31, 2020 is below. The S&P/ASX Small Ordinaries Index closed the year off +9.21%.

Ishan Dan

Ishan is an experienced journalist covering The Inside Investor and The Insider Adviser publications.