Roy Keenan from Yarra Capital Management shares insights with James Dunn from The Inside Network on the role of active management. The Inside Adviser
After the Hayne Royal Commission many advisers decided to steer away from large dealer groups in favour of becoming self-licensed. In the last six months, however, that trend has taken an abrupt turn.
The ‘thrill of the chase’ in the small cap space
While the actions of central banks around the world created a turgid year for small caps, Ausbil small and microcap portfolio manager Arden Jennings believe that it’s the state of monetary policy that will ensure strong small cap performance in the year ahead.
“It took small caps down last year, but I would say that was more in response to inflation and small caps were unable to pass inflationary pressures through with higher prices given their bargaining power and economic moats relative to large caps,” Jennings told the Inside Network’s Investment Leader’s Forum in Queenstown. “They weren’t able to insulate themselves from rising cost pressures, and we saw that with margins coming down.
“But on the flip side of that, there is great growth on offer within the small cap space. If rates are holding here or they’re falling, I think you’d be more than compensated given where valuations are as well as the growth on offer. If monetary policy is peaking or has peaked that’s great; you certainly wouldn’t want it to run away again and go higher, but we think there’s enough support there.”
Small caps have rallied steadily over the last several months, narrowing the price dispersion between them and their large cap peers, but their valuations still offer compelling opportunities and they have historically come back faster from market downturns than their large cap peers.
“We know that small caps recover faster from a market trough; in the dot.com bubble small caps really outperformed their large cap peers and the all ordinaries; that was again demonstrated in the recovery from the GFC, and likewise in Covid. Last year was pretty tough for small caps, but we do know that they tend to outperform their larger peers and the broader market after the trough.”
“There are still opportunities to get growth when large cap growth in the coming year is going to be virtually zero. Within the small cap space we can see the IT sector is offering really good growth, and a lot of that is coming off very low numbers as a lot of unprofitable companies cut costs and pull for cashflow and break even.. on the flip side retailing there are downgrades coming through in the retailing space.
There’s also far more to see in the small cap space. Jennings noted that the top 10 holdings in the broad market index account for 50 per cent of the capitalisation of the total index; in small caps, the top 10 holdings only comprise around 15 per cent of the index.
“There’s a breadth of undiscovered opportunities,” Jennings said. “You can find the next Afterpay, A2 Milk, Altium. These are the opportunities in our space that we’re on the road hunting for, and that’s why we’re taking a lot more active risk… For us, it’s about the thrill of the chase. Those undiscovered companies are under-researched by the broking community and they’re under-owned by our peers in the small cap market.”
Ausbil also plays the IPO market, and while that’s gone “pretty quiet”, it’s still reviewed more than 100 deals in the last 18 months – but being highly selective rather than taking a “spray and pray” approach means it’s only participated in 17. The other opportunity is founder led businesses; there are around 18 Ausbil’s small cap fund. Looking at their performance pre- and post-COVID relative to the small ordinaries, Jennings estimates that they’re up 128 per cent versus an index rise of 18 per cent.
“As founders they have skin in the game,” Jennings said. “And we know that incentives drive behaviour. Secondly, founders typically take a long-term mindset. So even if it’s at the expense of short-term profits they’ll make decisions based on the long-term interests of shareholders, not just to meet the next quarter or half year report the market is wanting.”
“Culturally, we find that founder-led businesses generally have a stable yet evolving culture and that’s generally for the better. While you can’t a dollar value on a company’s culture or a company’s reason for being, we know that a strong company culture does drive shareholder value over the long term.”
