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Microcaps: Year in review

Peter Rae
August 09, 2017

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by Peter Rae

While the financial year 2017 may not have been overly pleasing (with the performance of the ASX emerging companies index returning a dismal -2.3% for the year), a different picture emerges when looking at the performance of active managers in the space.

The majority of microcap managers outperformed the Index, which shows why this is an attractive hunting ground for alpha for fund managers and investors.

Below is a table illustrating the returns of managed funds (which actively focus on microcaps or the bottom end of the small-cap space), together with the performance of their listed microcap LIC counterparts.

Some analysis of the results reveals some interesting facts.

While some managed funds had negative returns for the year (for example, Acorn and Ausbil), the vast majority of fund managers had a positive performance for the year, and not a single one of the 19 fund managers in the aforementioned table underperformed the ASX microcap index.

Despite the “great rotation” or the “silent crash” in small caps/microcaps during the year, we did see two new microcap funds launch (Perennial and Eley Griffiths) and a new LIC from Wilson Asset Management. The more players in this space the better, as it improves overall liquidity in the market. It also broadens the spectrum of managers available to both advisers and self-directed investors who are looking to allocate capital to the space as part of their overall asset allocation.

Yet again, the majority of active managers easily outperformed the Index, demonstrating that this part of the market can be a great alpha generator for managers who put the work in. Aside from that, their investors would have also been handsomely rewarded in terms of performance. Based on information published by Perennial earlier in the year, the median microcap manager had delivered 18.8% annualised over five years, versus the -4.8% for the microcap index over the same period.

The SPIVA reports that track how active managers perform versus the index noted that Australian small cap managers outperformed the index 52% of the time over five years and 67% of the time over 10 years. However, my suspicion is that if SPIVA looked at microcap managers in Australia, the results would be equal, if not higher, than the small cap performance.

Of course, academics will tell us active managers can’t add alpha and index fund promotors will tell us active management is dead. Oh, and just as an FYI, for large cap managers, it’s 30% and 25% respectively.

The performance of most microcap managers also handily outperformed the ASX Small Ords index, and generated returns in line with the ASX All Ords index and the ASX 300/200 index, which is a fine effort.

Top of the pops in FY 2017 was the Forager Australian Share Fund, followed by Cromwell Phoenix Opportunities Fund and the Terra Capital New Horizons. All delivering portfolio returns in excess of 20%.

A corollary to good performance by one market participant means poor performance for other market participants. Here, the Monash Absolute Investment Company, Contango Microcap and Ausbil Microcap all had an “annus horribilis”, as her majesty would say.

However, judging any manager on a single year performance, either positive or negative, is short sighted. All managers need to be judged over a reasonable timeframe and taking into account a more holistic view of their investment philosophy and process. This year’s underperformers could be next year’s star performers.

Looking at the group overall, we can see that the average performance achieved by all the managers was +10.8%, which represented a 13.6% outperformance versus the microcap index and 3.8% outperformance versus the small cap index.

Published: Thursday, August 10, 2017

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