Lonsec’s review of the Large Cap Australian Equity Fund sector encompassed 36 active funds across traditional small cap, mid cap and micro cap funds. Lin Ngin, Senior Investment Analyst responsible for this review explains the difference between these funds.
“A traditional small cap fund invests primarily in the S&P/ASX Small Ordinaries Index, where a mid cap fund invests predominantly in the S&P/ASX51-150 segment.”
“Lonsec reviews five microcap funds, which typically invest in small stocks outside the S&P/ASX Small Ordinaries Index. Microcap stocks are generally a relatively immature business, offer the highest level of risk and are usually quite illiquid – but potentially offer the highest level of growth opportunity.”
Of the 36 funds reviewed, five attained Lonsec’s top rating, Highly Recommended; one midcap fund, the Ausbil Australian Emerging Leaders Fund and four small cap funds – Hyperion Small Growth Companies Fund, Pengana Emerging Companies Fund, Schroders Australian Smaller Companies Fund and the UBS Emerging Companies Fund.
“Six new funds were added to Lonsec’s small cap Australian equity universe in this review, including two microcap funds, the Ausbil Microcap Fund and the Macquarie Australian Microcap Fund,” said Ngin.
Sector observations
Strong gains….if you were in the right place
“The S&P/ASX Small Ordinaries Accumulation Index gained a solid 13.1% in 2010 – a far cry from the 53.2% loss in 2008 and the 57.4% gain in 2009,” observed Ngin.
“However there is a mixed story – the S&P/ASX Small Industrials Accumulation Index returned just 2.2%, while the S&P/ASX Small Resources Accumulation Index returned a strong 30.7% return for the year.”
The Lonsec review found that the “average” small cap manager in its universe is underweight the resources sector, largely due to a “quality” bias in their investment process. “This can be incompatible with small cap resources stocks where the company may not be generating cashflow or earnings, or may be a higher risk, single mine business,” said Ngin.
Midcap stocks continued to struggle compared to small cap stocks, with the S&P/ASX Midcap 50 Index returning just 4% in 2010. In contrast, funds that were able to invest in the other end of spectrum in microcap stocks were the strongest performers, with the S&P/ASX Emerging Companies Index returning 25.7% over the same period.
Limited IPO activity in this sector
Historically, IPOs have been a major source of investment ideas for small cap managers; however 2009 was a relatively quiet year with just $7.5 billion in IPOs across large and small caps. While 2010 saw $25 billion in IPOs, most was in large caps – or small resources.
“The lack of new industrial stocks is of some concern,” commented Ngin.
“This is compounded by the departure of some industrials, such as JBHiFi, which became a midcap stock and therefore out of the investment universe for most small cap managers.”
Other IPOs – such as Rebel Sport – have been put on the backburner after the lacklustre performance of high profile industrial IPOs such as Myer, Kathmandu and QR National.
Fund flows continue to be flat
While funds under management continued to grow, this was largely due to market movement – actual inflows were relatively flat. This is consistent with the findings of Lonsec’s recent large cap review.
“Unlike the large cap sector, the small cap universe has not been subject to competition from low cost ETFs and index style products,” said Ngin.
“These products are much less likely to impact the small cap universe as the argument for passive index style products is substantially weaker in this sector.”