There has been a sharp rise in investor demand within Australian Micro Caps and a corresponding increase in funds meeting this demand, according to Zenith’s most recent Sector Review.
Since 2016, the number of Micro Cap funds in Zenith’s rated universe has increased 125%, while the total funds under management (FUM) in Zenith’s rated Micro Cap funds increased from $115 million to $702 million over the three years to 31 December 2017.
Over the same period, Micro Cap funds rated by Zenith delivered a median return of 26.3% p.a., significantly outperforming the S&P/ASX Emerging Companies Index by approximately 9.4% p.a., with materially lower risk.
The median Small Cap manager on Zenith’s Approved Product List (APL) underperformed the S&P/ASX Small Ordinaries Accumulation Index by 4.3% (net of fees) over the 12-month period ending 31 December 2017. Over the same period, the median Mid Cap manager on Zenith’s APL achieved performance (net of fees) which was broadly in line with the S&P/ASX MidCap50 Index, while the median Micro Cap manager outperformed the S&P/ASX Emerging Companies Index by approximately 2.2% (net of fees).
Micro Cap funds will typically invest in companies outside of the S&P/ASX 300. They are generally highly volatile due to the lack of publicly available research on stocks and impact of strong capital movements. That said, they offer a high performance potential due to these risks.
Zenith Head of Equities Research Quan Nguyen said “stocks at the small/micro end of the market capitalisation spectrum have wider performance outcomes, which reinforces Zenith’s view that Micro Cap investing requires professional investment managers who possess the necessary experience and expertise to avoid the inherent risks.
The strong performance of the Micro Cap segment and limited capacity available have led to a number of Micro Cap offerings reaching capacity and closing to new investment. However, with the recent arrival of a number of new funds, the available capacity across the Micro Cap segment (currently rated by Zenith) has increased significantly.
The Micro Cap fund universe came within $200 million of its collective capacity in June 2016, however the rise in number of Micro Cap funds has translated to approximately $1.2 billion of total capacity becoming available as at 31 December 2017. However, extrapolating the FUM growth for the 2017 calendar year of approximately $400 million, we estimate that this capacity would be filled within three years.