Small caps predicted to outperform as economy recovers
SMSF investors who shun small cap stocks may miss out on valuable opportunities once the economic recovery takes off, warns an investment manager.
GSFM chief executive Damien McIntyre explained that while periods of underperformance for global small caps do coincide with recessionary environments, small caps historically go on to experience meaningful outperformance in economic recoveries.
“For instance, between 2000 and 2006, small caps outperformed large caps by 200 per cent, and between 2009 and 2014, they outperformed large caps by 35 per cent,” Mr McIntyre said.
“In fact, the MSCI World Small Cap Index has outperformed the MSCI World Index over the long term, with global small caps returning two times that of large caps over the past 20 years.”
Mr McIntyre said small caps are a larger, less well-researched universe and, overall, small caps trade at a wide discount to that of large caps on a PE basis.
“Historically, MSCI World Small Caps trades at a significant discount to MSCI World Large — that premium is between 1.0–1.2 times. It is currently trading at 0.8 times,” he said.
While he acknowledged that small cap investing can be linked to increased volatility, focusing on high-quality businesses and exhibiting considerable secular growth can help address these risks.
“Investing in profitable companies, with strong underlying cash flow, a conservative balance sheet and a demonstrated ability to allocate capital, helps protect investors on the downside,” he said.
Investors should also be looking at small cap opportunities across the world, he said, with the small cap opportunities in Australia alone too limited.
“Stock markets are inefficient and this creates opportunities for patient, well-informed investors to buy an ownership stake in a company below intrinsic value. This is particularly evident in smaller companies that tend to be under-researched by the investment community,” he said.
“Investors can take advantage of these inefficiencies through time horizon arbitrage, identifying strong capital allocators and recognising businesses at inflexion points.”
Miranda Brownlee is the deputy editor of SMSF Adviser, which is the leading source of news, strategy and educational content for professionals working in the SMSF sector.
Since joining the team in 2014, Miranda has been responsible for breaking some of the biggest superannuation stories in Australia, and has reported extensively on technical strategy and legislative updates. Miranda has also directed SMSF Adviser's print publication for several years.
Miranda also has broad business and financial services reporting experience, having written for titles including Investor Daily, ifa and Accountants Daily.