SMSFs could capitalise on ‘attractive’ small cap dynamic
“More value is on offer” across the discounted small cap market, which bore the brunt of volatility in 2022, according to a senior fund manager.
The ongoing global battle against inflation has continued to rattle markets, with monetary policy tightening from the world’s central banks undermining investor confidence in company earnings forecasts.
The equities market was dealt a major blow in 2022, prompting investors to explore alternative asset classes with less sensitivity to macroeconomic settings.
Small caps were among the heaviest hit by this shift in investor appetite, with the S&P/ASX Small Ordinaries Index falling by over 18 per cent in the 2022 calendar year, while the large caps market remained relatively flat.
But according to Adrian Ezquerro, principal and portfolio manager at Elvest Co, the sell-off across the small cap market in 2022 presents SMSFs with a lucrative opportunity.
“I think we’re seeing relatively more value on offer,” he told SMSF Adviser.
“We’re still a little cautious, but we think there’s a pretty good argument to be made to have a solid allocation of small caps given that valuation appeal that we’re starting to see in the small cap part of the market.”
Mr Ezquerro said SMSFs could access “outsized rates of growth” without paying a premium.
“For instance, the industrial part of the small cap market is trading at a circa 15 per cent discount to the large cap industrial segment,” he observed.
“So, there’s more value on offer, as it’s clearly a more dynamic space.”
The fund manager acknowledged the risks associated with greater exposure to the small cap market adding individual SMSFs would need to assess their comfortability with the allocation.
“There are more risks, of course, because these companies, when compared to large caps, generally aren’t as established,” he noted.
“But you can see that in terms of their growth profiles, they have, on average, more growth; they’re growing into deeper markets, albeit off a smaller base.
“That’s an attractive dynamic that I think most SMSFs would like at least some exposure to.”
Mr Ezquerro said SMSFs interested in broadening their exposure to small caps would benefit from maintaining a “longer-term time horizon”.
“[The allocation] has to be balanced against the [investor’s] needs in terms of shortage of income for the near term, bounced off against the potential for longer-term compound growth in excess of what you’d typically find in large cap exposure,” he said.
“… We’d be advocates for a degree of exposure to small caps, and at this entry point, probably a little more than what may have been the case two or three years ago.”
According to Mr Ezquerro, the travel and tourism, education, and industrial mining segments could offer lucrative opportunities for SMSFs looking to increase their exposure to the small cap market.
These industries, he observed, could benefit from the rebound in migration to Australia and the green energy revolution.
SMSFs increasing allocations to the small cap market can also leverage tax incentives offered by the Commonwealth government for investments in early-stage innovation companies (ESICs).
Incentives include a tax offset equal to 20 per cent of the investment and modified capital gains tax (CGT) treatment for ESIC investments between one and 10 years.
The investment limit is not capped for sophisticated investors; however, the maximum offset is capped at $200,000.
