Smaller cap stocks are ripe for active management given the many quality smaller companies available for those prepared to look beyond the ASX 100 index, according to award-winning small cap managers Richard Ivers and Mike Younger of Prime Value Asset Management.
The beauty of small cap investing is managers can be rewarded by digging deeper and by regularly meeting with companies. This is because companies outside of the ASX100 do not receive the same coverage by brokers, meaning managers can gain an edge via their own research.
But this only counts if the manager is free to construct their portfolios without the pressure of mirroring an index, according to Mike Younger, Portfolio Manager for the Prime Value Emerging Opportunities Fund.
“When looking to put a stock into the portfolio, we’re aiming for quality rather than being concerned about an index and potentially choosing the ‘least worst’ option from a sector heavily represented in the index.
“Practically, this means we tend to hold higher quality companies in the portfolio, and they’re companies that tend to hold up better during market downturns.”
The actively managed Prime Value Emerging Opportunities Fund has outperformed both the small ordinaries index and the small industrials index during each of the last six years.
The Fund has returned 10.6% per annum after fees over the last five years, 8.2% above the Small Ordinaries Accumulation index for the same time period.
It has also returned 11.4% after fees for the calendar year to 31 August 2023, compared with the Small Ordinaries Accumulation return of 3.5% over the same period.
Richard Ivers, Portfolio Manager for the Prime Value Emerging Opportunities Fund, said there is a healthy depth and breadth of quality companies across small cap stocks. “The small ordinaries consists of 200 companies with an average market capitalization or value of $1.6 billion. They are reasonable-sized businesses, and on average make a net profit after tax around $85 million.”
Yet quality alone does not guarantee a place in the portfolio. “We are on the hunt for quality, but we don’t invest in mining companies, and we have some ESG exclusions that include armaments and gambling.
“Even with these exclusions it is possible to deliver outperformance while still protecting capital across different market conditions.
“We’ve had an extremely volatile period that has really tested investor biases and styles. We’ve experienced bull markets, bear markets, periods in which growth has been in favour, and periods where value has been in favour. And, of course, we’ve had COVID as well.”
Placing a big emphasis on risk helps reduce volatility. “We’re trying to be more consistent in the returns we record each year, as opposed to swinging for the fences and trying to hit the ball out of the park. And this comes down to the value we place on the certainty of the outcome.
“We’re more attracted to opportunities where we think there’s a very high degree of certainty of that outcome with lower risk, as opposed to other opportunities which might have higher returns but bring higher risk.”
Managing risk comes down to a ‘good offense being your best defence’, according to Mr Younger, who says stock selection is critical to avoiding the worst of market downturns. “We put capital protection front and centre of everything we do.
“If you analyse our performance over the last five or six years, it shows that in months where the market falls we’ve actually outperformed the market at around 80% of the time.
“You can also see it in our risk metrics and over that same period of time we’ve had amongst the lowest risk of any of our small cap peers. But we’ve still been able to generate that consistent and strong outperformance.”
Prime Value Asset Management’s small cap team was shortlisted as a finalist in Zenith Fund Awards 2023 for the Australian Equities – Small Cap Award, having won the same category last year at the Zenith Fund Awards 2022.
The Prime Value Opportunities Fund is currently rated Recommended by Zenith Partners, and Recommended by Lonsec. Richard Ivers and Mike Younger also manage Prime Value’s Emerging Companies Fund for SIV investors, which is performing strongly.
To invest in the Prime Value Emerging Opportunities Fund please contact our Client Services Team at info@primevalue.com.au and 61 3 9098 8088