Edward West
26 June 2009
Johannesburg — SMALL-cap shares are looking compelling compared with their larger counterparts due to attractive valuations and the decline in interest rates, say two leading fund managers.
Small caps refer to the shares of companies with a relatively small market capitalisation on the JSE.
"As small caps are perceived as more risky investments, they have been hit much harder by the global financial crisis and subsequent economic downturn," said Brian Pyle, head of small caps at Old Mutual Investment Group (SA) (Omigsa).
For example, the Alt-X -- the JSE's market for small to medium and growing companies -- returned -62% in the 12 months to May 31. The FTSE/JSE top 40 index fell only 28% .
Also, small caps did not bounce back as hard during the recent market rally. In May 2009, the small cap index gained 4,8%, compared with the 11,3% of the top 40 index. The AltX index continued to decrease in May .
Pyle's view on small caps is shared by Paul Hansen, director of asset management firm Stanlib. Hansen said the only caveat was if the recession continued to deepen in SA, which could cause small cap shares to decline further.
"Small caps are bombed out, in the ashes. The Stanlib Small Cap Fund was the best performer in 2007 and the worst performer in 2008," said Hansen.
He said small and mid cap share prices had slumped due to the global financial crisis, and the fact that 60%-70% of investment into these shares last year was in the form of single stock futures which were sold off heavily later when margin calls could not be met.
"We think there are opportunities, although this is not for the faint-hearted. Some are trading at price:earnings (p:e) of two to three, and are good companies paying a dividend yield of 5%. Most of these companies hardly ever pay dividends," said Hansen.
Although falling interest rates would help small caps, in the recession the risks were higher for them than the big companies.
Pyle said the average p:e ratio at which small caps traded compared with large caps had widened to a 25% discount -- bigger than the long-term average of 15%.
He said interest rate decreases would be one of the catalysts to this differential normalising.
"Many companies reporting results show that times are tough, while prospects remain very uncertain and muted. However, the continued fall in interest rates is normally good for small and mid-caps relative to large caps."
Another factor in small cap recovery was the gradual improvement in investor risk appetite, which had been demonstrated this year in the rallies in the rand and local equities.
Pyle said Omigsa was dedicating resources to reassessing some of these companies, now that they were returning to normalised earnings growth and p:e multiples.
"We continue to focus on individual companies and the prospects for each one of them."
The biggest positions (by percentage of fund) in the Old Mutual Small Companies Unit Trust Fund managed by Pyle were: Astral , Italtile , Datatec , Hudaco and Wison Bayly Holmes.
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