FUND REVIEWS

Nedgroup Investments Entrepreneur, Old Mutual Mid & Small Cap Fund, SIM Small Cap Fund, Investec Emerging Companies, Coronation Smaller Companies

The small cap funds have just R6.3bn under management — little more than 1% of the assets held by domestic equity funds. It’s quite a contrast to the heady days of 1998, when it looked as if these funds were destined to overtake general equity funds.

Yet small cap funds are now much more reliable than in those days. They no longer focus on faddish IT businesses in which the largest item on the balance sheet was goodwill. They provide a blend of industrial, resources and financial shares, including such wellmanaged businesses as AVI, Santam and Italtile.

There are some large shares in this universe, such as Quilter, which has a R46bn market cap, Liberty, with R30bn, Impala (R61bn) and Sibanye Gold (R57bn). But small cap funds are usually seen as a proxy for SA Inc shares, especially industrial ones.

It has been a difficult market in which to operate, and over five years the sector has shown a negative return. This will be a big disappointment for investors who bought these funds on the strength of the widely held view that there is a small cap premium. While large caps have little room to grow in a stagnant market, small caps, with much lower market shares, have more headroom. They are also more likely to be driven by energised entrepreneurial management.

Sanlam puts some of the reasons to invest in the sector on its small cap fact sheet. They include the following:

● Small cap companies tend to outperform large cap firms as a result of being able to grow

their earnings faster, with higher volatility;

● Due to a lack of research there are many more undervalued and mispriced opportunities among small caps; and

● Some growing and emerging industries exist only in the small cap area. These include private education and restaurant franchising.

Today’s small caps are the large caps of tomorrow. There have been virtually no net flows into the small cap sector, which helps explain why this part of the market has struggled to grow. Liquidity has also been an issue, as so many small caps are virtually untradable, and many of the funds have migrated into mid caps, many of which are large businesses in their own right. And in many cases the big businesses of tomorrow can easily bypass the stock exchange, now that the private equity industry is much more highly developed.

The large houses have nonetheless kept their small cap unit trusts open, with the exception of Stanlib, where performance was so inconsistent it was embarrassing. There is quite a marginal cost to keeping these funds on the platform, and the small cap research carried out for the funds benefits the stockpicking for the other equity products.

The two large funds in the sector, with more than R2bn under management each, are Nedgroup Entrepreneur and Investec Emerging Companies.

Entrepreneur carries many of the same themes as its sister fund, Rainmaker — it has the same portfolio manager in Anthony Sedgwick and a strong emphasis on industrials, with little focus on the other sectors. Investec has a more liberal approach, with a large resource weighting and a significant property holding.

The other three funds remain below R1bn: in the case of Coronation it is a bafflingly small R140m, even though performance has been generally quite tolerable.

Sanlam Investment Management at one point managed R7bn of small cap assets — it was common for pension funds to offer dedicated small cap mandates to fund managers. Now it manages less than R1bn, with just R400m in the SIM Small Cap fund. It positions itself as the fund for the patient investor.

At Old Mutual one of the great characters of this sector, Warren Jervis, has, sadly, left, but the firm was lucky to have a previous manager, Brian Pyle, on the bench to take over. He will step back into the mainstream equity products once he has trained rising star Khaya Nodada to be Jervis II.

The closest passive fund is the Momentum Mid and Small Cap Index Fund, which happens to have done a lot better than Momentum’s active fund in the sector.

Other funds in the sector include one from Alpha Wealth, which has done so badly we should call it Omega Poverty, and an equally disastrous high-volatility fund from Cannon.

Small cap boosters are now saying that all along small caps are geared for strong economies, not weak ones. There’s no doubt that counters in sectors such as construction and vehicles could improve hugely if economic growth bounced back to 3% or 4%. But few companies in these sectors can be considered quality — these funds also need evergreen companies, and they are certainly there. ●