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If I had to list two of the top questions asked by investors, one would be “what are the best mid-cap/small-cap funds to invest in?” followed closely by “how do I invest in the Midcap 50?” It seems that many investors see the top 20 stocks as being growth challenged and are looking for opportunities in the smaller parts of the market.
Over the last five years, the Midcap 50 index (which represents stocks ranked 51st to 100th by market capitalisation) is up by 106%. This includes the return from dividends. By contrast, the S&P/ASX 200 total return over this period is 65%.
The Small Ordinaries Index, which represents stocks ranked 101st to 300th by market capitalisation (the so-called “small caps”) has returned just 31%.
The following graph, using a common base of 100, shows how these different parts of the market have performed. The S&P/ASX 200 is in blue, the Midcap 50 in red, and the Small Ordinaries in green.
Data: S&P Dow Jones, Chart: Switzer Super Report
In 2017, small caps have done a little better. The laggard has been the “top 20” stocks, which are increasingly been labelled as “growthless”. This part of the market has returned 1.15%, compared to the broader market’s 4.06%.
Source: S&P Dow Jones Indices
Is the recent outperformance of mid and small cap stocks going to continue? The momentum buyers certainly think so, and there is a case that the top 20, dominated by the banks, Telstra and the major retailers, are really struggling to grow. For investors, I don’t think you can ignore the mid/small caps because theoretically at least, this is where the growth should come from. A weaker Aussie dollar would also assist.
Investing in individual stocks is one way to gain exposure, but with smaller stocks, this obviously carries more risk (and potentially reward). Alternatively, you can look to professionals to give you this exposure.
Here is my take on some of the better funds to choose from. I would like to call them the “best”, but I don’t think this is a claim that is easy to make or necessarily easy to prove. Take out some manager insurance and consider two or three funds.
Geoff Wilson’s WAM Capital Limited (WAM) has a fantastic track record. One of the largest listed investment companies (LICs) at a market cap of circa $1.6 billion, it trades at a premium to net tangible asset backing (NTA), so investors pay to access this performance. On 31 August, this premium was a massive 25.5%!
The company runs an actively managed portfolio of undervalued growth companies, which are generally found in the small to medium industrial sector. WAM also provides exposure to relative value arbitrage and market mispricing opportunities. Among its top holdings at 31 August were exposures to other listed investment companies such as Hunter Hall Global Value and Templeton Global Growth Fund, and companies such as Fairfax, Nine Entertainment and Afterpay Touch. Cash holdings were almost 30%.
Performance has been very strong over the medium and longer term. Over the last 10 years, it has outperformed the All Ordinaries Accumulation Index by 7.5% pa (before fees). However, over the last 12 months, it has underperformed the same index by 4.6%.
WAM benchmarks to the broader All Ordinaries Accumulation Index. If it was benchmarked to the Midcap 50 index, its performance over the last three and five years would be less impressive.
Source: Wilson Asset Management
Mirrabooka (ASX: MIR) is also a listed investment company. It is part of the Australian Foundation Investment Company stable of LICs, and specialises in investing in small and medium sized companies located within Australia and New Zealand. It defines these as companies which fall outside the top 50 listed companies by market capitalisation. On 31 August, Mirrabooka was trading at a premium to NTA of 22.5%!
Among its top 20 holdings are exposures to Qube, Lifestyle Communities, ALS, Mainfreight and Iress. Typically, it owns 50 to 80 stocks.
It benchmarks against an average of the Midcap 50 and Small Ordinaries Index. Performance has not been strong recently on a relative basis, although five- and 10-year performance is above benchmark. The management fee in FY17 was 0.62% pa.
The UBS Australian Small Companies Fund invests in a portfolio of 30 to 60 small company shares and aims to outperform the S&P/ASX Small Ordinaries Accumulation Index when measured over rolling five year periods.
The top 10 stocks include holdings in Steadfast, Bapcor, NEXTDC, Technology One and Collins Food.
The management fee is 0.85% pa, plus a performance fee of 20% of any outperformance above its benchmark. Retail investors can access the strategy via an online broker that offers the ASX mFund Settlement Service such as nabtrade.
The UBS Australian Small Companies Fund has underwhelmed over the last 12 months. Performance over three years, five years and since inception in 2004, is well over benchmark.
This is a different style of listed investment company (LIC) that aims to deliver a sustainable income stream and modest capital growth by investing in high yielding ASX listed securities outside the largest 30 securities in the S&P/ASX 300. It targets a dividend yield of 6.5% pa of its net tangible asset value, paid quarterly.
The LIC is around $85m in size and is invested in approximately 50 stocks. The top 10 holdings include ASX, Bank of Queensland, Tabcorp, Bendigo & Adelaide Bank, Carsales and IOOF. Cash holdings can go as high as 50% (currently 13.8%).
At 31 August, the LIC was trading at $0.98, a 6.2% discount to its NTA of $1.045. Performance since inception (in August 2015) has been 10.46%, 2.2% above the increase in the All Ordinaries Accumulation Index of 8.27%.
Most exchange traded funds (ETFs) passively hug an index. iShares and SPDR each offer ETFs that track the S&P/ASX Small Ordinaries index. iShares’s ETF trades under ASX Code ISO and has a management fee of 0.55% pa, while SPDR offers SSO (management fee of 0.50% pa).
VanEck has recently transformed one of its ETFs to track the Midcap 50 Index. The VanEck Vectors S&P/ASX Midcap ETF trades under stock code MVE and has a management fee of 0.45% pa. If VanEck does its job, investors can expect to receive a return of the Midcap 50 index performance, less 0.45%.