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Small caps better protected from concentration risk

10 January 2017 By Oksana Patron



Small caps are a good place to invest going forward as they have the potential to grow faster than large companies with a dominant market share and currently show lower concentration risk level than the ASX 100 which has a heavy exposure to the financial sector.

Such was the opinion of Avoca Investment Management, with managing director, John Campbell, noting that investors should be aware of index composition and currently the S&P/ASX Small Ordinaries was much more balanced and aligned to the Australian economy than five years ago when it had "absurd resources skew of 48 per cent" and did not fully reflect the economy.

At the moment, consumer discretionary comprise 22 per cent of the benchmark, resources (including energy) 18 per cent, industrials 10 per cent, financials nine per cent, property 11 per cent and health six per cent.
"Since then, concentration risk had diminished in small caps but increased in large caps," he said.

"Investors need to understand these risks and, in the case of large caps, understand that the glory days of setting and forgetting their portfolios with a huge bank exposure, is unlikely to be a smart strategy for the next five years."

According to Campbell, small caps with an attractive business model would represent a higher growth potential than larger and more established businesses, while investors looking outside of the top 100 would open up a universe of potential investment ideas far exceeding what the large caps currently had on offer.

He also stressed that of the 25 merger and acquisition (M&A) transactions that took place over the past two years in the S&P/ASX 300, only one occurred in the top 100.

"Mergers and acquisitions have the potential to add significantly to a portfolio with the typical premium of most bids in the 30 to 40 per cent range,"

"It is unlikely that M&A will have much impact in the top 100 but could potentially be material in the Small Ordinaries.

"In short, some of the major hurdles against investing in small caps are no longer there.

"Our view is that small caps are a good place to invest going forward given the better opportunity to grow that small companies -- with generally smaller market shares -- have over large companies, the breadth of opportunity in stock selection, and the greater likelihood of M&A activity benefitting smaller companies than top 100 companies."

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