Are you envious of that friend who made a fortune by investing in small-caps, as you let go of the opportunity believing that small caps may be too risky? Here’s a word of advice from legendary emerging markets small cap investor Mark Mobius, who says that small caps are neither too volatile, nor too niche. Mark Mobius, believes that the emerging market small-cap segment is an opportunity that active fund managers could explore. The executive chairman of Templeton Emerging Markets Group tweeted, “We believe the EM small-cap space is fertile ground for active managers who can focus on risk management.”
The small -cap segment offers attractive prospects for active managers, as a multitude of mispriced securities, market inefficiencies and a paucity of research provide considerable investment opportunities, the veteran investor wrote in a recent blog.
Mark Mobius went on to explain that contrary to popular belief, small cap securities are not niche investments. He pointed out that the asset class represents more than 20,000 companies with an aggregate market capitalization of over $5 trillion and daily turnover of over $40 billion. Further, the liquidity within the Emerging Markets (EM) small-cap markets is comparable to that of EM large caps.
Mobius believes that the size of the small-cap investment universe provides a key advantage for active managers, providing abundant opportunities to discover value creating companies. According to him, the retail investors hold a disproportionate share in the small caps, and they trade more frequently, as they have a shorter investment horizon when compared to institutional investors. He identified this trend specifically in India, where investors have a vast number of smaller companies to choose from, and the skew of ownership is toward local investors.
In the blog, Mobius went on to debunk misconceptions relating to perceived higher volatility in the small-cap space. He compared the standard deviations of EM small caps, as against the larger cap EM stocks and concluded that the assumption of higher volatility in EM small caps does not always hold true. The 80 year old veteran said that the EM small caps are under-researched, and the companies outside the MSCI Index provide an avenue to find mispriced small cap companies.
It is imperative for the fund managers to recognise that there are numerous EM small-cap companies that will likely remain small, whether due to corporate governance issues, poor quality of management, lack of market growth or other factors, advised Mobius. According to him, the role of an active fund manager is to determine which EM small-cap companies will succeed over the long term, with a view to reducing downside risk and thus enhancing risk-adjusted returns.
In terms of returns this has been an excellent year for India’s small cap funds. L&T Emerging Business Fund, Sundaram Value Fund and Reliance Small Cap have all outperformed the benchmark with returns more than 40% in the last 1 year. The S&P BSE Small cap index is up by 28% in the last one year. With the markets at all time high levels, that mispriced small cap stock is an opportunity, just waiting to be discovered.