Even though the small cap sector forms the bulk of the JSE in terms of number of shares, it comprises only 3.5% of our stock exchange’s market capitalization, says Vanessa van Vuuren, portfolio manager at Sanlam Investments.
“Top quality companies with exceptional business models reside in the small cap universe, but most established unit trust funds are too large to hold a meaningful stake in a small cap company without breaching unit trust regulations.”
For those who can access them, small caps offer a promising hunting ground for tomorrow’s mid- or large-cap stars. Van Vuuren says the SIM Small Cap Fund provides exposure to this exciting segment of the market.
‘We have it covered’
“Our SIM Small Cap team covers more than 100 small and mid cap stocks and our coverage universe continues to expand. In fact, if you include the greater SIM equity research team, we have 100% of the small and mid cap universe covered. These stocks are properly modelled and valued. We believe that our extent of coverage and resources dedicated remain unrivalled in the SA market.
“Our mandate also allows us to invest in AltX shares, not included in the mandated investment universe of many of our competitors.
‘It pays to be part of the Sanlam Group’
Van Vuuren points out that because Sanlam can take meaningful stakes in companies, it’s able to influence boards, encourage good corporate governance and unlock value.
“The management teams of small and growing entrepreneurial companies are very focused in terms of who they meet with and being part of the Sanlam Group has given us valuable access to management. We have access to all new listings and capital raises in this space and therefore to a constant stream of new investment ideas.”
She adds that due to the illiquidity of small and medium cap shares, trading skills are extremely important in a small caps fund.
“SIM’s trading desk has access to trade blocks and the traders have good relationships with investment banks, a definite advantage.
“Another luxury of being part of such a large group is that we as portfolio managers can focus on research and analysis. We’re not disrupted by administrative tasks, as is often the case with smaller companies where the portfolio managers are also the business owners.”
‘We’re not benchmark cognisant’
Van Vuuren adds that SIM chooses investments on individual merit and good fundamentals and does not construct its portfolio to simply track the Small and Mid Cap Index.
“Fortunately, regulation allows us to retain stocks that outgrow the index after we bought them. This is great, because size is not a reason for us to sell a stock and neither do we sell stocks as soon as we’ve made a short-term profit.
“Instead we have constructed our portfolio to be invested over the medium to long term in a collection of long-term businesses with attractive fundamentals and the potential to evolve from being very small to becoming substantial businesses over time.
“To illustrate our strategy, an example of an investment idea that we selected for our portfolio to grow over time with is Curro, which we purchased a few years ago and have retained in our top ten holdings. Curro, a private education play, has performed ahead of its targeted growth trajectory and its profits are growing rapidly. Its more recent land banking project to acquire premises across South Africa is creating significant opportunities for the business.”
Another example of the type of investments that have been selected is Adapt-IT, a niche software player in the South African IT industry, focused on building its own software intellectual property (IP) in verticals of education, energy, manufacturing and financial services.
“While both of these companies are growing fast and doing well, they remain long-term investment cases. These are the types of investments that our research process is focused on identifying and we believe that the strategy to nurture and support these businesses with patience as they grow and evolve over the medium to long term will deliver superior returns to our clients over that time frame.”
‘How is the fund performing?’
Relative to its peers the fund is ranked 1st over the 1-year and 2-year periods to 30 Sept 2015 and 2nd over the 3-year period.
“Small caps are currently offering strong upside relative to their intrinsic value and we’ve seen decent earnings growth out of most small cap companies, but no material commensurate re-rating yet.
“This, together with the buying opportunities provided by the recent sell-off, has created a strong investment case for small caps,” Van Vuuren concludes.