Small-cap funds make up just R5.8bn of investment into unit trusts. And many investors will regret not investing more.
The average return over the 12 months to March 2021 was 56.3%.
There was an unusual net inflow of R101m into the sector during the March quarter as some investors got wind of these spectacular numbers.
But these funds have given just 0.4% annually over three years and 0.9% over five years.
It is hardly an opaque, speculative universe.
Momentum Metropolitan and Liberty are there. Large businesses such as Aspen Pharmacare, Woolworths, Mr Price and Sappi are all included in these funds — though all of them bounce in and out of the top 40.
There is more risk, but don’t let that put you off adding one of these funds to your portfolio.
Coronation’s Alistair Lea says investors who invest in small-cap funds are those who wish to benefit from the potential growth in medium-sized and small companies. They must also want to diversify their investments to include specific exposure to companies outside the top 40.
They need to accept the inherent volatility in investing in less liquid shares, as there are fewer shares trading freely in the market, which can restrict trading and amplify price movement.
And in general they should treat a small-cap fund as one of several funds in an investment portfolio.
After all, the universe includes household names — and not just chicken producers. Until recently Implats and AngloGold Ashanti were available to these funds; Nedbank recently fell into the mid-cap space.
Such funds are primarily about getting exposure to SA industrials.
There is little of the speculative rubbish which cluttered the JSE in 1987 and 1998. There are dependable industrial businesses such as Cashbuild and Italtile, and most of the retailers, such as TFG and Massmart, form part of the universe.
One of the ironies is that smaller managers have not set up small-cap funds. With their small size they only make economic sense if they are embedded in the large managers’ investment teams and provide research which the mainstream portfolios can use.
The largest funds are run by Ninety One and Abax, a large R90bn manager.
And Sanlam Investment Management (SIM), Old Mutual Investment Group and Coronation all have funds.
SIM’s Vanessa van Vuuren says that in the 10 years to March 2020, small-cap returns lagged the top mid-and small-cap funds by 3% a year.
But, she adds: "Despite the recent rebound, there remain many mispriced and undervalued shares that we expect to grow into tomorrow’s large caps."
SIM SMALL CAP FUND
This fund has remained true to the principles of small caps, thanks to its relatively small size of R380m.
For example, its largest share Renergen (10% of fund) has a market cap of about R2.5bn. But co-fund manager Vanessa van Vuuren believes it is among the most exciting long-term investments she has seen. It may not be profitable today, but it has natural gas resources and helium resources, a rare and inert gas with medical and industrial application. The fund has held these shares for five years at an average entry point of R10 a share, and over the past 12 months it has leapt to R21.40.
The fund is also a holder in the last remaining contractors, Raubex (4.3%) and WBHO (3%). Co-fund manager San Naidoo says there are green shoots in the infrastructure cycle, particularly on roads, and the last men standing have a strong chance of winning a large slice of the contracts.
WBHO is still marked down by investors for its unsuccessful foray into Australia, but the SA business remains solid, says Naidoo. And the fund picked up more Raubex shares when it fell below R17 last year — it has since almost doubled to R32.
The fund’s signature investments include Blue Label Telecom (4.8% of fund) and Curro (3.3%). Blue Label, Van Vuuren argues, is still perceived as little more than a proxy for Cell C, as it owns 45% of the network operator. But it has already written that down to zero. The core Blue Label distribution has a long history of cash generation.
Curro continues to grow even after a compound annual growth rate of pupils of 35% over the past nine years. It is still operating on 69% of school capacity, with the average age of campuses just five years. Van Vuuren believes the failings of the state sector will continue to drive demand.
Where it can, the fund follows the house view. It is by no means run as a silo. It can own shares which have fallen out of the top 40 index and can hold on to them even when they get promoted. So when resources were less popular, it picked up Sibanye-Stillwater (4.2% of fund) and Northam Platinum (5.9%).
Naidoo says Sanlam remains positive on the platinum group metals and in spite of the massive run they still see these shares as special situations. Northam has an excellent production profile, and Sibanye has the best exposure to palladium.
CORONATION SMALLER COMPANIES FUND
In spite of the power of Coronation brand, this is the smallest of the actively managed small-cap unit trusts, though with strong performance it has grown from R110m to R130m. It is now the best performer over one, three and five years.
Fund manager Alistair Lea says it is remarkable how well many shares have recovered after the Covid-driven drawdown in March 2020. For example, Mpact, a packaging business spun out of Mondi, used its cash to buy back 15% of its shares at depressed levels. Cashbuild has benefited from the demand for building materials and is using its strong balance sheet to buy its competitor The Building Company, if the authorities permit it.
Lea says his style is to rotate out of shares that have limited upside to those with more potential, but not rotating out of good-quality shares into bad ones. In the March quarter, for example, there were new positions in the JSE Ltd, Zeder Investments and RMB Holdings, which unbundled its interest in FirstRand and is now focused on property.
Lea argues that the JSE is a fantastic business as it is essentially a regulated monopoly which generates high returns on capital, and it benefits from volatile markets. Zeder, PSG’s agricultural focused investment trust, is in wind-up mode, Lea says, with an intrinsic value of R4 compared with a share price of about R2.60.
And the fund has been selling Bytes and Implats. Bytes is a powerful reseller of software, mainly in the UK, but it has reached an eye-watering p:e of 28. Implats has performed well for the fund, but platinum prices are now well above normal and Lea prefers to reinvest in lower heartbeat situations.
The fund’s largest holdings include mid-caps such as RMI (3.8% of the fund), PSG (4.6%) and Nedbank (4%) — a rare opportunity for these funds to buy into a large commercial bank. Other larger shares include Spar (the largest position at 5.7%) and Distell (4.3%).
Smaller shares include AdvTech (4.6%), Metair (4.7%) and WBHO (3.8%).
NEDGROUP INVESTMENTS ENTREPRENEUR FUND
The fund is more defensive as it has a bulwark of large-cap shares it accumulated before they entered the top 40; Naspers (12% of the fund, including Prosus today) was too small to qualify for the top 40 when the shares were originally bought.
British American Tobacco, or BAT, (about 5% of the fund) was bought when it was already big but not in the top 40.
But for the other 83% of the fund it looks similar to the rest of the sector. It is managed by Anthony Sedgwick at Abax; he also manages the sister Rainmaker Fund, so many of the views and themes overlap.
He says 15% of the fund is made up of attractively priced platinum producers: there is a chunky 9.4% position in Royal Bafokeng Platinum and 5.2% in Northam.
There is a further 15% in defensive value, through RMI, Santam and BAT, and 14% in niche financials such as PSG Konsult and Coronation.
The two largest slices both have 19% of the fund: domestic consumer, led by AVI and Italtile; and domestic industrial with Reunert, KAP Industrial and Hudaco.
Sedgwick says that in spite of the recent rebound in share prices, many domestic shares are still undervalued.
Santam (5.3%) has been the most disappointing performer in the fund given the ongoing uncertainty over business interruption claims, and the extent to which Santam needs to settle. But he says it has made substantial provisions already, and there will be certainty after the Supreme Court of Appeal hearing in September on what claims are valid.
RMI has also been a disappointing share, even though none of its underlying businesses — Discovery, Momentum and Outsurance — has the same issues.
But platinum has been a strong contributor, with platinum prices up 30% in the first quarter.
Abax at least sees some signs of an improvement in the domestic economy, which is why the portfolio isn’t dominated by rand hedges as it has been in the past.
NINETY ONE EMERGING COMPANIES FUND
This fund was once the largest fund in SA under the legendary Rhett Hammond, and it remains one of the largest funds in the sector with R2.3bn under management.
The fund has gone through several iterations, including a strong bias towards resources shares, when there was still a large universe of these shares available.
The fund is now affiliated to the Value pillar at Ninety One and is run by Andrew Joannou.
It is quite actively managed; for example, just in the first three months it acquired Netcare (its only hospital share), RMI, PPC and ArcelorMittal, and sold Momentum Metropolitan, Curro, Truworths, Adcorp and Textainer. It now has just three precious metals shares, which make up barely 5% of the fund — Pallinghurst, Pan African Resources and Royal Bafokeng Platinum.
The fund has a few unusual holdings, given its size. Hudaco is the largest share (5.9%), and it also has a large holding in Remgro (4.4%).
It has a 3% holding in its former parent, Investec, and like most of its peers it has grabbed the opportunity to buy into Nedbank (4.3%), which should be back in the large caps within 12 months. Financials now make up 20% of the fund.
Emerging Companies also owns sector favourites such as Cashbuild (5.7%) and Italtile (5.6%). Joannou says even in this economic climate these companies are both achieving at least 20% growth — the fashion for home improvement during lockdown did no harm.
The fund has a chunky 4.3% in Metair, which Joannou believes will benefit from the demand for new components on the back of Ford’s planned investment in SA.
Joannou says that as a larger emerging companies fund it finds it hard to jump into a share early, and therefore a long-term value approach suits it.
OLD MUTUAL MID & SMALL-CAP FUND
For years this was run by Warren Jervis as a separate boutique. Now under Kaya Nodada, it is fully integrated into the MacroSolutions team, which incorporates the former Old Mutual Equities.
Nodada says the fund has benefited from four consecutive positive quarters in global and SA markets. The cyclical counters in the portfolio such as Motus, Reunert (4% of the fund) and Raubex prospered, though defensive shares such as RFG (previously Rhodes Food Group) lagged. But almost all company results surprised on the upside. Some did this through capital restructuring and disposals, such as Massmart (3.6%) and Omnia.
And platinum continued to provide some of the best returns; Old Mutual focused on Royal Bafokeng Platinum and Implats (4.7%).
Nodada says the construction-based holdings have been one of the differentiators in the fund. It holds contractors Raubex (4.5%) and WBHO (3.7%), as well as Afrimat (4.5%), an important supplier to the industry. He says the team has built on the holding in Italtile it inherited from Jervis and it now makes up 5.7% of the fund.
Dis-Chem is another retailer held in this fund, though not in many of its peer funds. The fund also holds a longtime Old Mutual favourite TFG (4.3%).
Taxi financier Transaction Capital (3.7%) is the largest financial in the fund. The largest rand hedge after Implats is Reinet, in which its portfolio is almost equally divided between British American Tobacco and the Pension Corp in the UK.
Nodada says the team is examining whether to start investing in hospital groups. They have the balance sheets to get through the third wave of Covid, but such a traumatic event could hit investor sentiment and reduce share prices.
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