High risk, high return: scoping out small-caps

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<p><strong>Glenn Freeman</strong>: Ross, thank you for joining us today.</p> <p><strong>Ross Macmillan</strong>: Thank you, Glenn.</p> <p><strong>Freeman</strong>: Now, in the session that you moderated at the conference, you spoke to two small-cap managers, so Dawn Kanelleas from Colonial First State and Ben Griffiths from Eley Griffiths. In terms of small-caps, that session title &ndash; what do we mean there when we say higher returns but greater risk?</p> <p><strong>Macmillan</strong>: Well, Glenn, traditionally, investors have looked to large-cap stocks to get higher returns and that's been quite a sensible strategy over the past 10 years. If we have a look at the ASX 200 and let that represent large-cap stocks, we can see that the return has been something like 11 per cent per annum on average over the past 10 years. The average large-cap fund manager has done reasonably similar sort of return over 10 years. But then, if we have a look at the average small-cap fund manager, they have done something like 16.5 per cent per annum over the past 10 years, which is a great return. So, more and more investors who have traditionally looked at large caps are beginning to look at small-cap fund managers and small-cap stocks as a way of getting higher returns.</p> <p>But there are higher risks. Traditionally, small-cap stocks are younger companies in a development cycle. They haven't been trading for as many years as some of the larger-cap stocks that have perhaps been trading for 50, even 100 years. So, there are risks there. And we've certainly over the last 10 or 20 years, we've seen some of the risks associated with those small-cap stocks. While they can rise very high, the fall can be very sudden and certainly, a concern to a lot of investors.</p> <p><strong>Freeman</strong>: Is there much difference, say, in Australia in the way that we think about or define what a small-cap stock is versus some of the other markets?</p> <p><strong>Macmillan</strong>: At Morningstar, we assume that basically the top 200 stocks, the ASX 200, are the large-cap stocks in our market. But the Australian stock exchange has over 2,000 companies listed on it. So, most small-cap fund managers would exclude the top 200 companies because they are large-caps. They would perhaps exclude the bottom 200 companies because they are very small and micro-cap stocks, but that still gives around 1,800 stocks that small-cap fund managers have to trawl through to find those true investment gems.</p> <p><strong>Freeman</strong>: Do Australian small-cap investors have much variety, much diversification of choice in terms of selecting smaller companies to invest in? Is it all IT, tech startups and with the smattering of backdoor-listed Israeli marijuana companies perhaps?</p> <p><strong>Macmillan</strong>: There's a wide range of stocks in the small-cap area. If we look at large-caps, it's very much dominated by banks, insurance companies, that sort of financial services sort of sector. But in small-caps you've got a variety of sectors. You've got healthcare, you've got agricultural stocks. Recently, we've seen an expansion in the milk industry, milk-orientated stocks, stocks like Bellamy's; we've seen<a href="https://www.morningstar.com.au/Stocks/NewsAndQuotes/A2M"> a2 Milk (ASX: A2M)</a>, which was a small-cap stock that's now a large-cap stock.</p> <p><strong>Freeman</strong>: Ben and Dawn also got into some specific companies that they are quite bullish on. What were some of those that they mentioned on the day?</p> <p><strong>Macmillan</strong>: Yeah. Two very interesting stocks they mentioned, Glenn. And Dawn, firstly, outlined her thoughts on NEXTDC, which is a data storage, data business that really is growing with our expansion of use of the internet and it's a stock that for Dawn has gone up over 50 per cent.</p> <p>Now, Ben Griffiths in his portfolio he has a stock called Seven Group Holdings. Seven Group Holdings is what we call as a little bit like an old-fashioned conglomerate. It has a number of businesses within it. It has a Coates Hire business which hires out equipment. And certainly, equipment to the expanding infrastructure sector in Australian and other part of its business is it owns the Caterpillar business. They also have holdings in Seven Media. They have holdings in a number of oil stocks, including Beach, a number of interests in that industry. Ben has done quite well out of that stock as well. I understand that from where he first bought it, it's gone up over 90 per cent.</p> <p><strong>Freeman</strong>: And I guess, that's where some of the benefits come in, in actually investing in some of these companies via a fund. <a href="https://www.morningstar.com.au/Stocks/NewsAndQuotes/SVW">Seven Group Holdings (ASX: SVW)</a>, for instance, is one that our equity analysts also cover as an individual company.</p> <p><strong>Macmillan</strong>: Yeah, definitely. And they are always analysing. They are out there looking for new companies. They are building big spreadsheets so that they really understand the cash flows, the earnings, what drives the growth and also what impacts the expenses in these businesses that an individual really can't do, would struggle to do if they were going to build up a portfolio of small-cap stocks. So, in a lot of ways, that's one of the ways that they are able to lower that risk that an individual may face if they were attempting to do the same thing.</p>

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