WAAAX on: taking the pulse of small-cap players

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Lex Hall: Hi. I am Lex Hall, Content Editor for Morningstar Australia. Today, we're talking about Australian small-caps and in particular, Australian tech stocks and also, the small-cap focused funds that are interested in them. And joining me is Ross Macmillan, Senior Analyst for Morningstar Manager Research.

G'day, Ross.

Ross Macmillan: Thanks, Lex. How are you?

Hall: Good. How did the first few months of 2019 go for Australian small-caps?

Macmillan: Well, Lex, firstly I should talk about 2018, after six years of positive returns on the Australian share market, we had a year where the market ended up – the ASX 200 was down 3%. Actually the small ordinaries where a lot of the small-cap fund managers are searching for stocks ended up down 8.7%. But that really hides the volatility that was in that final three months of the year. In the December quarter, the small ordinaries was down a massive 14%. So the end - just 8.7% down for the year - was quite a reasonable return.

Now a lot of the small-cap fund managers were able to beat the small ordinaries, but still produce some negative returns. Now in 2019 the first three months we've seen risk back on and we've seen the market bounce back quite strongly. A lot of the stocks are performing very strongly. For example, two tech stocks that you might know is WiseTech: three months ago if you had bought that stock you would be up now 45%; and Afterpay: if you had bought that stock three months ago you'd now be up over 65%.

Hall: Huge gains. We know the American tech stocks really well. What are some of the local names in the Australian tech space?

Macmillan: Yeah, if we think about the U.S. market first, we're thinking about the FAANG, the Facebooks, the Amazons, the Apples, the Netflixs and the Googles. They are sort of companies that everyone knows because they are huge multi-billion dollar companies with products each one of us are probably using every day. But we have the equivalent sort of stocks in the Australian market. We have a group of stocks called WAAX, which is, WiseTech, Altium, Afterpay and Xero. Now they have some interesting products too and a lot of us know some of those companies. But certainly apart from Altium, most of those companies have an operating history of less than a decade. They're young, growing companies. And so, those sort of companies appeal to a small tech fund manager who has got a growth philosophy, who is looking for stocks that perhaps aren't making huge profits at the moment but have products or services that will grow and expand and probably not just within the Australian market, but in the global market.

Hall: OK. And how do they compare more broadly to the Australian – the American household names? They represent what sort of proportion of the Australian…?

Macmillan: Well, they – the FAANGs are now recognised as some of the largest companies on the American market. They are within you know the top 20 stocks on the American market, where most of the tech stocks in the Australian market are in the small ordinaries. There's very few of them at this time in the ASX 200, which tends to be still dominated by our banking sector, big mining companies and some of they are consumer defensive stocks like Woolworths.

Hall: OK. Let's switch to funds. Which small-cap focus funds, sort of, catch your eye?

Macmillan: Thanks for asking that question, Lex, because we just recently had the Morningstar award ceremony for the fund managers of 2018 and our three finalists in the domestic equity small-cap section were Colonial First State Australian Small Companies Fund, Fidelity Future Leaders Fund and Investors Mutual Smaller Companies Fund. Now those three finalists were selected out of 33 strategies that Morningstar cover in the Australian small-cap market and they are three very, very strong strategies. All three strategies are Morningstar Medalists, but more importantly all three strategies in our recent reviews scored very highly and received a positive rating on people which is their investment team, their process, which is their investment processes, and also on performance. So, the ultimate winner was the Fidelity Future Leaders Fund, but they are the three sort of strategies that Morningstar rates highly and would recommend to investors.

Hall: OK. Ross, thanks for your insights.

Macmillan: Thank you.

Hall: I'm Lex Hall, Content Editor for Morningstar Australia. Thanks for watching.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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