Mid & small cap stocks

The place to be when the excessive negativity inevitably subsides.

The South African mid and small cap indices have underperformed the broader equity market to such an extent since December 2016 that they increasingly present an attractive potential investment opportunity. Even a small positive change in sentiment and or economic indicators will have a positive impact on the mid and small cap sector.

This is according to Loftie Botha, portfolio manager of the Momentum Mid and Small Cap Index Fund. Over the 30 month period ending June 2019, the FTSE/JSE Africa All Share returned 24.2% while the FTSE/JSE Africa Mid Cap and FTSE/JSE Africa Small Cap indices returned 1% and -13.5% respectively.

Botha notes that this underperformance is predominantly driven by the fact that relative to the Top 40, the mid- and small-cap financial and industrial stocks tend to derive a greater portion of their revenues from within South Africa, exposing these companies to the struggling South African economy. This reality is reflected in sentiment with South African business confidence levels being at the lowest level since April 1985 according to a sentiment index compiled by the South African Chamber of Commerce and Industry.

“South African companies depending on domestic demand for growth have had a very tough decade,” says Botha. “Over the 20 years to June 2019 the FTSE/JSE Africa All Share, mid and small caps indices in South Africa produced roughly the same return of around 15% per year. Admittedly, the local economic backdrop remains challenging. However, at current levels, there is an enormous amount of negative news priced in already.”

“Mid and small caps are higher risk investments and we are not suggesting that investors make material allocations to this sector. We do however believe that investors should have some exposure to mid and small caps at these market levels, as it could potentially contribute handsomely to overall returns over the medium term,” Botha notes.

With this in mind, Momentum has created a proprietary Mid & Small Cap Index by taking the SWIX and stripping out the SWIX40 shares. The index is tracked or replicated by the Momentum Mid and Small Cap Index fund, which is well diversified and holds approximately 120 different shares. Mid & Small Cap Index is a good completion index for investors already invested in the SWIX40.

The fund has outperformed all its peers since inception. In the Morningstar survey, the fund was first over one year, returning 4.7% to July 2019, which was 11.1% more than the average peer, as well as first over two years returning 1.3%, which was 7.9% per year more than the average peer.

“Investors are either greedy or fearful, with fear ruling sentiment around South African mid and small caps at the moment. If history repeats itself, and fears subside, even just partially, mid and small caps’ investment performance may again quickly catch up to the broader market. We do however encourage people to seek advice from a professional financial adviser or investment adviser when considering investing in riskier asset classes,” Botha concludes.