Small caps shaking off Jekyll and Hyde image - STANLIB

The JSE's small capitalisation sector is shedding its old Jekyll and Hyde image, say the small-cap specialists at STANLIB, South Africas largest unit trust company.

Small caps have enjoyed five years of 40% compound annual growth. In the past, such giddy re-rating would have prompted fears of another rapid fall from grace. Not any more.

Anthony Sher, head of STANLIBs small cap franchise, notes: "Share prices have moved toward the upper end of conservative valuations, but nothing looks wildly out of line given the state of the economy and the earnings achieved by well-managed companies in this index. Some growth opportunities can still be identified.

"There are fewer concerns this time around about wild swings between boom and bust behaviour. Several factors contribute to the change, involving investors, regulators and small-cap companies themselves."

The three issues identified by Sher are:

The big lesson learned by investors in 2000-01 when some small caps halved in value and a few vanished from the JSE entirely. The late 90s technology boom and positive sentiment around start-ups and leaner, more agile companies created bubble conditions. Counters were doubling in value. Some investors bet most of the portfolio on the sector, losing heavily when the market fell. Sher believes a new wave of smart small-cap investors has emerged since then. They use small-cap dynamics to turbo-charge equity upside, but do so within a diversified portfolio "without betting the farm." A reverse would disappoint these well-diversified investors, not devastate them.
 
JSE rigour. Regulators worldwide tightened up listing and governance requirements after the tech bubble burst, including the JSE. Sher believes new regulations have restored confidence and that the image of the small cap sector has been a particular beneficiary. Todays small cap index is characterised by financially strong, well managed companies with a credible track-record.

Greater corporate 'ballast'. Five years of 40% growth have turned these companies into sizeable operations that meet the JSEs small-cap criteria, but in the eyes of Joe Public are BIG players. At the upper end of the index, the market capitalisation of these companies approaches R5 billion. Even at the lower end of the scale, capitalisation tops R1 billion. These companies look and behave like leaders, says Sher. Their managers may be opportunistic in that they try to maximise industry and macro-economic opportunities, but they still combine smart tactics with sound strategy.

Sher adds: "Gravitas tends to reduce the potential for spectacular lift-off, though surprises are still possible as the sector remains relatively under-researched by the major stockbrokers.

"This means that in-depth scrutiny is still rewarded as astutely selected counters can still surprise the market with unexpectedly strong gains. But for a dose of the dizzy excitement that characterised the sector eight or nine years ago, you may have to widen your net.

"It is therefore possible to use a 60% allocation into small caps as a solid underpin while making a foray into the JSE's Fledgling Index for the surprise packages that might double in value in six months. Use of small caps as a solid base from which to seek further gains shows just how radically things have changed in the small-cap universe."