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How to get small-cap exposure through Listed Investment Companies.

Photo of Boyd Peters By Boyd Peters, Contango MicroCap

The ASX All Ordinaries Index provided little Christmas cheer. A few days before the holiday it was at 4147 points and falling, and three depressing weeks of market falls in December had wiped away most of November's gains. The end-of-year atmosphere was a hangover of anxiety and uncertainty from 2011.

Although some companies' valuations might appear compelling on the basis of price-earnings (PE) and earnings per share (EPS), the central issue entering the New Year surrounded the global debt and liquidity crisis. As markets slowly fell, some investors awaited a crunch to signal a floor; others hoped for a "ring the bell" moment to signal a point of re-entry.

We can begin a crystal-ball exercise by looking at valuations of specific sectors and companies, particularly the heavily sold small-cap and micro-cap sectors.

Table 1 below shows small-caps were the worst performer and micro-caps were the best by a significant margin over five years, as shown by the S&P/ASX Emerging Companies Accumulation index. This is interesting because while some people perceive there is little differentiation between the two, there clearly is. Accordingly, it may be useful to clarify and distinguish between small-cap and micro-cap companies.

Table 1: Index Performances

 at 30.11.2011

Performance (%p.a.)
   1 Year  3 Year  5 Year
S&P/ASX 100 -5.6 7.6 -1.1
S&P/ASX 200 -6.0 8.0 -1.3
S&P/ASX 300 -6.3 8.1 -1.4
ASX Small Ordinaries Accum -12.1 15.0 -3.6
ASX All Ordinaries Accum -6.6 9.0 -1.1
S&P/ASX Emerging Companies Accum -13.6 28.0 0.3

Table 1: Source CTN/ S&P. At 30.11.2011

Looking at performance, Table 2 identifies that the driver of the strong returns in smaller companies has, over the long term, been the Resources sector.

Table 2: Small Industrials vs. Small Resources

 at 16.12.2010

Total Return %    
   1 Year  3 Year  5 Year  10 year  20 year
S&P/ASX Small Industrials Accum -9.5% 34.0% -31.8%  47.4%  283.3%
S&P/ASX Small Ordinaries Accum -18.8% 44.6% -20.7%  93.7%  344.3%
S&P/ASX Small Resources Accum -29.8% 72.8% 15.6%  377.2%  622.0%

Table 2: Source 2 Source CTN. As at 16.12.11 based back to 31.12 of respective period.

Smaller companies' outlook positive

Contango's outlook for smaller companies remains positive. Notwithstanding the recent volatility, the Australian economy is still well placed to cope with any global downturn, with plenty of firepower at the disposal of the RBA and fiscal policy.

Also, the amount of engineering construction over the coming years (many long-term projects that should continue regardless of the global backdrop) will support economic growth.

Global factors will mean the sharemarket will be subject to periodic downturns and volatility, but the solid medium-term outlook for the Asia linked Australian economy should support improvements in the equity market over time.

Generally, small companies provide leverage to global growth although, as has been observed recently, the recovery may be volatile and drawn out. From this perspective investors' focus should be on fundamental valuations and earnings certainty in order to generate above-market returns.


Contango observes little difference between price-earnings (PE) of large-cap and small-cap companies (10.7 times versus 10.2 times). However, our estimates have 2012 PE multiples at around 7.3 times for Small Resources, corresponding with a similar number for the CTN MicroCap portfolio, and here we see value. Either earnings have yet to be revised downwards for this part of the market, or they are relatively cheap.

Earnings growth for the ASX 100 is modest but muted compared to the smaller part of the market. Clearly the issue will be what happens to earnings in Small Resources, compared to how much of this growth has already been factored into share prices. 

Table 3: Fundamentals

 at 18.12.2011

- S&P/ASX Small Industrials 4.3% 124.2% 53.1%
- S&P/ASX Small Resources 13.5% 8.1% 11.6%
- S&P/ASX100      
 - S&P/ASX Small Ordinaries 3.9% 3.9% 4.5%
 - S&P/ASX Small Industrials 5.6% 5.3% 6.0%
 - S&P/ASX Small Resources 0.6% 0.9% 1.6%
 - S&P/ASX100 5.2% 5.5% 5.9%
 (e) = market consensus forward estimates      
  2011  2012 (e)  2013 (e)
PE (relative to ASX 300) 106.8% 95.2% 85.8%
 - S&P/ASX Small Ordinaries 111.6% 108.1% 106.6%
 - S&P/ASX Small Industrials 89.7% 68.8% 56.0%
 - S&P/ASX Small Resources 99.5% 100.4% 101.5%
 - S&P/ASX100
EPS GROWTH 5.6% 25.0% 24.6%
- S&P/ASX Small Ordinaries 5.9% 9.4% 14.7%

Table 3: Source Contango Asset Management Ltd. At 18.12.2011 

Companies in focus

(Editor's note: do not read the companies mentioned below as recommendations. Do further research of your own or talk to an adviser before buying small-cap shares. See notes and disclaimer at end of article.)

Companies providing recent positive contribution to the Contango Smaller Companies Fund portfolio included Senex Energy, Saracen Mineral Holdings, Aurora Oil and Gas, Anvil Mining and Regis Resources. Recent additions to the fund portfolio include Nufarm, Forge Group and M2 Telecommunications Group.

Some of the larger holdings in Contango MicroCap Limited portfolio include:

  • Industrial Minerals (IDM), which is developing its southern Oregon (US) mineral sands deposit.
  • McMillan Shakespeare (MMS), a provider of workplace benefits administration. Services include administering salary packaging and fleet management (covering procurement of motor vehicles and finance, and arranging related services such as insurance.)
  • NRW Holdings (NWH), a WA-based provider of services to the resources sector. It provides civil contracting services, including rail formation, bulk earthworks, mine development, road and tunnel construction, and a range of contract mining services.
  • Troy Resources (TRY) is a profitable explorer/developer/producer operating in Argentina and Brazil.
  • Saracen Mineral Holding (SAR) is an emerging gold producer in the South Laverton region. It raised $66 million in September 2011 to fast-track exploration/development projects, which we believe to be compelling.

Managing your investment portfolio

Constructed with proper financial advice, a professionally managed portfolio should be considered for any exposure to small companies, either through a unit trust or a listed investment company (LIC). There are simply too many companies to fully research and follow.

LICs are an attractive investment vehicle to consider. As well as being cost effective, they provide investors with a high level of control and transparency over their investments. Investors can also see what they are invested in and have a say in the way the company is managed.

LICs can also provide dividend certainty, which is particularly valuable to those with self-managed super funds (SMSFs). A strong history of fully franking dividends adds to their desirability.
Although not spared the pain through recent market falls, LICs are in most instances currently trading below the value of their portfolios (that is, trading at a discount). This means you could buy a dollar's worth of assets for 90, 80 or even 70 cents.

Structurally, an LIC being a closed-end pool of capital is a benefit as the manager does not have to sell shares to fund redemption requests, as open-ended funds, such as unit trusts, may have to.

Mirabooka, Ozgrowth, Westoz, WAM Capital and Contango MicroCap are some managers focusing on the small-cap and micro-cap space. In many instances, investors can only access specific fund managers through an LIC.

About the author

Boyd Peters is National Distribution Manager at Contango MicroCap (ASX code: CTN). CTN is an investment company investing in a diversified portfolio of 60 to 100 Australian micro-cap companies listed on ASX with a market capitalisation generally between $10 million and $350 million. There are more than 1000 companies in this category. CTN produces a free Quarterly MicroCap Investment Commentary.

Data used in this article has been prepared by CTN to December 16, 2011 and may contain errors in calculation. Past performance does not indicate future outcomes. This article is an extract of a full paper, which can be found on the articles page at the CTN website. Please refer to this page for full notes and disclaimer regarding this article.

From ASX

Listed Investment Companies provides a wealth of information on LICs. Use ASX Market Update information to review LIC premiums and discounts to NTA since 2004. View the monthly sector update to see overall LIC performance. Examine quarterly performance returns to gauge an LIC's investment performance against others.

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