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Smaller end of market offers hidden value

small-cap stocks

Many small-cap stocks on the ASX are offering strong returns but are often overlooked by investment managers focusing on well-known names.

Stocks outside the ASX 200 are often poorly researched or left unexamined by many investment managers, leaving investors unable to access that part of the market, according to a manager with a strong track record of performance in the small-cap and nano-cap market.

Altor Alpha portfolio manager David McNamee said the Australian Securities Exchange (ASX) contained around 2300 stocks, of which 1500 had a market capitalisation below $200 million and were therefore off the radar for many investment managers.

McNamee said the top 200 stocks were well researched by many investment managers and it was difficult to find an edge in the upper parts of the market where information was plentiful.

“Information has become a commodity and people have moved online with their trades, and if they are smart enough, they can do it themselves in this part of the market,” he said.

“For managers holding stock at the larger end of the market it is becoming more difficult to provide value, yet it does not make commercial sense for them to look at the smaller end of the market.

Stocks within the very small-cap, or nano-cap, market have been a long-term interest for McNamee, who helped launch the fund under Altor Capital in April 2019. Access to the fund, which also makes monthly distributions, is open to wholesale investors with $50,000 or more to invest.

McNamee said access to information in this part of the market is very different and most investments are based on in-depth discussions with the management of firms that offer potential due to upcoming catalysts in their business, such as a new product development, the signing of a major contract with government or industry, or a public listing.

Brown Capital director Jarrod Brown, who provides marketing and distribution services to Altor Capital, said investments in the fund are offered as units in a unit trust that operates a managed investment scheme that allows the fund to access listed and unlisted investments.

He said the fund has a higher risk profile than many equity funds and thus has a 12-month lock-in period for investors, but takes a long-term approach to its investments and does not follow market declines in the same way mainstream funds have done.

This approach has allowed it to beat its benchmark return of the Reserve Bank of Australia cash rate plus 4 per cent, and since inception last year it has made a return, net of fees, of 82.97 per cent to the end of June.

McNamee said the validity of the model was evident in the COVID-19-driven global market downturn that took place in March, where nearly all stocks on the ASX declined before rebounding.

“Our investment model and stock selection meant we only captured 80 per cent of the downside, but were positioned to capture 270 per cent of the upside when markets recovered,” he said.

“This occurred because the stocks we invest in and their catalysts are not correlated to the market and we gain from any increase in value as a result of a catalytic change.”

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