Don’t miss out on opportunities in smaller companies

A portfolio that has performed well throughout Covid-19 bodes well for future returns. 

When we launched our small cap investment opportunity in December 2019 we had no idea its first year would coincide with a global pandemic and nationwide lockdowns that would bring trade in certain areas to a standstill for extended periods. Despite this, the fund has posted credible, positive performance since inception.

Figure 1: Our small cap investment opportunity has delivered exceptional performance despite Covid-19.

Source: Denker Capital, FactSet, Morningstar. 28 February 2021.
Fund returns are net of the A2 class annual management fee of 1.35% (excl. VAT). The annualised returns are the weighted average compound growth rates over the periods measured. The highest and lowest annual figures since inception will be available once more than one calendar year of performance exists. 
*STeFI: Alexander Forbes Short Term Fixed Interest Composite Index

The long-term return potential of carefully selected small companies presents a great investment opportunity.

The relative performance potential of smaller caps, compared to the larger listed companies, is even more attractive now than it was at the end of 2019. The last time we saw such exceptional investment opportunities in the smaller companies’ sector was almost 20 years ago, during the 2004 to 2007 economic boom. For an investor looking to invest in a specialist South African equity fund, while diversifying away from larger listed companies, the time to take advantage of this long-term return potential is now. As mentioned in a previous article, smaller companies usually do well in economic booms – responding quicker and potentially growing faster than larger companies.

As at the end of February, of the 17 positions in our fund, seven companies’ shares are priced materially higher than they were a year ago. The remaining 10, which represent 49% of the fund, are trading at prices that are on average 19% lower. The FTSE/JSE Top 40 Index yielded a 36% return over the same period. These figures give us an indication of the relative performance potential.

Figure 2: Quality small cap companies offer attractive long-term potential. 

Source: Denker Capital, FactSet. 28 February 2021.

Despite the difficult trading conditions created by Covid-19, the companies that the fund invests in have performed very well operationally in 2020:

• They have managed to generate cash in a tough environment and, in many cases, their profit levels have recovered to pre-lockdown levels.
• More than half of our holdings have already reported – or expect to report – earnings that are similar or higher than before Covid-19.
• Ten out of the fund’s 17 holdings have no debt or extremely low levels of debt, with only two holdings having debt-to-EBITDA ratios in excess of two times.
• Over 70% of our holdings continued to pay dividends after March 2020.

This gives us confidence that this selection of smaller companies provides a very attractive investment proposition in an environment where growth is hard to come by, global interest rates are at unsustainably low levels, and valuations across many asset classes appear to be elevated. The companies in our portfolio have started to recover well, and if the trend continues we believe that the window of opportunity for new investors will start to narrow towards the middle of the second quarter.

What makes this fund different to other small cap unit trusts is a combination of our investment strategy, experience and the investment vehicle.

Despite the current investment opportunity, investing in the universe of small cap shares requires a disciplined and proven approach. Our depth of skill and experience, investment strategy and approach to risk management have come together to provide you with a concentrated portfolio of companies that offers attractive return potential over the next few years:
• Using a qualified investor hedge fund as a vehicle (even though we don’t short stocks) means that you can fully benefit from our convictions because there are fewer constraints relating to position sizes and cash levels.
• The investment team responsible for this fund is led by portfolio manager Jan Meintjes, who is joined by portfolio managers Claude van Cuyck and Madalet Sessions as investment committee members.
• The team has been researching, analysing and investing in South African companies for almost 70 years combined.

Disclaimer

The information in this communication or document belongs to Denker Capital (Pty) Ltd (Denker Capital). This information should only be evaluated for its intended purpose and may not be reproduced, distributed or published without our written consent. While we have undertaken to provide information that is true and not misleading in any way, all information provided by Denker Capital is not guaranteed and is for illustrative purposes only. The information does not take the circumstances of a particular person or entity into account and is not advice in relation to an investment or transaction. Because there are risks involved in buying or selling financial products, please do not rely on any information without appropriate advice from an independent financial adviser. We will not be held responsible for any loss or damages suffered by any person or entity as a result of them relying on, or not acting on, any of the information provided. Please note that past performances are not necessarily an accurate determination of future performances.

The Manager of the range of Denker Capital South African funds and feeder funds is Sanlam Collective Investments (RF) (Pty) Ltd (SCI), a registered and approved Manager in terms of the Collective Investment Schemes Control Act. The Manager retains full legal responsibility for third party named portfolio. The Sanlam Group is a full member of the Association for Savings and Investment SA. A schedule of fees and charges and maximum commissions is available from the Manager. Standard Bank of South Africa Ltd is the appointed trustee of the Sanlam Collective Investments schemes.

International investments or investments in foreign securities could be accompanied by additional risks such as potential constraints on liquidity and repatriation of funds, macroeconomic risk, political risk, foreign exchange risk, tax risk, settlement risk as well as potential limitations on the availability of market information. Collective investment schemes are generally medium- to longterm investments. Please note that past performances are not necessarily an accurate determination of future performances, and that the value of investments / units / unit trusts may go down as well as up. Changes in exchange rates may have an adverse effect on the value, price or income of a product. Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. Collective investments are calculated on a net asset value basis, which is the total market value of all assets in the portfolio including any income accruals and less any deductible expenses such as audit fees, brokerage and service fees. Actual investment performance of the portfolio and the investor will differ depending on the initial fees applicable, the actual investment date, and the date of reinvestment of income as well as dividend withholding tax. Forward pricing is used. Additional information of the proposed investment, including brochures, application forms and annual or quarterly reports, can be obtained from the Manager, free of charge. The Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The performance of the portfolio depends on the underlying assets and variable market factors. Performance is based on NAV to NAV calculations with income reinvestments done on the ex-div date. The Manager has the right to close any portfolios to new investors to manage them more efficiently in accordance with their mandates. Lump sum investment performances are quoted. All the portfolio options presented are approved collective investment schemes in terms of Collective Investment Schemes Control Act, No 45 of 2002 (CISCA). The portfolio management of all the portfolios is outsourced to financial services providers authorized in terms of the Financial Advisory and Intermediary Services Act, 2002. Management of this portfolio is outsourced to Denker Capital (Pty) Ltd, who act as a juristic representative on the Sanlam Investment Management (Pty) Limited regulatory license.

While CIS in hedge funds differ from CIS in securities (long-only portfolios) the two may appear similar, as both are structured in the same way and are subject to the same regulatory requirements. The ability of a portfolio to repurchase is dependent upon the liquidity of the securities and cash of the portfolio. A manager may, in exceptional circumstances, suspend repurchases for a period, subject to regulatory approval, to await liquidity and the manager must keep the investors informed about these circumstances. Further risks associated with hedge funds include: investment strategies may be inherently risky; leverage usually means higher volatility; short-selling can lead to significant losses; unlisted instruments might be valued incorrectly; fixed income instruments may be low-grade; exchange rates could turn against the fund; other complex investments might be misunderstood; the client may be caught in a liquidity squeeze; the prime broker or custodian may default; regulations could change; past performance might be theoretical; or the manager may be conflicted. The S-ALT SC Qualified Hedge Fund was formerly registered as the S-ALT YN Qualified Hedge Fund. The name change was approved with a change of investment policy, and as such the historic fund performance ceases to exist.