Smaller SA companies continue to outperform
The Denker Capital S-Alt SC Qualified Hedge Fund + continues to outperform the broader equity market. In this article Jan Meintjes, portfolio manager, explains why and provides five reasons why the South African small cap sector continues to offer investors attractive opportunities.
Five reasons why we see continued opportunities in SA small cap equities.
1. Valuations of higher quality small cap stocks are much more attractive than their larger cap global and local stocks.
This is mainly because larger asset managers and sell-side analysts have shunned these companies because of lower liquidity. The increase in passive investing has also focused more attention on larger, more liquid companies. This means that smaller companies are often overlooked and less understood by mainstream market participants.
The valuation gap should provide a margin of safety as global equities sell off.
2. Investors in smaller companies listed on the JSE are enjoying some protection from the global equity rout we have seen over the past few months.
Most of the current small cap opportunities are mainly exposed to the South African economy. Apart from the risks of higher input prices and the vulnerability of the SA consumer, they are less exposed to geo-political risks and the sentiment swings of US FANG stocks (Facebook, Amazon, Netflix, and Google/Alphabet) and Meme stocks. Meme stocks are stocks that skyrocket in price in a short period (often hours or days) because of a sudden surge in interest online or on social media and subsequent buying among small individual investors. Current examples of Meme stocks include Virgin Galactic (SPCE), AMC Entertainment (AMC), GameStop(GME) and Bed Bath & Beyond (BBBY).
3. The smaller size of these companies allows them to be much more agile than the larger companies.
They’re coming out much stronger as conditions continue to normalise after the pandemic. Combined Motor Holdings (CMH) is a great example of this, posting profits that are well over 50% larger than before Covid-19. When the pandemic hit, CMH was able to react quickly. They reduced headcount faster than other larger companies, employing more flexible remuneration models, and consolidating different businesses and brands into fewer trading sites.
4. A number of smaller companies continue to benefit from a recovery in volumes after Covid-19.
This provides for a growing earnings trend over the next few years. Larger local and international businesses may face declining volumes and profits over the medium term as they navigate recessionary conditions. Smaller companies will not be immune to weaker economic conditions, but a recovery off a lower earnings base will provide a welcome buffer in a difficult environment. Famous Brands, Spur and Sun International are examples of business that should continue to benefit from higher volumes over the next 12 months. Leisure and travel activities have not yet recovered to pre-Covid-19 levels, so these businesses should benefit as these sectors continue to normalise.
5. The listed small cap universe has been less affected by rising interest rates.
This is because it includes very few commodity stocks and long duration equities.
• In the last month or so the prices of shorter-term growth sensitive companies, like commodity companies, have pulled back sharply as the possibility of a global recession muddles growth expectations.
• With global interest rates rising fast for the first time in over a decade, we are seeing equities with long-term growth expectations (long duration stocks) come under pressure. This is mainly because their valuations are generally more sensitive to higher long-term interest rates.
The Denker Capital small cap fund continues to outperform.
The S-Alt SC Qualified Hedge Fund +, has outperformed the broader local equity market materially since its inception in December 2019.
The FTSE/JSE Small Cap Index has also outperformed the market over the same period, as well as over shorter periods.
Figure 1: Annualised performance since inception as at 31 May 2022
Source: Morningstar, Denker Capital, 31 May 2022. Inception date: 1 December 2019. The A2 class has an annual management fee of 1.35% (excl. VAT). Returns are net of fees. Returns for periods longer than one year are annualised. The highest annual calendar year return since inception was 45.01% and the lowest was 6.06%.
Figure 2: Cumulative performance since inception as at 31 May 2022
Source: Morningstar, Denker Capital, 31 May 2022. Inception date: 1 December 2019. The A2 class has an annual management fee of 1.35% (excl. VAT). Returns are net of fees.
The long-term return potential of the companies we invest in presents a great investment opportunity.
Over the next year we expect our portfolio of 20 high quality small cap stocks to comfortably grow earnings in double digits while delivering an average dividend yield of over 6% (for those stocks that pay dividends). The average price to earnings multiple for the companies in our portfolio is well below 10x, indicating that there is a lot of value in our current portfolio.
Our investment strategy, approach to risk management, experience and the investment vehicle differentiates our fund.
• Although there are many opportunities in the universe, investing in small cap shares requires a disciplined and proven approach. Our experience, investment strategy and approach to risk management come together to offer you a concentrated portfolio of companies that we believe will offer attractive returns over the long term.
• Using a qualified investor hedge fund as a vehicle (even though we don’t short stocks) means that investors 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 have over 70 years of combined experience researching, analysing and investing in South African companies.
• The team is led by portfolio manager Jan Meintjes, who is joined by portfolio managers Claude van Cuyck and Madalet Sessions as investment committee members (pictured below).
For more information, or to invest, please contact us at firstname.lastname@example.org A minimum initial investment of R1 million is required.
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Source of performance figures: Morningstar. Returns are annualised and net of fees unless otherwise stated. An annualised return is the weighted average compound growth rate over the performance period measured.
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