The Australian Microcap & Nanocap Landscape

Although not frequently grabbing the media or investors attention the minnows of the ASX actually make up nearly 85% of the total number of companies listed on the ASX. They currently encompass some 1800 companies but conversely they only account for approximately 20% of the total market capitalisation of the ASX. The 300 largest listed ASX companies capture the remaining 80% of ASX’s market capitalisation, which is currently sitting at just under $1.7tn.

The Australian Microcap & Nanocap space is quiet a mature market. The microcap sector can boast 2 dedicated microcap conferences both of which have been running for a number of years and attract a mix of both private and institutional investors each year. Multiple fund management houses offer dedicated managed funds focusing specifically on microcaps. Likewise there are a few microcap focused listed investment companies to select from. Therefore for investors wanting exposure to the Microcap & Nanocap space through a professionally managed vehicle there is decent array of choices. No ETF’s however yet exist to offer investors a passive exposure to this end of the Australian stockmarket.

The ASX in addition has its own dedicated microcap index known as the S&P/ASX Emerging Companies Index, which was launched in 2009. The index currently contains 133 constituents with the median market capitalisation of companies in the index being a shade under $170m and the minimum market capitalisation being $30m. The biggest company in the index has a market capitalisation of $563m. Hardly a microcap company you could argue especially considering the cut-off for the last spot on the S&P/ASX 300 Index these days is circa $150m. Even the bottom rung on the broader S&P/ASX All Ordinaries index (largest 500 ASX companies) is a mere $29m. Thus the S&P/ASX 300 Index and indeed the S&P/ASX All Ordinaries Index provide some limited exposure to Australian Microcap & Nanocap companies by default.

Sector wise the microcap index is dominated by the information technology sector and materials sector. These two sectors comprise just over 40% of the S&P/ASX Emerging Companies Index. Contrasting that sector composition to the S&P/ASX 300 Companies Index, which is dominated by the financial sector weighing in at roughly 36% of the total index. Microcaps therefore can provide investors an opportunity to even out some sectorial imbalances caused by holding an equity portfolio primarily containing ASX 300 stocks. Or indeed microcaps can help make selected sector tilts in an overall equity portfolio.

Another noteworthy fact to consider is the disparity in the level of diversification offered by each index. The S&P/ASX Emerging Companies Index may only include 133 constituents but the top 10 stocks in the index represent only 17.5% of the total market capitalisation of the index. Parallel that to the S&P/ASX 300 index while containing more the double the number companies its top 10 stocks represent 46.6% of the total market capitalisation its respective index.

Microcap performance has lagged that of the top end of the sharemarket for a few years now but 2016 is shaping up to be a stellar year for microcaps. The S&P/ASX Emerging Companies Index is up 31.61% on a total return basis year to date versus the S&P/ASX 300 Companies Index, which has delivered a total return of 4.22% year to date to the end of October 2016.  So possibly the cycle may have finally turned for microcaps and they can close the relative underperformance versus their larger listed cousins which has occurred over recent times.

One thing to note when looking at the total returns for the S&P/ASX Emerging Companies Index is that it’s almost entirely price driven. There is little or no contribution from dividends to the overall total return of the index. This is a notable distinction from S&P/ASX 300 Companies Index, which has a decent level of dividends feeding into its overall total return. As microcaps are in the nascent stages of their development the vast majority of cash generated by the business is recycled back into business to fund growth. The cash generated by larger more mature companies is either partially or substantially distributed back out to shareholders. This lack of dividend paying stocks in the microcap space is something to be noted by investors looking to make an allocation to microcaps in their portfolio. This dearth of income can affect both the income received by the overall portfolio but also the total return achieved from any microcap allocation within a portfolio.

In conclusion the Australian Microcap & Nanocap section of the ASX can offer investors some useful diversification be it market capitalisation/size or sector diversification. Additionally the ASX Emerging Companies Index provides a meaningful benchmark against which to judge the performance of active managers who offer dedicated microcap funds, be it a managed fund or a listed investment company.  As alluded to in the introduction of this article while not grabbing the headlines on a regular basis the Australian Microcap & Nanocap section of ASX I believe can offer something worthwhile to an investors portfolio’s if they are prepared to give these minnows a little attention and understand their value proposition to a portfolio. In short they're interesting.