Small caps outstrip Top 40

[] — IT’S not only in South Africa that smaller companies are prospering. Internationally, they’re also recommended by market experts as being where the best potential for growth lies.

In fact, that recommendation is coupled with the observation that the very best potential should be sought in emerging markets as their smaller companies benefit most if the country’s economy grows, as South Africa’s are doing. In such cases they also perform better (often much better) than large companies.

The small companies’ index relative to the Top 40 tends to confirm this. Since the formerly neglected small cap sector began outperforming the Top 40 early in 2002, it has so far climbed around 510%. Compare that with the Top 40’s 137%.

Well-known international research group Bank Credit Analyst earlier this month recommended that investors consider smaller companies in emerging markets. They say that those benefit due to good local demand and that smaller caps perform when money/credit growth and domestic demand are accelerating.

However, large companies tend to be dependent on the international business cycle. “We’re positive on the domestic demand story in most emerging markets and expect that it could get an additional boost from falling bond yields,” the report said.

Morgan Stanley has just made a similar recommendation. Chief strategist for emerging markets, Jonathan Garner, increased his projection for growth in the Morgan Stanley Capital International index for small caps by 8.2% to 1,060.

Garner said that consensus forecasts for world growth remain positive, which benefits emerging markets.

It’s been especially the smaller, speculative mining shares on the JSE that excelled, with small platinum shares taking the lead. For example, Eland Platinum, an exploration company, climbed by 476% over the past 12 months before a sharp correction occurred. And Wesizwe Platinum climbed by 470% before tumbling 36% in a matter of days.

Although gold shares no longer enjoy the same status among speculators, there were good performers among them.

Gold and uranium company, Simmer & Jack Mines (Simmers) gained more than 400% over the past 12 months. It’s interesting to note that both Eland Platinum and Simmers appear in the Sanlam Small Cap Fund, which was the top performer in its sector last year. One of the more enthusiastic investors in Eland Platinum was the Coronation Resources Fund at just over 4% of its portfolio.

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Mining shares may have produced the most spectacular performance, but the backbone of the index was more broadly based, with many industrial and financial shares that performed very well.

Can this exceptional performance continue? It’s more or less unanimously agreed that as long as the economy maintains a healthy growth rate, smaller companies will produce good profits and capital growth. But don’t expect a repeat of the exceptional performance of the past few years.

However, the huge increase in infrastructure spending is filtering through to those companies over a wide front, while other factors, such as the emergence of the black middle class, boost profits.

The biggest risk is that the JSE will be hit by international developments. In the past small caps suffered most when a setback occurred. That’s why it’s important to regard an investment in them as just one part of your portfolio.

The writer holds shares in Simmers.