Sweet spot Tribeca’s Aylward thinks the market is skewed to the large caps, at the expense of the midcaps companies, those ranked 51 through 100 based on ASX market capitalisation. He admits a few mid-caps did blow up during the GFC – for example, Babcock and Brown, ABC Learning, Allco, Valad, and quite a few REITs that graduated from the Small Ords to the ASX 100”. The mid-cap space is a “sweet spot”, Aylward says, because it’s dominated by businesses growing earnings and reputation simultaneously.. Tribeca believes businesses moving into the mid-cap space will have some or all of the following attributes. First, a credible brand or franchise will be well-developed, and the company will be among the leaders in its industry, certainly domestically and possibly internationally. This may have been achieved organically or by acquisition, although usually a combination of the two. Second, in more developed industries, the mid-cap company will often have already defended its position against aggressive market behaviour by incumbents but will still be young/small/competitive enough to counter new industry entrants. Third, relationships with capital markets will be developed to where the business is properly financed for future growth. Corporate governance can also be better developed. So, why does information arbitrage in this part of the market persist? “Essentially, the reasons are similar to those in the small-cap segment: market capitalisation in the Australian equity market is very concentrated in the top 20 to 30 stocks and it’s here that brokers concentrate their efforts.” “There’s a hunger for cyclicality, but trying to market-time this is hard, and the outcome is unreliable. A lot of institutions haven’t allocated to small-caps because of perceptions of low liquidity, volatility and cyclicality. You have to remember you’re there for the alpha and don’t overthink the beta.”
Falling tides Peter Sumner, MLC’s Australian equities portfolio manager, oversees 10 managers covering the small-, mid- and large-cap sectors of the Australian equities market. One-third of those managers are benchmarked to the top 200, one is over the ASX300, and one over the top 50 only. “The common belief that midand small-caps can outperform the large-caps over time is not necessarily true – the small-cap sector was smashed in the GFC. People think you can add more value to small- and mid-caps, and this is again not necessarily the case. “MLC is about preserving capital and managing risks, for the long-term 20 to 30 years. It’s not a simple equation of being overweight or underweight in a sector, this is too blunt a description. The problems with small caps are liquidity and their continued performance, while micro-caps are a buy-hold, because the transaction and tax-event costs are high.” MLC is underweight, relative to the index, in resources and mining (materials) because, in Sumner’s view, “we don’t need to be in the BHPs, the Rios: we go for high beta stock. In the mid-caps’ materials sector, we’re in Macarthur Coal”. MLC is underweight in specific stocks such as BHP, Commonwealth Bank, and Westpac, and overweight in Suncorp, Brambles News Corp and Fairfax, while neutral on Telstra and Rio. Overall, MLC is underweight in financials and materials, and overweight in consumer discretionary, telcos, industrials, health care and consumer discretionary.
