This enables a greater understanding of industries and the competition within them, and the ability to identify good businesses that haven’t been recognised by the market. “Having identified a company, we begin a more detailed analysis by looking at their competitive advantages, the quality of management and the valuation of their stock, using metrics around earnings, cashflow and return on capital,” he says. Similarly, AUI has a team with serious heft in terms of industry experience. Its team of analysts has an average of over 22 years’ relevant experience and most have worked in senior roles for companies in the sectors they are responsible for. “It’s one of the most experienced and stable investment teams in Australia,” says Bryant. For example, Acorn’s resources analysts are qualified geologists.

Similarly, its healthcare & biotech analyst worked in the pharmaceutical industry for many years before joining Acorn. “This is the type of knowledge and skill that is make-or-break when it comes to investing in the micro-cap sector,” Bryant says. Perpetual’s Callopy says the manager only invests in “companies with a strong balance sheet. [This can] provide a buffer for earnings volatility, and indicates whether a company can continue as a going concern through the tough times”. Callopy notes that importers in the micro-cap sector, or companies with offshore manufacturing, are benefiting from the strong Australian dollar. And they do not have to translate offshore earnings back to the local currency like larger multinational organisations have to.

He says the smaller companies index is becoming increasingly dominated by the strong performance of resources companies and rising commodity prices on the back of demand, particularly from China. But since many of these companies have no current earnings, a short mine life or highcost production processes that would render them uneconomic if commodity prices normalised. “We view these types of investments as speculative and prefer investing in resources companies that are in or near production,” he says. “This investment criteria ensures that the companies we invest in continue to make money even with significantly lower commodity prices.” Having a broader spread of investments – from 70 to 100 companies – is critical, says AUI’s Bryant.

“You simply can’t invest in this sector using 30 to 50 stocks which is the range a lot of large-cap managers work within,” he says. “Micro-caps are certainly more volatile than their large-cap counterparts and suit investors with a longer term investment horizon – our recommended timeframe is at least five years,” he says. “In addition, the microcap sector rebounded much more strongly than the broader Australian sharemarket when the recovery started after the GFC.” For instance, from the end of February 2009 through to the end of September 2010 the Acorn Capital-Australian Graduate School of Management Microcap index returned more than 115 per cent compared to the broader ASX 200 return of 47 per cent.

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