The 15th Australian Microcap Investment Conference in Melbourne took place this week, with over 20 companies presenting amidst a challenging environment for the microcaps sector. Institutions, facing pressure on fees and costs, have largely withdrawn from small-cap stocks, leaving these companies to attract investor interest on their own. Trashed valuations mean more opportunities for investors willing to invest time and shoe leather in their own due diligence. Despite a keenly engaged audience, the sector faces significant structural and cyclical challenges.
Microcap valuations reach a decade-low
According to Salter Brothers director of equities Gregg Taylor, microcaps are currently trading at their largest discount to large caps in ten years. In the year leading up to October 1, only 23 constituents of the S&P/ASX Small Ordinaries index saw an increase in value. Excluding resource stocks, the numbers are even more unfavorable. Taylor noted that “history shows that if you invest at this point of the cycle, you are more likely to do well than not well.”
Salter Brothers defines microcaps as companies with a market capitalization between $50 million and $500 million. The sector is impacted by high interest rates and inflation, but Taylor attributes the current malaise to the fact that most institutions have abandoned microcaps due to their AI-driven ‘quant’ strategies favouring dealing in billions – rather than millions – of dollars. “Fees are under pressure, which calls for more AI and data-driven strategies,” he said. “That doesn’t work so well with microcaps … and they’re retreating from the market.” With the investors exiting, there’s even less research on the sector.
Few IPOs mean brokers have little incentive to invest in analysts. Microcaps used to be a source of zing (or ‘alpha’) in otherwise staid portfolios. Indeed, more than one-third of presenting companies at this year’s conference were speculative biotechs. But these days more options are available for the ‘funny money’. “There’s genuine competition for risk assets and that’s not going away,” Taylor said.
Read Also: Sex may temporarily relieve nasal congestion
Private markets offer hidden opportunities
Salter Brothers’ portfolio consists of around 30 companies, with approximately 40% in the tech sector and 12% unlisted. The fund does not invest in resource stocks, and around 12% of its holdings are private. Taylor highlighted that only 1% of companies with a market capitalization under $500 million are listed. He cited Alfabs Australia (ASX:AAL) as an example of a profitable company with a $20 million market capitalization that is relatively unknown. Ai-Media Technologies (ASX:AIM) is another example, with few investors appreciating its pivot from a “body shop” hiring out voice-to-text translators, to an automated service with much better margins.
Regtech companies benefit from regulatory changes
WRKR (ASX:WRK) provides the “plumbing” for employers to remit employee super to the large super funds. With the introduction of rules mandating real-time payment of super, the process has become an administrative pain for companies and, of course, a boon for WRKR.
Funds withdraw, but opportunities emerge
Paradise Investment Management, led by veteran stock picker David Paradise, has returned $700 million of its $3.3 billion Australian small caps fund to investors. “The less money you have in small caps, the more likely you are to outperform in the future,” Paradise reportedly said. Taylor believes that good fundamentals will ultimately prevail, despite the current challenges. He notes that after the last two sharp downturns, microcaps saw returns of over 100% in the subsequent two years. Taylor said, “I’m not guaranteeing that will happen again, but it feels like we are at that maximum point of pain.” He advises investors not to invest everything at once, suggesting “leaving a bit in the tank until they do another raising.”
