Small cap stocks: too risky, too uncertain and way too volatile.
The prevailing complaints about small cap investing may be falling on deaf ears at the moment, as more and more money is finding its way into the small cap market.
Not a problem, says portfolio manager Jay Bala with AIP Asset Management, who says that investors can profit from the bull run in the small cap sector as long as they keep their heads about them.
The weekly, sometimes daily 10 and 20 per cent swings in stock prices for small caps (companies with less than $150 million in market capitalization) are enough to scare off many who prefer the relative safety offered by the larger equities. But there can be plenty of upside for those who are brave enough to venture into unknown territory.
That lack of recognition can be the first advantage of the small cap market, which generally gets much less attention from mutual fund managers, opening up the possibilities of diamonds in the rough. High returns are another —and that’s not just for those lucky enough to pick the one winner amongst a sea of losers, since historically, small cap investing has been shown to outperform the large caps.
And with the current ultra-long bull run, investors are searching for ways to avoid the high valuations in the large cap market, says Bala.
“People are thinking, we had a great year last year, but how much more room are we going to have to run here? You might get an eight, nine per cent return whereas with small caps, some of them are doing 20, 30 per cent returns,” says Bala in conversation with BNN.
“The bond market is 20-30 times of the equity market and as small amounts of money leak out of the bond market, you have a bull run in the equity market,” says Bala. “The same thing goes for small cap versus large cap. 90 per cent of the capitalization is in large cap stocks, so even if just ten per cent of that money flows into the small cap space, you’ve just doubled or tripled the amount of money that’s in that space.”
And while there’s risk to jumping in with smaller, perhaps newer companies who might have less proven track records than the bigger corporations, the volatility can be managed as long as investors are rational about how much of their investment portfolios are devoted to the small cap space.
“You’ve gotta be a little bit nimble, and at the end of the day it’s about asset allocation,” says Bala. “If you’re allocating about five per cent of your portfolio [to small caps], that’s sort of your alpha generation. And if you lose half of that money, it’s a two-per cent hit to your entire portfolio, so you’re going to be able to rebound.”
As to where the money is going within the small cap space right now, Bala says that because the sector is more prone to being news-driven, stocks related to blockchain and marijuana are currently the strong performers.
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