The Contrarian View

September 27, 2019

Dr. Michael Burry, the investor who bet against the subprime bubble in the United State a decade ago and one of the main characters in “The Big Short”, recently spiked some discussions in the financial news about the current stock market. He believed the shift in focus to passive investing creates opportunity for small cap investors. One of the key reasons is liquidity. With the rise of passive index funds, the shares of small cap companies are being held by some passive funds. The lack of liquidity reduces the trade volume and fewer investors get into this market. As a result, the market is inefficient.


We, as a small cap fund, believe this dynamic also rings true in Australia. There is a general belief that small caps should outperform large caps in the long run, given that small cap contains a higher degree of risk. But in the past decade, large cap clearly outperformed the broader market. Why is that? One reason is that the market is being impacted by the rise of passive funds. Research suggests that about a third of the small cap market is now held by passive and quant-based funds. Once the passive funds buy the shares, they hold them for as long as the fund operates. In other words, a fewer number of shares are traded in the market. This situation is more serious following the closure of a number of actively managed small cap funds in the first half.


The small cap market is unloved with fewer participants. What should we do? We believe the current small cap market provides a great opportunity for long-term value investors. With the closure of some small cap funds in the first half of the year combined with the market’s inherent inefficiency, our research efforts have the potential to create significant value. For example, as mentioned in last week’s blog, the market reacted to Enero’s result slowly. The result was good but the share price did not move. We took this opportunity to invest in Enero. After the result was out for two weeks, the market realised the strength of its earnings result and the share price advanced. This late reaction is rarely seen in the large cap market. We aim to take advantage of the limited research coverage within the small cap universe.


We believe the small cap market has structural inefficiencies. The market typically has limited research coverage and many companies are therefore overlooked. In addition, the non-growth small and microcap stocks have, of late, been largely ignored. We are excited by the opportunities that are emerging as individual companies are oversold. We are actively pursuing investments in undervalued, under the radar types of investments as we have always done.




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