Here are some interesting numbers relating to small cap funds in South Africa:
- Small cap unit trusts collectively manage about R7bn AUM, or only 2% of the total AUM managed by equity fund managers in South Africa.
- Small and mid cap stocks make up c.16% of the JSE’s entire market cap (with the Top 40’s forty stocks making up a massive 84%).
- Ignoring market cap, small and mid cap stocks number 75% of all the listings on the JSE (actually, higher than this if you include those stocks too small for even the Small Cap Index).
- Yet, with only forty stocks to choose from in the Top 40, there are over 1,200 equity funds operating in the Top 40 sector.
- And, with over 120 stocks in the small and mid cap indices, there are only 7 unit trusts that operate in this space (my Small Cap Fund is one of these).
I don’t know about you, but I find these numbers mind-boggling: there are not just fewer funds and more stocks in the small and mid cap space, but AUM is deeply under-represented / under-allocated to this space too.
The lack of a crowd in small and mid caps is likely a good reason for this space’s relative undervaluation and its long-term attractiveness. Likewise, the crowd that operates in the very limited Top 40 space is likely a reason for its shares being efficiently priced and minimal alpha existing here.
Just as a matter of illustration, here are the long-term Price-Earnings-Growth (PEG) ratios for the JSE’s Top 40, Mid Cap and Small Cap Indices. Notice how efficiently priced the Top 40 is:
Those who know PEG ratios will know that a PEG of 1.0x implies that a share is efficiently priced. The Top 40’s long-term PEG ratio is exactly 1.0x, implying that only really beta exists here.
Likewise, with the Mid Cap and Small Cap indices showing PEGs lower than 1.0x, it implies that these sectors are cheap and you can buy undervalued growth here. In the small cap space, that is growth undervalued by a massive relative 60% (PEG of 0.4x). Adjusting for illiquidity, this is likely less, but it does serve to illustrate the sheer attractiveness of this part of the market.