Small vs Large capitalisation

  • Dennison Hambling

With markets driven increasingly by a flight to indexation or passive styles, with retail investors buying anything that sounds good (or known to them) and retirees scrambling for income from the global monetary response to repeated crises it is no surprise that opportunities and inefficiencies are arising in investment markets.

One such opportunity is the decade long lag that has now opened up between large cap companies (which receive incessant ETF funds flow) and small capitalisation companies (which do not).

Historically small cap companies where considered higher risk, but higher return investments. Indeed, you can see them marginally outperforming their larger cousins into the top of the GFC.

Since around 2012 however small caps have lagged persistently. Interestingly over the past 20 years they are now nearly 1% p.a. behind their larger peers (2.8% p.a. over 10 years) and their standard deviation, being one measure for risk (there monthly ups and downs in price) is only 95% of that of the larger caps.

Thus the higher risk / higher return conventional logic to investing has been thrown on its head. Larger companies are now higher risk and higher return and looking forward 10 years from now probably return free, risk.

That sort of sums up the world we live in.


Today we are finding terrific companies, in the $100m-1b range, which are growing, have low debt levels, are often leaders or in a position of comparative advantage which are priced at 50% of what a larger company in that space would be. They are lower risk indeed.

Given the growing nature of the businesses we believe they will also be higher return as well, or if cashed up private buyers will come along and close the valuation gap via increasing takeover activity in this space.

To highlight the extent of the “dislocation” today the combined positions in the 360 Active Value Equity Fund trade at:

  • 51% of the markets EV/EBITDA,
  • 55% of the markets Price to Free Cash Flow and
  • 34% of the markets Price to Book value (at 71% of book value).

These sort of value distortions tend to only occur at significant turning points and feel akin to the post tech washout, and post GFC washout eras enjoyed by the investment team.

What this opens up is the opportunity to invest for good medium and long term returns without the potential sleepless nights that everyone who invests in large caps should be (but I suspect are not) having. Having positioned our portfolio in high quality companies, we are excited to about 2021 to take advantage of returns that are now currently on offer.