Small caps to stay attractive post-COVID 19

Small caps will continue to shine and stay attractive for investors in the post-COVID 19 world as some key structural trends are likely to emerge or accelerate, DNR Capital said. 

According to the manager, in the post-COVID 19 world certain companies would be beneficiaries of these trends due to the strong tailwinds over the medium to long-term, while many others would be negatively impacted as business models would remain challenged. 

Examples of some of the structural trends emerging from the COVID-19 pandemic, and the small cap companies impacted would include: 

• an acceleration in the transition to a more digital-based economy, 
• market leaders strengthening their competitive positions, 
• an increased investment in healthcare and infection prevention, 

The transition to a more digital world included a relatively large immunity of the digital world from the virus outbreak compared to the severe disruption seen in the physical world, with the transition to a work-from-home environment and the use of collaboration tools highlighting the benefits of modern cloud-based software applications. 

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This would mean that corporates would be likely to continue prioritising high levels of IT spending to modernise IT infrastructure and facilitate remote working. 

Also, during economic downturns the competitive makeup of industries often changed as industry leaders strengthened their competitive positions and competitors suffering from stretched balance sheets were forced to cut costs compared to better-funded companies. 

This may, on the other hand, impact long-term market shares and the future margin and cashflow potential, with the industry leaders strengthening their competitive positions. 

As far as increased investment in healthcare was concerned, DNR Capital stressed that governments and the healthcare industry were looking to improve their level of preparation for the next virus outbreak. 

“Although the short-term outlook remains uncertain, the market recovery was spurred on by several factors. Many companies were deeply oversold, with valuations having fallen significantly. Governments and central banks have responded with unprecedented levels of fiscal and monetary stimulus, limiting the downside,” Sam Twidale, DNR Capital portfolio manager said. 

“Looking back on the recent correction, a defining feature was the indiscriminate nature of the sell-off, with high-quality companies seeing significant share price falls. The dislocations between share prices and valuations based on long-term cash flows provided an exceptional opportunity for long-term investors. 

“While the COVID-19 pandemic is causing a significant disruption in the near term, we believe investors should not lose sight of the longer-term opportunities. Certain companies will be big winners from the structural trends emerging from the crisis, and we have been positioning the DNR Capital Australian Emerging Companies fund to take advantage of this.”