Small cap managers should not be considered only on the size of their funds under management due to differing strategies in that sector of the market where stock values can be very poor.
In a research update released by Morningstar yesterday senior analyst -manager research Kathryn Young stated the capacity of a small cap strategies was an important consideration for investors given that the S&P/ASX Small Ordinaries index was 13 times smaller than the S&P/ASX 200 and also contained a high number of low quality stocks.
However Young stated that capacity was a difficult single measure to use with small cap managers who often adopt different strategies and limits in their portfolios.
She pointed to the BT Smaller Companies which had an estimated capacity of about $2 billion and the Pengana Emerging Companies with had a maximum capacity of $520 million but said both were regarded by Morningstar as highly rated funds.
Young stated that both market conditions and a small cap managers' investment style also impacted their capacity and while small cap managers usually expressed their capacity in dollar term estimates the underlying metrics considered by the managers to reach that figure included the number of days it would take to liquidate positions and the market impact associated with putting new inflows of money to work.
"There is no easy answer to the ‘how much is too much' question but we continue to monitor the strategies we cover for any signs of detrimental asset bloat," Young said.
"This issue is difficult to analyse externally but there are some warning signs. For example, the number of the stocks in the portfolio may increase if the manager is struggling to put money to work and turnover may decline from average levels if the manager is unable to trade like he or she has historically."
"Similarly, while most small cap strategies have very high active share, we monitor whether the allocation to large benchmark constituents increases from normal levels."
