Smaller companies strategies are suitable as a small part of a well-balanced portfolio, according to Morningstar’s Sector Wrap-Up for Australian small companies funds.
The report, which assessed 35 individual strategies, awarded the highest Morningstar Analyst Rating of Gold to one strategy, Kinetic Emerging Companies, while eight strategies attained Silver and 10 Bronze.
Morningstar said high growth made small-caps strategies appealing, but financial planners needed to adopt strategies with regards to overall portfolio diversity and ensure investments were not skewed to one industry.
It said market volatility levels had fallen since the previous Sector Wrap-Up; however, investments in the small-cap segment remained riskier than large-cap stocks and investors were warned to have the right risk tolerances prior to investing.
The report highlights the role of quality active management in the sector, where active management has ensured consistently higher returns than the average investor, with lower risk over most measurable time periods.
Morningstar also found the impact of the end of the resources boom was of increasing concern for many fund managers who have invested in small industrial companies likely to benefit from the same thematic drivers, but not linked directly to commodity prices.
Performance fees are also gaining prevalence in the small-cap sector.
The report advised that when assessing fee structures, managers needed to look at:
- whether or not the base fee is correspondingly discounted;
- the quantum of the performance fee itself;
- whether the performance fee is benchmarked to an appropriate index;
- whether there is a high watermark which cannot be reset;
- review the amount of outperformance the fund manager needs to post before beginning to collect any performance fee; and
- assess the length of the crystallisation period.
The golden rule of diversity still applied, said Morningstar, which advised that managers who invest across industries, sectors, countries, regions, and fundamentals would give investors their best chance of achieving their financial goals.
