Australian small-cap managers outperformed the benchmark by an average of 5.7 per cent in 2015, but underperformed compared with the previous two years, according to Zenith Investment Partners.
Zenith Investment Partners' Australian Shares Small Companies Sector Review found that active small-cap managers produced absolute returns of 15.9 per cent in 2015 – an outperformance level of 5.7 per cent.
This pales when compared with the outperformance reported by small caps in 2012 and 2013. Zenith indicated that the sector outperformed the benchmark by approximately 16 per cent per annum.
Zenith lead analyst, Australian small-cap sector, Quan Nguyen said: “The key to outperformance during the 2012 to 2013 period was overweighting industrials and underweighting resources.”
Mr Nguyen pointed out that strong performance usually results in a change to the index.
“Strong performance will naturally drive an increase in market capitalisation and liquidity and those success stories will be promoted out of the index.”
Small-cap managers are therefore restricted to holding, and particularly to buying, stocks that have been promoted out of the index.
“In other words, the opportunity set of high quality, defensive stocks, and hence excess return potential has been reduced,” he said.
The report found that the S&P/ASX 100 Index has averaged 33 changes every six months. Notably, in September 2015, there were around 25 changes in the small-cap index versus approximately 5 in the large-cap index.
Nonetheless, Mr Nguyen maintained that the forward prospects for active management within small caps remains strong.
“The addition of stocks from a wide range of sectors and the removal of many resource stocks has provided much greater diversification,” he said.
“Overall, we believe the current environment provides more scope for active managers to outperform by leveraging their strengths in stock selection."