Small-cap funds have taken advantage of increased market volatility to boost returns but they may struggle to maintain this momentum, according to S&P Fund Services' latest sector report.
The Australian equity small-cap sector review indicated there has been renewed interest in this market with the emergence of several new offerings and strong inflows.
"We attribute this to the strong returns generated, with many managers capitalising on the elevated level of market volatility that featured during the global financial crisis (GFC) and the period that followed," S&P Fund Services analyst Andrew Yap said.
"During the period of market dislocation, investors reduced their exposure to small-cap stocks, succumbing to fear and discounting fundamentals.
"This led to a rise in the number of mispriced securities, which represented good value for those that took a longer-term, through-the-cycle view."
As market conditions subsequently moderated and fundamentals returned, many of these securities experienced sharp recoveries, Yap said.
"While uncertainty surrounding the state of the global economy is likely to see market volatility continue, we do not believe this will be of the same magnitude as that experienced during the height of the GFC," he said.
"This lower volatility, in isolation, may prove insufficient to spur a second round of amplified returns, which are likely to moderate to levels more consistent with their longer-term historical averages."
The S&P review covered 44 small caps offered by 38 managers and included six newly rated funds.
Fund managers Eley Griffiths and Invesco were the only managers to retain their five-star ratings.
"But overall, we remain encouraged by the number of quality offerings in this sector," Yap said.
