Small cap or micro-cap funds can be alpha generating machines. In today’s market where momentum seems to govern, fund managers willing to tread into the murky depths of AIM-listed stocks can find some real value gems, ignored by the large brokers.
However, once a fund manager has established a successful small cap fund, the success can then become a hindrance. If the assets under management balloon, the strategy might not work as well. These managers know the risks of small cap investing, liquidity being one of the main issues.
Therefore while a manager might be able to buy 30,000 shares in a small company, if the strategy grows in popularity, which managers want of course, it might be difficult to buy 3 million shares in the same company.
Alternatively, if a manager has a large position in a small company and decides to take profit by selling the shares it would have a drastic impact on its share price, regardless of its fundamentals.
Speaking to Isaac Chebar, manager of DNCA’s Invest Value Europe fund recently, he said: “When the strategy was smaller, we could have smaller stocks but as it grew it became harder to replicate this.”
This means as money pours into a small cap strategy, the manager can either top on those stocks already held or go looking for other diamonds in the rough which is always fraught with danger.
Furthermore, small cap funds can be fairly nimble, although might have a percentage limit it can put into one stock. While some of the famed ’ten-baggers’ like Keystone Studios have done well for lots of AIM-focused managers, if a strategy limited its position to say 20,000 shares in the company, its value will certainly have increased during its time on the market but obviously not as much as if the limit was 100,000.
This is not just a problem in the active part of asset management, passive products have the similar issues. This is due to capacity and an extreme example was VanEck’ Vectors Junior Gold Miners ETF a couple of years ago.
This ETF was the smaller sibling of the Vectors Gold Miners ETF and tracked an index of smaller by market cap gold producers. If thinking of Robert Schillers’ behavioural finance theory for which he won the Nobel prize for economics (the same year as Eugene Fama) then herding becomes an issue, for both passive and active funds.
VanEck’s Junior Gold Miner’s ETF ballooned to $4 billion in AUM. This caused huge problems for the product. One issue is that under Canadian rules, if a shareholder has a 20% stake in a company it has ‘to automatically extend a takeover offer to all remaining shareholders at the same terms,’ according to a Scotiabank report. This is not the aim of investing.
The company had to move fast and increase its previous market cap range to an upward limit of $2.9 billion, quite an increase from its previous ceiling of $1.6 billion. In the meantime between upping its limit, the ETF took the incredible move of including stocks not in the index, which shows how success can really scupper a good idea.
Back in the active space, there have been numerous examples over time of firms soft closing funds due to capacity issues which can make the fund unwieldy and also cause problems if mass redemptions are sort. Legacy Aberdeen Asset Management had issues back in 2013 when investors sort the returns of emerging markets, one of the firm’s specialist fields. Aberdeen soft closed the fund, using a variety of methods to keep inflows down. These were not as harsh as other fund houses in similar positions, for instance making initial investments far larger and hiking the initial charge. Aberdeen simply asked IFAs to take the fund off their buylists and limited marketing.
Many a fund manager would like the problem of how to soft close their funds as the strategy was attracting too much money but these have slowed down. Last November Goldman Sachs Asset Management soft closed its GS Global Small Cap CORE Equity fund to new investors as it had hit £507 million in AUM. Funds that have been soft closed can be reopened as with Aberdeen and investors will presumably hope that lightening can strike twice.
