Packersoldkidney
17-11-2004, 04:54 PM
Article in today's Sydney Morning Herald by Allan Kohler - worth a read if you have the time.
Betting big time on the small stocks
By Alan Kohler
November 17, 2004
The money pouring into hedge funds, the rise of boutique small cap fund managers, probably the growth of DIY super funds and even the apparent willingness today of a lot of GPT unit holders to bet that an auction will develop by voting against Lend Lease's scheme of arrangement, are all manifestations of the same thing: a global shift towards greater risk.
Underlying this are two powerful, related phenomena: a cyclical reduction in volatility and dispersion (the difference between the best and the worst); and the low inflation/low interest rate environment that makes double-digit investment returns hard to achieve.
Except in Australia, this year.
Usually, small companies are valued at a discount to big ones because they're inherently riskier. Over the long term the average discount is 20 per cent but, sometimes, when fear stalks the market, as in the mid-90s and after the 2000 tech bust, it blows out to as much as 40 per cent.
Right now in Australia the small cap discount is 4 per cent. The All Industrials price earnings ratio is 15.7 times while the Small Ordinaries average P/E is 15.1 times. Over the past six months the Small Ords has risen 24 per cent while the 20 Leaders has gone up 8 per cent.
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Pretty soon a dollar of earnings from a tiddler will, on average, cost more than a dollar of earnings from a giant company.
The powerful bull market in Australian small cap stocks over the past six months is part of a global trend driven by two powerful forces: the secular decline of the US dollar and the worldwide flight towards higher risk.
Even though US interest rates have doubled, the cost of American money is at an historic low. The US dollar is also overvalued and in decline.
Therefore the Australian currency is seen as a one-way bet and the economy is sound: basically the cost of speculating in Australia is zero at worst - if anything, currency gain has been more than paying for the cost of the money.
Underlying this is the increased appetite for risk. To some extent this is a characteristic of all bull markets and is underpinned by 14 years of economic growth and greater confidence after the re-election of the Howard Government.
Between July 1 and the election the average daily rise in the Small Ordinaries index was 2.8 points; since the election it has accelerated to 4.2 points per day.
But there's more to it. Expectations of double-digit investment returns were built up during the high-inflation 1980s and then reinforced during the internet bubble and property boom of the '90s.
In the past five years inflation has been subdued and equity and property returns have shrunk. The main exception to this has been the emergence of China as a driver of commodity prices, but exposure to commodities has not been sufficient, on its own, to maintain excess investment returns from balanced funds.
At the same time wealth management has become extremely competitive; short term performance tables are life and death.
To try to keep performance in double figures, fund managers are increasing their tracking error (versus the benchmark indices) by taking bigger bets on fewer companies.
Moreover, super fund trustees are shifting more and more money into hedge funds and boutique fund managers which specialise in small cap stocks. In many cases, individuals approaching retirement are setting up DIY funds to punt their super on speculative stocks to try to get their lump sums up.
Also, with global financial market volatility now very low - the US Vix index of volatility, for example, is at an eight-year low - the reported "value at risk" of banks and institutions can be reduced while the actual exposures are increased (VAR is basically the size of the position times volatility - if one goes down, the other can go up).
Outperformance of small cap stocks has been a worldwide phenomenon this year
Betting big time on the small stocks
By Alan Kohler
November 17, 2004
The money pouring into hedge funds, the rise of boutique small cap fund managers, probably the growth of DIY super funds and even the apparent willingness today of a lot of GPT unit holders to bet that an auction will develop by voting against Lend Lease's scheme of arrangement, are all manifestations of the same thing: a global shift towards greater risk.
Underlying this are two powerful, related phenomena: a cyclical reduction in volatility and dispersion (the difference between the best and the worst); and the low inflation/low interest rate environment that makes double-digit investment returns hard to achieve.
Except in Australia, this year.
Usually, small companies are valued at a discount to big ones because they're inherently riskier. Over the long term the average discount is 20 per cent but, sometimes, when fear stalks the market, as in the mid-90s and after the 2000 tech bust, it blows out to as much as 40 per cent.
Right now in Australia the small cap discount is 4 per cent. The All Industrials price earnings ratio is 15.7 times while the Small Ordinaries average P/E is 15.1 times. Over the past six months the Small Ords has risen 24 per cent while the 20 Leaders has gone up 8 per cent.
AdvertisementAdvertisement
Pretty soon a dollar of earnings from a tiddler will, on average, cost more than a dollar of earnings from a giant company.
The powerful bull market in Australian small cap stocks over the past six months is part of a global trend driven by two powerful forces: the secular decline of the US dollar and the worldwide flight towards higher risk.
Even though US interest rates have doubled, the cost of American money is at an historic low. The US dollar is also overvalued and in decline.
Therefore the Australian currency is seen as a one-way bet and the economy is sound: basically the cost of speculating in Australia is zero at worst - if anything, currency gain has been more than paying for the cost of the money.
Underlying this is the increased appetite for risk. To some extent this is a characteristic of all bull markets and is underpinned by 14 years of economic growth and greater confidence after the re-election of the Howard Government.
Between July 1 and the election the average daily rise in the Small Ordinaries index was 2.8 points; since the election it has accelerated to 4.2 points per day.
But there's more to it. Expectations of double-digit investment returns were built up during the high-inflation 1980s and then reinforced during the internet bubble and property boom of the '90s.
In the past five years inflation has been subdued and equity and property returns have shrunk. The main exception to this has been the emergence of China as a driver of commodity prices, but exposure to commodities has not been sufficient, on its own, to maintain excess investment returns from balanced funds.
At the same time wealth management has become extremely competitive; short term performance tables are life and death.
To try to keep performance in double figures, fund managers are increasing their tracking error (versus the benchmark indices) by taking bigger bets on fewer companies.
Moreover, super fund trustees are shifting more and more money into hedge funds and boutique fund managers which specialise in small cap stocks. In many cases, individuals approaching retirement are setting up DIY funds to punt their super on speculative stocks to try to get their lump sums up.
Also, with global financial market volatility now very low - the US Vix index of volatility, for example, is at an eight-year low - the reported "value at risk" of banks and institutions can be reduced while the actual exposures are increased (VAR is basically the size of the position times volatility - if one goes down, the other can go up).
Outperformance of small cap stocks has been a worldwide phenomenon this year