Why does the ASX under-price small caps?

Advertisement

Goldman has a nice observation today about the Australian share market:

sdvsqa

Australia: The only country without a small cap premium

Over the past decade, Australia is the only market in the world without a small cap premium. Small companies have underperformed by 45% since 2004 making Australia a significant outlier given globally small firms have outperformed large caps by 60%. We see a better outlook for small caps given our view that the worst of the small cap headwinds are behind us.

It is a long term phenomenon but has gotten worse:

xcvsdfv
Advertisement

Why?

  • A high A$ has had a greater impact on smaller companies given their greater domestic exposures.
  • Australia’s labour market has become increasingly uncompetitive and lacks the flexibility of many other global economies. This factor has likely weighed more heavily on small cap margins given variable costs like labour tend to make up a larger portion of their cost base.
  • The oligopolistic nature of many Australian industries has likely squeezed small cap margins. The fact that the small cap industrial cyclicals have underperformed so heavily while consumer-facing firms have outperformed would tend to support this thesis given the pricing pressure that larger firms have been able to exert on their supply chains.
  • Funding challenges: A lack of competition in the banking sector and a small corporate lending market likely put smaller firms at a larger disadvantage.
  • Fewer incentives for small companies and less focus on innovation (i.e. underrepresentation on a global basis of innovative sectors – IT, Health Care).

That pretty much sums it it up. It’s houses and holes or bust, yoh!

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.