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Choosing offshore small and mid-caps

A look at the Russell basket of indices.

MARC ASHTON: Welcome to the Moneyweb Offshore Investing podcast, today I’m joined in studio by Simon Brown. Simon, thanks for joining us.

SIMON BROWN: Thanks, Marc, always a pleasure

MARC ASHTON: Today we’re talking small and mid-cap investing, and whenever someone asks why I have an interest in investing I always use this statistic of PSG – R1000 invested in 1998, today if all dividends were reinvested you’ve made more than R1 million. That is just a highlight of a small business that has been able to grow, make good investments, ends up in the mid-cap space, becomes a really dominant player in a number of the markets invested. The idea that the typical ten-bagger is what a lot of people talk about, they love this idea of being invested in the small cap space simply because these returns are out there. Small and mid-caps performed alright in the South African market, are there opportunities to invest in the international small and mid-cap space without having to go and pick individual stocks?

SIMON BROWN: There absolutely are, the individual stocks are incredibly hard to pick in that space, I always say the big stocks sure maybe but in the small space and the mid-cap space go and get the ETFs. There are a lot of them, there are probably a couple of hundred listed in the US. So what I say is let’s filter this two ways, firstly I go and look at the Russell basket of indices, so we know the S&P, we know the Dow, we know the FTSE, these are companies that make indices. There is also the Russell, who only really operate in the US and they focus predominantly away from the large stocks, they focus on mid and small caps.

So we’ve got the Russell 2000 in America, we’ve got the Russell 3000 in America, which have respectively 2000  and 3000 shares in them just to indicate the size of them. They’re in that mid and small cap space, so when we talk about massive diversification you’ve got indices with 2000 shares in them. On the one side you say 2000 shares, it’s never going to go anywhere. No, they do, they can offer the returns but because of the diversification it can pull back some of that inherent risk with picking an individual mid-cap. Your PSG example is spot on but, of course, there were others, if you had gone and bought not PSG, the one next to it you might have lost your R1000.

MARC ASHTON: The interesting thing when we looked at the return that the small and mid-cap indices had delivered in South Africa we got about 50-odd percent over the last three years, can you give us some idea of how the international players are performing?

SIMON BROWN: Well, the mid-caps, so I’m looking at the iShares Russell mid-cap ETF, if you look at a three-year return there we’re sitting at about an 80% return, excluding dividends. Now, these guys are not going to be huge dividend players, they’re the small and mid-caps, your small caps hardly ever pay dividends, so that’s really, really chunky. If we go into the small cap space we’re sitting at a slightly lower return but at about a 70% return, again excluding the dividends, as modest as they will be. Both of them outperforming our local mid-cap index, more importantly you’ve also got obviously rand depreciation that would have added to the return.  

MARC ASHTON: So going offshore definitely would have been better. The thing I want to ask you about though, everyone remembers 2008 in the South African market, small and mid-caps, the moment that the liquidity dried up suddenly there was this flight to quality away from the risk shares, do we hit the same impact if we go and look at the offshore shares?

SIMON BROWN: We do but to a lot less of a degree and it’s simply because what we’re finding in the American markets, what we call low liquid in America would be a top ten or a top five liquidity stock in South Africa. The liquidity in the US market is absolutely humungous. So that in part will help to offset it, the other point is because of that massive diversification, because it’s literally 2000 shares, what that then says is well, you’re going to find pockets where you’ve got no liquidity, not that it dries up, that it disappears but that holding at best is going to be about 0.5%. If I go back and look at what happened in 2008, both of these that we’re talking about – the Russell mid-cap and the Russell small cap – both of them took a fair pounding, both around 50% off top to bottom, which is exactly what our Top 40 did. So, in fact, they were more aligned with our Top 40 than with the local mid-cap index.

MARC ASHTON: So I think what we can sum up from this podcast is there are opportunities to invest offshore in the small and mid-cap space. We don’t need to be out there being individual stock pickers, we can actually buy indices with 2000 or 3000 stocks. This was Simon Brown talking to Moneyweb.

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