@Dejavoo , One could say that the past 18 months has been a...

@Dejavoo ,

One could say that the past 18 months has been a strange time for markets, but my long-made observations have left me believing that at any given time there is something strange going on in capital markets, meaning the notion of "normal" market conditions is somewhat meaningless one.

As you rightfully say, micro/nano caps have been decimated (and not just in the tech space, but just about across the board - financials, mining/oil& gas services, engineering construction, professional services, capital goods, retail).

In fact, I cannot recall a time when the Large Cap vs Small/Micro Cap valuation gap has been wider. The flight to liquidity and earnings certainty of the large caps, at the expense of the small end of the market, has been prolific.

Of course, for many small/micro/nano cap cases - the majority of them, for sure - it was a case of dubious quality companies being little other than children spawned of an era of free capital, and then they became exposed as being flawed business models once capital became properly priced. (I certainly drank of the Kool-Aid in a few cases - how could one avoid it? But more on that later.)

So if one wanted to summarise the 2022 and 2023 investor playbook, it would go something like:


1. Buy only large companies with earnings certainty.
2. Don't buy anything under $500m Mkt Cap.

And the extent of the frenzied rush over the past 12 months to "Big-Companies-With-Earnings-Certainty" has been such that all the rules of long-duration growth stocks becoming less valuable, when the cost of capital (i.e. the rate at which future cash flows are discounted into present day values) rises, have been broken/forgotten.

This has left many large cap stocks looking fully priced (e.g., ones I own: BRG, CAR, REA, REH, TNE) or at best, just fairly priced, but certainly not glaringly cheap (eg., AUB, CSL, DTL, RHC, SMP, SDF).

If I divide my family's capital up into discrete "buckets", it looks like this (the securities highlighted in the yellow are the ones I purchased over the past 18 months):



Dealing briefly with each of those separately:

1. LARGE & MID CAPS (82% of invested capital)

This represents my largest single positions. Top 10 holdings account for 40% (AUB, CAR, SNL, SDF, OOO, NHC, TNE, DTL, RMD, REA).

Note that it includes KOV, LYL, and SNL, which are small caps, as well as two ETFs (OOO= oil futures and WIRE = global copper producer ETF) and some inflation indexed government bonds, GSIC50) so adjusting for all of those, I probably have only around 64% of my portfolio in genuinely large caps stocks (28 of them, which is about as many as I'd like).

The only major changes to this part of my portfolio over the past 12 months were:

1. Reducing overall energy exposure.

Don't misunderstand me: I'm still bullish on energy (it took two decades of ill-considered energy policy to get the world where it is today; global energy deficiency is going to be with us for several years to come), but I find that the underlying securities are no longer as ridiculously undervalued as they were two years ago.

2. Buying of large cap tech stocks (CAR, DDR, REA and TNE).

In early- to mid-2022 at the time the inflation bogeyman impacted them via higher interest rates.

But by contrast, the market is now totally ignoring interest rates as an investment consideration, seemingly, so I am in the process of reducing some of these large cap tech positions (along with AUB and SDF, which have become outsized positions relative to the residual upside I can identify.)

(Given the current giddy-up in energy prices again, I wonder how long it will take for the penny to drop that a new energy-driven wave of inflation might break out across the world?)

3. Looking (mostly in vain) for the right beaten-up retailers (NCK is all I came up with) and buying RMD


2. SMALL & MICRO CAPS (12% of invested capital)

I first committed time to actively researching micro-caps in around 2017/18 and for the first few years things went swimmingly (it was like shooting fish in a barrel ... free money will do that!).

But for the past two years, it has been a tough gig (as everyone knows).

A snapshot of where things stand today for me is represented by the following table (whose colour coding probably requires some explanation):


(*) denotes stocks that were taken over

The grey stocks are the ones I've sold (light grey being the ones I held 18 months ago, but which have been sold since) and the dark grey being the stocks I've subsequently bought and sold.

The 31 stocks shaded green and blue are the ones I currently own - blue being stocks I've acquired over the past 18 months and green being the ones I owned 18 months ago. (The dark green ones - KOV, LYL and SNL - are included in the table because they are microcaps, but they are holdings going back many years, and are in my top 20 largest positions, so they are treated in my mind as "large caps". For context, these three stocks today account for 11% of my capital; that's almost as much as the other 28 micro-caps I own).


And then besides the colour coding, the stocks are delineated in "BAD", "NEUTRAL" and "GOOD" columns, which should be self-explanatory, with the caveat that "BAD" doesn't necessary mean broken investment thesis or permanent capital loss. (For the grey "BAD" ones, that is/was the case... so ALC, LPE, QFE, BMT, KNO, ANO, PGH, STG, SWM all confirmed dud investments. But while share prices are underwater on DVR, ENN, IGL, AFL, DRA, FDV, and SP3, the investment cases for these are still intact, even if it is going to require a degree of engagement with directors to precipitate the restoration of value.)

In pure performance terms, when I run the rough numbers I find I've washed my face over the past 12 months fishing in this micro-cap pool, but it hasn't been done at all elegantly.

I haven't conducted an accurate attribution exercise but it is abundantly clear to me that the vast majority of the alpha contribution came from just a handful of stocks: KPG, KOV, LYL, SNL, and five that got taken over. (The remaining "GOOD"stocks - ABV, CLG, LBL, MEA, NXD, SHM, SXE - are either very recent additions, or the positions were too small to make much of a difference.)

So, around 50 investments made in the micro- and nano cap space, and so far a mere third of them are winners (and of those, just over half only made any real impact). That's not a very good hit rate.

Viewed another way, as many "BAD" stocks as "GOOD" ones... that's not too flash; it's not much better than shooting craps.

Granted, the period under review has seen a perfect storm for micro-caps and I've made money, but still.... when I cost the time and effort involved, I'm not sure its been a good ROTI (Return on Time Investment).

Which is why, while I'm convinced that there are far more investment opportunities in the small- and micro-cap part of the market, I'm increasingly of the view that at my stage of life, I no longer have the patience and energy to isolate the risks that inevitable accompany the higher returns from micro caps.

So I'm increasingly looking to outsource that activity to others.

Which segues into the last bucket:

3. EXTERNAL MANAGERS (6% of invested capital)

About three years ago, I started looking around for investment managers to whom I could increasingly outsource my family capital. I was hoping to be at around the 30% mark , or maybe have, at least a quarter or a fifth managed externally by now, but finding the right investment partner has proven more difficult than I had expected.

There invariably seems to be some or other gating factors blocking me: either the manager is insufficiently different, style-wise, to me. Or the fund is too small. Or there is some fund structure issue. Or there is some kind of probity red flag that makes me uncomfortable.

Which is frustrating because I have a high level of conviction that the events of the past 12 months, and the indiscriminate selling of micro- and nano caps that has resulted, means that there are sure to be a number of truly great investment opportunities when looking out on a three-year view.

I just couldn't be arsed hunting for them, so I wish I could find some people who I could trust to do it for me.


What about you?
How are you viewing the world?


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