Update No. 126 – 18/08/13

We are primarily invested in small and medium companies. Such companies tend to be laggards in respect of their reporting, with most reporting on the very last possible day. I commented on Twitter this week that this will mean the last weekend in August will be a very busy one for me, or anyone who loves small-caps.

This gives me the opportunity to spend the early part of reporting season looking primarily at stocks we do not, and are unlikely ever to own. This is useful primarily as a means of testing market sentiment. I do not try to time the market, but I do like to get a feel for how the wider market is being valued. Small-cap valuations tend to lag their larger cousins in a bull-market. My view broadly is that the larger end of the market is pretty fully valued at present; I believe there is some very good value to be had at the smaller end, however. Market commentators often refer to this as a stock-pickers market, which is one of the most rubbish terms ever invented. It is ALWAYS a stock-pickers market.

Although I view the market as pretty fully valued, I suspect this will be a market that could kick on. If there is a fairly decisive result in the upcoming Federal election (despite market commentators trying to pretend it’s ‘neck and neck’ I expect it will be quite decisive), I think the speed at which consumer sentiment will improve will surprise. I believe much of the negative sentiment in the mining and mining services industries is also overdone; much of the rest of the economy will be carried along very quickly if these two things correct.

I commented back in March that the weighted average market capitalisation of our portfolio was $320m. I will revisit the ‘portfolio metrics’ in September after reporting season has been completed and digested, but at present, our weighted average market capitalisation has grown to about $419.7m.

I mention this in order to demonstrate a point I wanted to make this week. With the weighted average market capitalisation of our portfolio up about 33% and our growth in asset price of less than 7%, it seems pretty clear to me what has happened – the value of larger capitalisation stocks has moved faster than their smaller peers. I can tell this from our portfolio, which without major changes in construction has become more heavily weighted to the larger cap holdings.

Actually, I have far better evidence than just our portfolio… Over the last 3 years, the ASX200 (including dividends) has an annualised return of 9.97%, whilst the ‘Small Ordinaries’ (including dividends) has returned -0.19% per annum. Over the last 12 months, the top 200 have returned 25.07% compared to 2.56% for the Small-Ords. Year to date (since January 1 2013) the ASX200TR has returned 12.27% as against -4.34% for the Small-Ordinaries (all preceding figures based on COB 12/08/2013 prices). Interestingly, since July 1 2013, the Small-Ords are up 12.55% to the ASX200TR’s 6.61%, so the tide may be turning…

It should be remembered that the Small Ordinaries contains a lot of companies which can be best described as speculative rubbish. However sentiment is a powerful thing and amongst the rubbish are (in my view) a lot of good little businesses that have been mispriced for too long.

If I am correct, when that tide turns (or if it’s turning), we are well positioned – the recent run in equities prices has been almost exclusively focused on large-cap, high-yielding stocks, if the strong run is to continue, the next phase will see investors who can no longer find value in that space moving down into the smaller-cap area where some good values still exist – Tony Hansen 18/08/13

P.S. For the first time in the Funds history, we have bested the market for 5 weeks running this week, hopefully reporting season will prove prosperous and we can extend that further. We’ve only had one holding report so far, I expect three or four this coming week, with the remainder in the last week of August.

EGP Fund No. 1 Pty Ltd. Up by 9.80%, leading the benchmark by 2.55% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 49.08%, leading the benchmark by 31.90% all-time (April 1^st 2011).

^{*1 after 31May 2013 dividend of 2.333 cents per share plus 1 cent per share Franking Credit}

^{*2 calculated based on dividends reinvested}