Small cap stocks are a very under owned asset class, especially in Canada where our stock market is heavily tilted to cyclical industries like oil and gas and financials. Investors looking for diversity in their portfolio should look at small caps for growth and diversity away from these industries. Small cap is typically defined as a company with a market cap under $5B, however in Canada small cap can even be anything under $3B as our market is smaller.
When scanning the investment world for small caps, there are many interesting companies trading at very good valuations in sectors that are unrepresented in the S&P/TSX Small Cap Index. We like to call these “special situations” companies that may fit into a broad category but are very unique. For example, in the AcuPure Small Cap Equity managed portfolio run by Portfolio Manager Donny Woo, one of the important aspects of the portfolio is that the sector breakdown is very different than the S&P/TSX Small Cap Index, creating a return profile that looks nothing like the cyclical path of the TSX or TSXV.
Small caps can be like having private equity exposure. Some high-quality Canadian small caps are illiquid in nature and would probably be private companies if they were in the US markets. This is a very interesting asset class, one that is often founder led, under the radar companies with big returns.
All small caps are not created equal. Buying a TSXV ETF for example would not produce this PE like return or be idiosyncratic to the Canadian market. Since many of the small cap companies in Canada are cyclical, owning a TSXV ETF would not achieve the benefits of owning great small cap companies. Investors need to look to advisors like we have at Acumen to dive deep into these companies and really understand management and their capital allocation decisions.
Further, there are thousands of public small cap companies that simply do not work out. Having an advisor can help you stay away from the hot stock tips you see on TV or whatever is being talked about on financial television. For example, at Acumen, we have a limited number of Canadian small cap stocks that we feel are truly investable (less than 100). Investors need to be able to navigate these waters to produce the desired returns.
In short, small caps are an excellent way to diversify your portfolio on many levels when done correctly. If you would like to hear more about small caps, and how you can really diversify your portfolio in a concentrated Canadian market, let’s talk.