It is unlikely that most investors in South Africa can name a good company outside the Top 40 Index. This is because most investors regard an investment in mid-cap and smaller companies as too risky.
This misconception stems from a behavioural finance concept called familiarity bias. In terms of this concept, people invest in what they are familiar with rather than do a thorough analysis to identify the best investment. This is usually due to the fact that investors believe they can control the outcome if they are familiar with something.
An analysis of the risk/return characteristics of the various market capitalisation indices from June 2002, as well as the total market, reveals that investors need to carefully consider all the options, both familiar and unfamiliar, when making an investment decision (see accompanying table).
Since June 2002, the total performance (with dividends and interest reinvested) of the FTSE/JSE Mid-Cap and FTSE/JSE Small-Cap indices was significantly better than that of the FTSE/JSE Top 40 and FTSE/JSE All Share indices. What’s more is that this outperformance was achieved at a much lower level of risk. This means an investment in the small- and mid-cap sectors would have improved the risk/returns profile of an equity portfolio (see the risk/return graph below).
Investors can benefit from the good performance of these two sectors by investing a portion of their long-term savings in a unit trust in the sector for smaller companies. The top performer in this sector, and the only fund with a 5 PlexCrown rating — the maximum rating a fund can achieve and which denotes consistently good performance on a risk-adjusted basis — is the RMB Small/Mid-Cap Fund.
This fund delivered an impressive return of 49,2% for the 12 months ended May 2010, and 24,0% per annum over the last 10 years.
Annualised performance from June 2002 to June 2010
Small Cap Index: 26,7%
Mid Cap Index: 23,9%
Top 40: 14,2%
JSE All Share: 15,4%
Read more news, blogs, tips and Q&As in our Smart Money section. Post questions on the site for independent and researched information