Big market falls can help savvy investors

Most share market investors hate big market falls such as the one we have just witnessed due to the Ukraine war.

However, seasoned investors relish market downturns – that’s when they get the chance to finally go shopping because some great companies they have had their eyes on are suddenly on sale.

That is particularly the case for this market downturn because it has happened broadly and across the board – even companies that have just reported excellent profit results have had their shares hammered along with those with poor results.

Strong reporting season followed by generalised share falls

Indeed, the recent reporting season was generally a good one and while it obviously relates to the past, there are still signs that the Australian economy is emerging from the pandemic lockdowns in reasonable shape.

Of course, rising interest rates and inflation are headwinds for markets generally but if you go looking there are sure to be plenty of excellent companies going for good prices – some of which may well be beneficiaries of higher inflation and interest rates.

Small caps hit hardest

Small companies have been hit particularly hard, with the small ordinaries down as much as 11% this year, although in the past week it had tracked back up a little to a fall of just under 9% this year.

By contrast, the ASX 200 – the index of the 200 largest Australian companies – was only down 4% for this year after earlier falling as much as 6.5% – clearly showing that small companies have been hit much harder by this market fall.

Some might think that is a result of the plethora of technology stocks amid the smaller companies but even when you subtract technology the falls have been fairly indiscriminate.

In many ways that could be totally unjustified, given that many good small companies boast higher growth rates than those in the ASX 200 and eventually that growth in sales and profits will be recognised by the market – possibly by an entry into the ASX 200 in the very long term.

Finding the next Afterpay

It is important not to forget that companies such as Afterpay started small and grew rapidly and there will be many more examples of that model to come.

So how do you take advantage of this market downturn?

Well, that depends on your investment style and the amount of effort you want to put in.

For active investors who like to pick their own stocks it is time to get busy reading up on the ins and outs of individual companies, their results and their businesses.

Nothing replaces research and this way you can tailor purchases to your personal investment style, screening for growth, dividends, reliability of earnings, business sector, ethics and anything else you care to mention.

Reading Small Caps is one way of keeping up with the large number of smaller companies out there and noting some potential companies to research further.

Having a broker that does a lot of work in the small cap space can be a big advantage here because they are much more likely to perform research in companies you are interested in.

Many listed small cap funds provide choices

Another way to get access to small cap opportunities is to use a listed or unlisted small cap fund manager and let them do all of the hard work of screening stocks and meeting management.

I think the small cap space is one area in which active managers really earn their fees so using one makes a lot of sense in an area in which specific knowledge can be a lifesaver.

Some of the Australian listed examples of small cap funds include:

Acorn Capital Investment Fund (ASX: ACQ), Bentley Capital (ASX: BEL), Bailador Technology Investments (ASX: BTI), Excelsior Capital (ASX: ECL), ECP Emerging Growth (ASX: ECP), Lanyon Investment Company (ASX: LAN), Glennon Small Companies (ASX: GC1), NAOS Ex-50 Opportunities Company (ASX: NAC), NAOS Emerging Opportunities Company (ASX: NCC), NAOS Small Cap Opportunities Company (ASX: NSC), Ozgrowth (ASX: OZG), QV Equities (ASX: QVE), Ryder Capital (ASX: RYD), Salter Brothers Emerging Companies (ASX: SB2), Spheria Emering Companies (ASX: SEC), Sandon Capital Investments (ASX: SNC), Westoz Investment Company (ASX: WIC), WAM Research (ASX: WAX) and WAM Microcap (ASX: WMI).

Also worth including in this list even though it is a small and mid-cap investor is the highly regarded Mirrabooka Investments (ASX: MIR).

This list is by no means exhaustive and there will be many more unlisted small cap funds but it is enough to kick start your research to find the best active managers in this space.

Of course, it is also possible to take a portfolio approach and, for example, allocate your capital among the four best listed funds you identify.

Remember, small cap management is one area in which the old warning that past performance may not indicate future performance may not hold true.

Look for a manager that has performed well over a good length of time because that indicates they most likely have a solid research methodology and investment record that has been successful in varying market conditions.

Passive way to get exposure to small caps

Another strategy worth considering is to go passive by using an exchange traded fund, or even an active ETF.

Some examples include BetaShares Australian Small Companies Select Fund (ASX: SMLL), BlackRock’s iShares S&P/ASX Small Ordinaries ETF (ASX: ISO), VanEck Small Companies Masters ETF (ASX: MVS) and State Street’s SPDR S&P/ASX Small Ordinaries Fund (ASX: SSO).

Whichever way you go, it is always worth getting some exposure to the small cap sector in Australia (and also the world, although that is a whole other story).

Some of the best and fastest growing companies come out of the small cap universe and it is also an area of the market that tends to get easily oversold which makes it ideal for judicious buying.