| Diversification
with Small Cap |
As investors we are all aware of the benefits of diversification
within our portfolios. Diversification within a portfolio can be done
in a number of different ways; within asset classes, across various
sectors, across different manager styles and across various countries.
I have included with this article a chart illustrating
the benefits of asset allocation and diversification within various
sectors. The diagram illustrates very clearly why asset allocation
is important and why sticking with a disciplined process works so
well. Process works because of consistency – consistency in
the face of an ever-changing market environment. As we never know
each year what part of the market will perform the best, diversifying
among asset classes with a disciplined process works best over time.
Investing a portion of your equity portfolio into small
cap stocks is one way to increase your portfolio diversification.
Traditionally small cap investments have performed well in an economic
recovery. Smaller companies are more adaptable and can easily re-deploy
resources to suit a growing economy.
Recently I have received a number of questions on what
is the best way to participate in the growth in China. There is not
simply one answer to this question as there are a number of ways one
can approach this market however Canadian small cap securities is
one way that I believe is worth considering.
Due to extremely low labour costs, the Chinese are not
likely to import many manufactured products from Canada. China however
is very interested in Canada’s natural resources and industrial
products. There are a few strong large cap companies in these sectors
however the bulk of them fall within the small to mid cap range. I
believe that owning a small amount of small to mid cap companies makes
sense for the overall portfolio. I recommend that investors hold between
15 to 20% of their equity portfolio in the small-mid cap sector.
In my opinion the best way to participate in this sector
is via a mutual fund. There are too many individual companies to make
it practical to invest directly in them. By purchasing a well-diversified
mutual fund you can participate in the growth opportunities of 60-100
companies in this sector therefore minimizing your overall risk.
Adding some small cap equities to your portfolio will reduce the
overall volatility of the portfolio, as there is a low correlation
between the performance of small cap stocks and other equity asset
classes. One of the main reasons for this lower correlation in Canada
is that the small cap index has a 27% larger percentage of consumer
and cyclical stocks in it than the S&P/TSX Composite. Interest
sensitive stocks represent a large percentage of the large cap equities
in Canada but not so in the small caps.
After reviewing a number of small cap mutual funds and their managers
I have determined that the Elliot & Page Growth Opportunities
fund offers the best management in this area in Canada. The manager
Ted Whitehead follows a very disciplined approach to selecting and
selling positions within the fund. The fund currently holds close
to 100 different companies in the small and mid cap sectors. The
sector allocations are illustrated in the pie chart below along
side the funds performance over the past five years.
Did You Know?
The requirement to have adequate funds saved for your
retirement is becoming more and more critical as our population ages.
Did you know that currently only 12.9% of our population is 65+ but
in 30 years from now individuals 65+ will represent 22.7% of our population.
Currently there are 4.76 working age adults for each person 65 and
over but in 30 years there will only be 2.44. For reasons like this
it is even more evident that careful planning for your retirement
and how it will be funded is critical.
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YTD