Get an Edge by Clearing out the Junk


While the newly-launched Equitable Investors Dragonfly Fund will typically be focused on micro to mid caps, its investment universe is not defined directly by company size. Equitable Investors seeks out attractive investment characteristics and market inefficiencies that tend to be more prominent - but not exclusively - among smaller firms. We've been preparing a paper running through some of the quantitative work researchers have done on the factors and characteristics that help us focus on the listed businesses most worthy of a closer look. "Quality" is one focal point. The story of the small company premium is well told - and challenged from time-to-time. But a more robust version of the small company premium story comes from leading US quantitative investment firm AQR (headed by Cliff Asness), which found in its report, "Size Matters, if You Control Your Junk" (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2553889), that after culling low quality companies, a more persistent size premium emerged that could not be explained away by illiquidity premiums, seasonality or some of the other arguments against the size premium. “Quality” for this study was measured by the components of the Gordon Growth Model, which says value is determined by profitability, the dividend payout ratio, risk and growth. This research wasn't just focused on US markets - it took in global markets including Australia. Higher excess returns from the quality filter were found in Australia, in-line with the global experience, although not as pronounced as in the US. The accompanying chart, abbreviated from one in the AQR report, demonstrates excess returns for small caps after filtering out junk are evident under varying measures of size other than market cap (book value, sales, total assets, PP&E and employees).


 Change in Small Company Excess Returns from Controlling for Quality (using four size measures) | source: Asness et al, “ Size Matters, If You Control Your Junk”


Equitable Investors Pty Ltd is a Corporate Authorised Representative (No. 001256627) and Martin Pretty is an Authorised Representative (No. 001256674) of Glennon Capital Pty Ltd (AFSL No. 338567)

Popular posts from this blog

Feel the Cash Burn as Profit Season Closes (or "In memory of Pocketmail")

Another crazy month of reporting financials has come to an end on the ASX, with the typical last minute dump of reports on the evening of August 31 (or the following morning) reflecting unfavourably on business models or financial robustness. "Have you heard if Company X has approached anyone about a convertible note or something like that", an investor peer asked me in passing on Friday. No, I hadn't. But I had looked at the financials Company X had just released and I know why he was asking. Cash on hand was equivalent to about 45% of its annual cash burn. Without fresh funding, Company X's brief life could soon come to an end. Too often founders or cornerstone investors choose to raise just enough funds to get to the next milestone, at which point they are sure investors will significantly revalue the business, allowing a less dilutive round of funding to get to the next milestone. Company X probably thought the same thing - the only problem is that its sha
Read more

We reckon equity is a key incentive

We reckon that the managers and directors most aligned to maximising shareholder value will be those with a considerable portion of their wealth tied up in equity in the business they are involved in. Earlier today we used software group Reckon (ASX code: RKN) as an example in this post on livewire. In discussing RKN, we touched very briefly on the evidence backing up our logic on equity incentive. We discuss this further in Equitable Investors' paper on the factors and inefficiencies we seek to capitalise on as part of our investment process: "Seeking Advantage - Focusing on the Underlying Drivers of Excess Returns Most Evident in Smaller Companies to Optimise Investment Portfolios for Return and Risk". You can find the paper at www.equitableinvestors.com.au or by clicking here . Or you can read our earlier blog entry on Alignment of Interest here .
Read more

New commentary up on livewire: An overlooked small cap agri stock

"When your competitors go one way, do you follow them, or do you go the other way?" That question was asked of a room of close to 100 financial advisers by keynote speaker Geoff Ramm at Centrepoint Alliance's annual conference last week. The focus at the time was effective marketing but resonated with this investment manager in a different context. The stocks that contributed most to the performance of the Equitable Investors' Dragonfly Fund in the month of September were clear cases of neglect. Investors, on the whole, had turned their focus elsewhere... Read the full article here .
Read more

Disclaimer

Nothing in this blog constitutes investment advice - or advice in any other field. Neither the information, commentary or any opinion contained in this blog constitutes a solicitation or offer by Equitable Investors Pty Ltd (Equitable Investors) or its affiliates to buy or sell any securities or other financial instruments. Nor shall any such security be offered or sold to any person in any jurisdiction in which such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.

The content of this blog should not be relied upon in making investment decisions.Any decisions based on information contained on this blog are the sole responsibility of the visitor. In exchange for using this blog, the visitor agree to indemnify Equitable Investors and hold Equitable Investors, its officers, directors, employees, affiliates, agents, licensors and suppliers harmless against any and all claims, losses, liability, costs and expenses (including but not limited to legal fees) arising from your use of this blog, from your violation of these Terms or from any decisions that the visitor makes based on such information.

This blog is for information purposes only and is not intended to be relied upon as a forecast, research or investment advice. The information on this blog does not constitute a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Although this material is based upon information that Equitable Investors considers reliable and endeavours to keep current, Equitable Investors does not assure that this material is accurate, current or complete, and it should not be relied upon as such. Any opinions expressed on this blog may change as subsequent conditions vary.

Equitable Investors does not warrant, either expressly or implied, the accuracy or completeness of the information, text, graphics, links or other items contained on this blog and does not warrant that the functions contained in this blog will be uninterrupted or error-free, that defects will be corrected, or that the blog will be free of viruses or other harmful components.Equitable Investors expressly disclaims all liability for errors and omissions in the materials on this blog and for the use or interpretation by others of information contained on the blog.