4 Reasons not to invest with Microequities

Over the years as a relationship manager, I have the unique vantage point of having heard almost every reason under the sun as to why people decide to either invest or not to invest in products ranging from Term Deposits to Managed Funds. Below I’ve outlined a few of the reasons potential investors raise with me when deciding not to invest in Microequities – every coin has two sides.

1) “This isn’t the right time of the market” or “I’m worried the market is toppy”

This is one of the most common reasons clients decide that they are not going to invest. From what I’ve seen, it is the old-adage “it isn’t timing the market – but time in the market”, that many of our prospective investors tend to forget.

It is important to review broader market-based returns as well as the returns of active fund managers over time. If we look at 100+ years of data on the ASX returns, we see that the “market” falls over 20% of the time. One in five years. If you have a short-term timeframe (i.e. under five years) you have around a 20% chance of getting “unlucky” and timing your foray into the market in one of those negative returning years. None of the best investment guru’s claim to generate returns from ‘timing’ the market; and having a long-term view allows you to detach from the daily yo-yo of short-term share price movements which I’ll discuss in the next point. This is part of the reason why we note 5+ years as the recommended timeframe for looking at any ‘equity’ investments – Microequities included.

2) “I’m looking at another fund with a better 1-year return”

Value investing is a long-term quest, a journey more like a marathon than a sprint. Like market timing concerns, timeframes play an important role in investors returns. If you have a short-term timeframe then there is every chance that volatility will result in a negative performance over one or two years. The 12-month return of any investment fund can be volatile depending on market conditions and sentiment. We ascribe no value to short term market performance or volatility because it is not necessarily an indicator of the fundamental changes in underlying value of the businesses we invest in. We chose instead to focus on the underlying earnings per share (EPS) of the business partnerships we hold. Once you change your focus to the EPS growth over the long term, the interim volatility is not a concern. We don’t see volatility a risk – we view risk as a negative change to the underlying businesses.

3) “Your fees are too high”

Your objective as an investor should be to obtain the maximum long term returns for a given unit of risk. Many prospective investors mistake the low fee “ETF” investments as a proxy for what they should pay in fees regardless of the overall return they receive. An old colleague of mine used to call such products “benchmark minus”, as you received the benchmark return, minus their fee for managing the product. The consequence of these low fee investments is that many clients equate the skills and expertise of actively managed investment funds, with the effort required to track a benchmark. Chalk and cheese.

Next time you look at fees of an investment, look at after returns fees. Think of it this way, would you rather a greater after fee return or would you prefer to pay less fees and get a lower return? When assessing any fund manager, you should always ensure that the returns profile you are looking at are ‘net-of-fees’. You also want to compare the due-diligence and research that goes into finding, monitoring and selecting the funds underlying investments. Our focus is not to track an index or benchmark. We are benchmark agnostic; the focus being to generate the best return we can for clients with best level of risk. I’ve included a chart below that is a relevant comparison over a long-term timeframe.

Value of $100,000 invested at inception

4) “Microcap stocks are too risky and speculative”

The overall perception of the Microcap asset class is one of speculative, risky companies that may or may not exist tomorrow – mining explorers and biotechs. The universe of microcap companies on the ASX is quite large, however when you distill and filter the list by a series of risk mitigating criteria as we do, you can reduce a large proportion of the risk. Over many years of investing, Carlos and the team have fine tuned the investment process to manage for risk before reward. We have an ownership model whereby we: 1) Only invest when we can buy the company at a discount to what we think the business is fundamentally worth; 2) We only invest in companies that are profitable; 3) Only invest in companies with little or no debt. These are our risk mitigation pillars and characteristics we look for.

We believe the best quality asset a person can purchase is a profitable, growing industrial small business. No other asset class possesses such compelling risk/reward metrics and the innate potential to grow intrinsically over time and for a long time. And when the universe is filtered as we do, these businesses have operating profit and low or no debt that we can buy at a discount to the assessed intrinsic value on market.

Given what you know now, are your reasons for not investing still valid?