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 Financial Happenings Blog 
Sunday, April 17 2011

State Street Global Advisors have released 3 new Exchange Traded Funds (ETFs).   The SPDR S&P/ASX Small ordinaries Fund is most of interest to this firm as we believe that allocating some of a client’s Australian share exposure (and international share for that matter) to small companies.

This ETF will comprise of shares in the S&P/ASX300 Index but excluding those in the S&P/ASX 100 index.  More information regarding the index can be found at Standard & Poors.

The theory behind the use of small companies is that they are riskier prospects (as compared to larger companies) and thus for investors to invest in them they require a high expected return.  Thus there should be a risk premium from investing in this style of companies over time.

Smaller companies also have a greater probability of struggling and can easily lose everything along the way so if you are going to invest in small companies a well diversified exposure would seem to make good sense.

The SPDR S&P/ASX Small ordinaries Fund seems to tick both boxes, focussed on small companies and well diversified through an index approach.

The following table sets out returns to the end of March 2011 for the Small Ordinaries Index, ASX200 Index and our preferred Australian Small Companies investment – Dimensional’s Australian Small Company Trust.

 

3 mth

6 mth

1 Yr

3 Yr

5 Yr

7 Yr

10 Yr

S&P/ASX Small ordinaries Index

-1.19%

9.87%

13.49%

-0.91%

2.80%

9.60%

9.94%

S&P/ASX 200 Index

3.23%

7.75%

3.44%

1.09%

3.18%

9.73%

8.85%

Dimensional Australian Small Company Trust

1.24%

13.06%

16.77%

5.47%

8.06%

12.78%

12.79%


Unfortunately I am not sure that using the S&P/ASX Small Ordinaries index as the benchmark digs deep enough into small company territory to provide a significantly different outcome to investing in the standard ASX200 index.  1.09% over 10 years is ok but taken into account a 0.5% MER for using the ETF as opposed to a 0.29% MER for an ASX200 ETF and the advantage is still there but not substantial.

On the other hand our preferred Australian small company investment has provided a strong premium (except for the last 3 months) over both indices.  Please note that the Dimensional returns are after Dimensional fees but there would be extra administration service and possibly adviser fees to hold the fund.

Why such a difference?

The key difference is that Dimensional looks at companies past the top 300 (by market capitalisation) companies listed on the ASX.  As at the 31st of December there were 437 securities.  Dimensional will look at companies with a $50 million market capitalisation or greater.  This sees the able to invest in companies much smaller than the 300th sized company on the index.  As a point of interest the smallest company currently held in the SPDR/ ASX Small Ordinaries ETF is Berkeley Resources with a market cap of $135.6 million (not including options).

Will small companies always out-perform large companies?

The 3 month returns clearly show that the premium will not always be there from investing in smaller companies.  If it was there would be no extra risk and if there is no extra risk you shouldn’t expect to achieve better returns than large companies.

Concluding Comments

We definitely believe it is in an investor’s interests to invest in Australian small companies as part of a well diversified long term portfolio.  The SPDR S&P/ASX Small Ordinaries Fund is one way to gain that exposure but not this firm’s chosen approach.

Regards,

Scott

Posted by: AT 07:42 am   |  Permalink   |  Email
 
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