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February was a wait-and-see month for the micro cap companies. The month began with an index decline (OMX Small Cap Index) of minus three percent (-3%), but the fund's structure ensured robust resistance to the downturn. Index continued horizontally under low volatility and ended at minus three percent (-3%). The fund exhibited smoother fluctuations than the index and more controlled risk. This is mainly due to the fact that the fund's positions are still relatively equally weighted, that the trend-following low-volatility strategy worked well and the fund's broad focus on all sectors. The fund lost half a percent (0.5%), which was two and a half percent (2.5%) better than the fund's reference index (OMX Small Cap Index).
The biggest positive contributors during the period were Hexatronic, Softronic, Karnov Group, Tobii Dynavox and Cellavision. These six stocks, along with several other companies, received capital allocation in early February due to their long-term trend. Several of these companies have clear scalable business models with the potential for continued strong growth.
The fund equalizes all positions every six months, the next equalization takes place at the turn of April and May. Equal weighting a broad portfolio with stocks has historically been shown to deliver a higher risk-adjusted return than a broad value-weighted portfolio. The image below shows the S&P 500 (red) compared to a quarterly equal-weighted S&P 500 ETF (green).
Return on S&P 500 and Xtracker S&P 500 Equal Weight (quarterly) over the period 03/01/2021 to 03/02/2024. Source: Infront
The fund has a trend strategy which involves favoring companies with low volatility and a clear trend between the balances to an equal weight. For example, Softronic continues to stand out with an impressive trend and volatility of 33.36%, compared to the average of 44.5% in well-known small cap indices.
Return for the company Softronic AB during the period 2022-01-30 to 2024-03-01. Source: Infront
The continued low level of long-term interest rates compared to short-term interest rates signals a market expectation of interest rate cuts, something that the central banks have also begun to signal cautiously. The next forecast will be published on March 27. When the interest rate cuts happen, many small companies are expected to recover strongly. With today's high financing costs and yield requirements, many small companies are undervalued.
Now is a good time to invest in small caps, which have historically outperformed large caps over time, despite lagging in recent years. This gap is now expected to begin to narrow. Statistically speaking, small companies always recover better than large companies after a so-called "bear market". This pattern was confirmed during market development in Q3 2023 and is expected to continue in 2024 although both January and February were weak months for the smallest small caps.
Did you know that?
The Small Cap Index has lower volatility than the Large Cap Index.
#The small company effect
Small companies have long-term yielded higher returns than large companies, Rolf Banz published the first evidence in 1981 and the phenomenon still applies today, even if large companies in certain periods have given higher returns. The most recent was the period 2021 – 2023, but since October 2023 we see that small companies have performed significantly higher returns compared to large companies.
Read more: Rolf Banz (1981) examines the empirical relationship between returns and the total market value of NYSE stocks between 1936 and 1975. He finds that smaller firms (small capitalization firms) have higher risk-adjusted returns than larger firms on average.