Making it big in small caps

Barry Henderson was the best-performing small-cap fund manager in Australia. He was managing $1.4 billion in the sector for Colonial First State between 1994 and 2003 and in one year alone generated a return of 99 per cent, and achieved an average return of close to 20 per cent during his time.

After leaving Colonial he set up shop with Greg Perry, who was previously the head of equities at Colonial, and it would be fair to say one of Australia's best ever fund managers. Perry was responsible for the "GDP plus" philosophy that has been used by many investors, which is to invest in stocks that aren't expensive but whose earnings are growing faster than the economy.

The two formed QED Capital, which invested in global markets and whose claim to fame was probably that it returned investors' money without loss as the financial crisis took off in early 2008. After suffering a health scare, Henderson decided to take his family on the equivalent of a two-year Leyland brothers' adventure around Australia and the US. Now that he's come back, he's managing money by himself, for himself.

In the past 12 months he has returned 34 per cent from his top 10 stocks in a 20-stock portfolio. There is one thing he wants to get off his chest: "The big advantage of investing for yourself is that your performance is not measured every day, or every month. You only make a loss when you sell, and you can afford to be a holder for the long-term when you invest your own money. It's easier than ever to manage money from your own desk at home."

But it's not just the ability not to sell that is a key advantage the individual has over the institutions that live and die on whether it can beat an arbitrary benchmark every three months.

A portfolio manager, who goes by the nom de guerre The Idle Speculator, has been living off his own money for more years than he can remember and, like Barry, he knows the importance of dividends: "Dividends make the difference between investment and speculation. You can't live on shares. You need cash. The fact that dividends come through with regularity means that you don't have to time your exit from a share to make your rent or mortgage, because you have an income stream on the horizon."

Over the past 20 years, The Idle Speculator has accrued returns of 19.5 per cent a year for his mother's British portfolio, of which about 7 per cent has been delivered by dividends including special, or one-offs.

He says that small listed companies, or small caps, can be a helpful part of a balanced portfolio for someone of any age because of the potential to make greater gains than you would make from the overall market. But you have to be wary. "Obviously there are big risks involved in small companies, which include liquidity risk, so you must ensure that your exposure isn't too great." What is life, anyway, without a little risk?

Richard Hemming edits the fortnightly newsletter Under the Radar Report: Small Caps.