Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 202

Corporate activity helps build a small cap portfolio

A common theme of investing in small cap stocks is limited liquidity, or in other words, difficulty acquiring or selling stock. This can naturally present a challenge for those on the outside looking in (and even those on the inside looking out). Investors can be left scratching their heads as to how an equity fund manager has built a significant stake in a particular stock given its limited trading volume.

This article outlines the corporate opportunities presented to fund managers and some key points for retail investors to position their portfolios towards higher quality small-cap stocks and management teams.

 

Rights issues

Rights issues allow companies to raise funds without penalising existing shareholders. Raisings are typically done at a decent discount where existing shareholders are invited to purchase additional shares in the company. For small caps, rights issues are usually non-renounceable, that is not tradeable, which means liquidity might not improve as the rights are tied only to existing shareholders. However, any underwriting of a rights issue shortfall provides a way for new shareholders to access shares which is effectively a placement of rights which are not taken up by existing shareholders.

Key point: watch for management and substantial shareholder involvement. If they are not prepared to take up their rights in full, then consider, why should you? Is the offer accelerated or not? If not it can have a drag on the share price.

 

Placements

Placements are the bread and butter of growth capital in small caps, often providing the most effective entry point for a fund manager to gain meaningful positions. Placements may be done in conjunction with a share purchase plan (SPP) which provides all existing shareholders the ability to subscribe for up to $15,000 worth of stock under the same terms as those participating in the placement. We like it when companies offer an SPP as it shows they are treating all shareholders equally.

Key point: for a retail shareholder when deciding whether to participate in an SPP, consider these two red flags; firstly, is the placement only for working capital purposes? Secondly, is the placement occurring at a price lower than a previous placement?

 

Private placements

A private placement is when a company conducts a share transfer to one particular shareholder. Typically, this will occur either to a strategic investor or to a fund manager who is unable to buy the desired share parcel on the market. Private placements are encouraging for investors and they shows that someone is willing to be the only party providing growth capital and are therefore likely to be a long-term investor.

Key point: is the placement a transfer of existing shares from a large shareholder or new equity raised? We prefer seeing new equity private placements as it shows key shareholders are not cashing out and it provides the company with growth capital.

 

Sell-downs

As a rule of thumb, if directors or management are selling, external investors should not want to buy. There are however exceptions where it can prove to be a highly effective way of improving liquidity, attracting institutional investors and improving the business profile within the market.

A sell-down should be judged on a case by case basis, and questions to ask include:

 

 

  • Who is selling down, why and how much?

 

  • What is the cash balance of the company?

 

  • Is this the best way to improve liquidity?

 

  • Are they likely to require a capital raising short term?

 

We like to see a strong management track record or share price returns and organic growth before we consider participating in a sell down.

Key point: be sceptical where you see a manager sell-down to exit their full position, as skin in the game is paramount for quality small caps.

 

IPOs

Investors can be right to ignore a small cap IPO, as the business can be ‘dressed up’ for sale and a prospectus can only tell you so much. You are unlikely to get a good read on how successful management has been on actuals vs forecasts in the past, and this can create a high level of downside risk.

Unlike a private placement or sell-down, IPOs tend to be more widely spread to participating investors. This means fewer ‘long-term hands’ and more ‘short-term hands’ will receive stock. Furthermore, a lot of the time you are either paying down debt or funding an individual cashing out. In any good quality small cap, you don’t particularly want to be funding either of those.

Key point: take a long-term view. Would you be happy to own shares in this business for three years or are you just banking on a short-term trade? If the latter then you’re probably not the only one and the optimism might not translate to reality.

 

Advice for retail investors

You can learn a lot from the actions of a company’s board, management, and key shareholders. How they conduct their corporate activity can give you confidence or otherwise in their long-term thinking. A healthy amount of scepticism can prove a valuable commodity when picking stocks.

 

Robert Miller is a Portfolio Manager at NAOS Asset Management. This article is general information, it is not intended as financial advice and does not consider the circumstances or investment needs of any individual.

  •   18 May 2017
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

Is now the time to invest in small caps?

Small caps are compelling but not for the reasons you might think...

Hold fire on your fund manager over short-term declines

banner

Most viewed in recent weeks

Australian stocks will crush housing over the next decade, 2025 edition

Two years ago, I wrote an article suggesting that the odds favoured ASX shares easily outperforming residential property over the next decade. Here’s an update on where things stand today.

Australia's retirement system works brilliantly for some - but not all

The superannuation system has succeeded brilliantly at what it was designed to do: accumulate wealth during working lives. The next challenge is meeting members’ diverse needs in retirement. 

Get set for a bumpy 2026

At this time last year, I forecast that 2025 would likely be a positive year given strong economic prospects and disinflation. The outlook for this year is less clear cut and here is what investors should do.

Meg on SMSFs: First glimpse of revised Division 296 tax

Treasury has released draft legislation for a new version of the controversial $3 million super tax. It's a significant improvement on the original proposal but there are some stings in the tail.

Building a lazy ETF portfolio in 2026

What are the best ways to build a simple portfolio from scratch? I’ve addressed this issue before but think it’s worth revisiting given markets and the world have since changed, throwing up new challenges and things to consider.

The 3 biggest residential property myths

I am a professional real estate investor who hears a lot of opinions rather than facts from so-called experts on the topic of property. Here are the largest myths when it comes to Australia’s biggest asset class.

Latest Updates

Investment strategies

Building a lazy ETF portfolio in 2026

What are the best ways to build a simple portfolio from scratch? I’ve addressed this issue before but think it’s worth revisiting given markets and the world have since changed, throwing up new challenges and things to consider.

Investment strategies

21 reasons we’re nearing the end of a secular bull market

Nearly all the indicators an investor would look for suggest that this secular bull market is approaching its end. My models forecast that the US is set for 0% annual returns over the next decade.

Property

13 million spare bedrooms: Rethinking Australia’s housing shortfall

We don’t have a housing shortage; we have housing misallocation. This explores why so many bedrooms go unused, what’s been tried before, and five things to unlock housing capacity – no new building required.

Investment strategies

Market entry – dip your toe or jump in all at once?

Lump sum investing usually wins, but it can hurt if markets fall. Using 50 years of Australian data, we reveal when staging your entry protects you, and when it drags on returns. 

Investment strategies

The US$21 trillion question: is AI an opportunity or excess?

It has been years since the US stock market has been so focused on a single driving theme, and AI is unquestionably that theme. This explores what it means for US and global markets in 2026.

Economy

US energy strategy holds lessons for Australia

The US has elevated energy to a national security priority, tying cheap, reliable power to economic strength, AI leadership, and sovereignty. This analyses the new framework and its implications for Australia.

Strategy

Venezuela’s democratic roots are deeper than Trump knows

Most people know Maduro was a dictator and Venezuela has oil. Few grasp the depth of suffering or the country’s democratic history - essential context as the US ousts Maduro and charts Venezuela’s future. 

Sponsors

Alliances

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.