It gets progressively harder to generate strong returns the further up the market capitalisation ladder you go. It's much easier to find strong returns at the smaller end of the market – particularly with small caps.
Some of the strongest-performing listed investment companies (LICs) are the ones that focused on the small end of town.
Here are two of the best LICs on the ASX:
WAM Microcap Limited (ASX: WMI)
WAM Microcap is one of the newest LICs launched by Wilson Asset Management. It aims for shares that have market capitalisations of less than $300 million at the time of acquisition.
Even at the small end of market WAM Microcap follows the same strategy as the other WAM LICs, it looks for undervalued growth companies and sells them when they reach the calculated valuation.
Some of its current top holdings include travel agent business Helloworld Travel Ltd (ASX: HLO) and healthcare business Integral Diagnostics Ltd (ASX: IDX).
Since inception in June 2017 the WAM Microcap portfolio has returned 24.1% before fees and expenses. It has just started paying a dividend and currently has a grossed-up dividend yield of 2.08%.
Naos Emerging Opportunities Company Ltd (ASX: NCC)
This LIC is the oldest of the current three LICs in Naos' stable. It usually invests in shares that have market capitalisations below $250 million.
It has a much more concentrated portfolio than most other managers, with a target of up to 15 positions. Strong convictions can mean strong returns if the right shares are chosen, but the opposite is true too.
Over the past five years its portfolio has returned an average 17.09% per annum before fees. One of its larger holdings include telecommunications company MNF Group Ltd (ASX: MNF).
It has been paying a growing dividend since 2013, it currently has a grossed-up dividend yield of 8.03%.
Foolish takeaway
Both LICs have generated strong returns since inception. Small caps are the most volatile and will continue to be, but that is the price of admission into the small cap arena. I think both will make good long-term buys at today's prices, but investors must accept that there could be a lot of steep declines over the years.
