One of the main ways to deliver market-beating returns, or avoid bad returns, is to stay within your circle of competence. It can be a very dangerous game to try to invest in things that you don't understand.
How are you supposed to assess whether that business has a market-beating product? If a problem happens to the industry or business, will you know if that's a problem?
The small cap space of the market is a very interesting place. It's full of businesses that few investors and analysts look at. It actually makes sense to look at smaller businesses because it's much easier for a small business to double its profit than it is for a large business. Larger size affects performance.
I'm not an expert in most small caps, which is why only a few shares I own would be considered small. But that doesn't mean I have to avoid that area of the market entirely. I (and you) can invest in a fund manager with expertise in that area. Small cap managers are able to offer something very different to a typical fund manager.
That's why I own shares of WAM Microcap Limited (ASX: WMI) and I'd like to own more over time.
WAM Capital Limited (ASX: WAM) started off life investing in small businesses but now it has grown to such a large size that it can't invest in the smallest businesses any more without owning a significant amount of those businesses.
That's why WAM Microcap could be so good. It's going back to the 'roots' of the Wilson Asset Management philosophy of investing in small caps.
WAM Microcap invests in shares that have market capitalisations of less than $300 million at the time of acquisition. WAM Microcap itself is a much smaller company then WAM Capital.
Foolish takeaway
It's been a fantastic first year for WAM Microcap, with its portfolio up by 28.4% before fees since June last year. This has been achieved with a significant cash holding as well, with cash being 23.9% of the portfolio at the end of May 2018.
I wouldn't expect every year to be like that, but over the next ten years I think WAM Microcap could be a very good performer. Although the occasional year could be very volatile.
