ASX Share Investors are using Small Caps to Reduce Risk

It is really important to reduce your ASX share portfolio’s risk and Small Caps play an important part in your ASX Share portfolio and can help you reduce that risk.

Read more about Investing in Small Caps. Why we picked these ASX Small Cap gems and their outstanding performance.

Why ASX Shares and other global market risks are rising

ASX Shares and global markets climbed in 2019 after a reversal led by the US Federal Reserve from tightening to loosening, leading to falling interest rates. The S&P/500 Index climbed 20% in 2019/early 2020. Consequently, there has been significant multiple or PE expansion, which means share valuations across the board are stretched.

The coronavirus is a real X factor in terms of its effect on global growth and this comes with the devastating bushfires in Australia and of course, there is the ongoing Trump-led US trade war against China.

How ASX small caps can reduce your ASX Share portfolio’s risk

Small Caps are not in the major share indexes (eg S&P 200), because they are simply too small. When commentators talk about the Share market they really mean the ASX Shares in the major indexes. Because Small Caps are not in these indexes, they often have low market correlation, which means they don’t move in line with the market and so they can reduce your overall share market risk.

When you buy the CBAs and BHPs of this world, you are buying a significant part of the ASX share market. When you buy the Small Cap Clover Corp (ASX Share: CLV), you are buying an ASX stock that has some market risk, but it has greater risk relating to the growing market for Omega3 rich baby powder.

When you are looking to make money investing in ASX Shares, it is always important to think about your overall share portfolio risk. I can’t emphasise this enough.

3 quality small caps to diversify your ASX Share portfolio

Here are 3 small caps ‘Under the Radar’ that can help you manage share market risk. The factors that I’m looking for here are what Under the Radar defines as “Quality”. You can read about these criteria on our website in, but they include balance sheet strength, cash flow, sales growth, management, industry competition, barriers to entry, and customer base. Moreover, these are the sort of ASX shares you want to buy more of if they fall in price.

It’s worth remembering that to achieve diversification you will need more ASX stocks. We advocate ASX Share investors buy between seven to 10 stocks to get the benefits of reducing stock-specific risk. Again, we expand upon this on our website.

ASX Small Cap: Pacific Current (ASX Shares: PAC)

This ASX small cap is the owner of minority stakes in boutique fund managers.

The small cap is now less exposed to financial markets and equity markets than it has been historically, with only 4 of the 10 main investee funds directly dependent on equity market returns. Management estimates 75% of FY21 revenues will come from investment managers not directly linked to public equity markets. Instead of being a double down on equity markets, a holding in ASX Shares: PAC can now serve as an investment hedge against public market equities.

ASX Small Cap: Austal (ASX Shares: ASB)

This ASX Small Cap is a global designer and builder of ships.

Small Cap Austal’s main shipyards are in WA and in the US where it designs and manufactures twin hulled aluminium ships and ferries. The Small Cap currently builds two vessel types for the US Navy: Expeditionary Fast Transports and Littoral Combat Ships. It is more than halfway through multiple ship orders for both types.

If you do not own shares in Austal, we would recommend that you give some consideration to an ASX stock valued at just over US$1bn but has a strong balance sheet, global Tier 1 customers, a progressive dividend policy, and a global outlook.

ASX Small Cap: Evolution Mining (ASX Shares: EVN)

This Small Cap company has diversified gold mining operations in Australia.

Small Cap Evolution operates six domestic gold mines and is the country's second-largest producer of the yellow metal. Small Cap Evolution has the second lowest costs of the top ten gold producers globally.

Evolution has been one of Under the Radar’s best ASX Shares in terms of performance, having originally purchased under $1 some five years ago. The shares in this ASX stock are now $3.72 and the Small Cap has been paying consistent dividends, but a determination to purchase on price weakness has paid off handsomely too. Significantly, the ASX share price is down about a third from its $5.50 high in mid-2019.

This ASX stock gets a guernsey not only because of its long and enviable track record but because gold is one of the world’s great hedges. Gold has weathered the storm for a millennia and we do not see this changing.

5 highest performing Oil Stocks on the ASX

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