Smaller companies have traditionally provided higher growth rates and investment returns over the long term. They benefit from higher exposure to pockets of the market which are contributing to higher levels of innovation, disruption, and R&D spending driving higher levels of growth, and they tend to provide investors with ‘pure play’ exposure to major secular growth trends. Furthermore, as small caps grow and transition to becoming future bigger companies with higher market capitalisations, the liquidity risk premium attached to them when they are small reduces over time, contributing to superior returns.
Opportunities:
- The European smaller company universe has higher exposure than large caps to more innovative and disruptive companies in sectors such as technology, healthcare equipment, engineering, clean tech, communication services, and online retail. It also has lower exposure to more traditional, old-economy areas of the market such as banking, insurance, oil & gas, telecoms, utilities and autos.
- This exposure to more growth-oriented areas of the market has helped to support smaller companies, and not only in 2020. We believe it will continue to drive higher earnings growth over the longer term.
- A selective approach is critical in smaller companies to identify the future bigger companies from a broad investment universe. The levels of analyst coverage are low and the asset class lacks maturity in Europe. This leads to inefficiencies which can give experienced investors attractive valuation entry points.
Investment strategy, philosophy and process:
The prime focus of the strategy is to invest in strongly-financed, well-managed, competitive, small- and mid-sized companies which demonstrate a strong ability to sustain attractive returns on capital and which the manager believes have good prospects to grow into bigger companies during the investment time horizon.
The manager will invest in 40 to 60 companies, ensuring that each holding is of material size within the portfolio but providing sufficient diversification benefits at this end of the market-capitalisation spectrum.
Our investment approach is focused on sustainable, quality, growth business models: strongly financed, well managed, competitively advantaged companies with high or improving returns that are exposed to strong secular growth drivers in their end markets. These long-term growth drivers include technological advancement, disruptive industry shifts, solutions for a better planet, healthy living, consolidation and regulation.
As part of our fundamental research process we actively engage with management teams including integrated environmental, social and governance (ESG) analysis and enhanced engagement for companies that are not covered by our research partner, MSCI ESG Research. That way we gain additional insights into how much progress is being made on ESG and sustainability.
Our detailed screening process leverages on our own watchlist of candidate companies as well as on extensive use of other systems, and seeks to identify specific features such as quality growth, undercovered gems, or high and productive R&D.
Investing in sustainably growing small and mid-sized companies requires regular engagement with the senior management teams of all candidate companies and holdings to assess their business fundamentals and progress on strategic planning. Our discussions with them include a broad assessment of competitive positioning, industry growth dynamics, operational structures, business model scalability, capital allocation priorities and balance sheet positioning, as well as the company’s approach to ESG and sustainability strategy.
We organise additional direct engagement with companies that are not rated by our ESG research partner – typically those that are lower down the market-cap spectrum, that issue smaller free floats, or that have been recently listed – or companies with weak or negative ESG rating trends. The aim of these discussions is to gain additional insight into the company’s approach to ESG matters and its overall sustainability strategy. Our ESG engagement framework features a range of discussion points that are systematically reviewed and monitored to assess where progress is being made and where more attention is required.
