Disco, doors and lawsuit lenders: Our Elite Rated managers on their best stock bargains of 2023
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Stock markets generally have had a tough start to the year, with many company share prices tumbling due to worries over inflation, interest rates and conflict in Europe.
Smaller companies have felt the pain most and have underperformed their larger company peers in every developed market*, as shown in the table below.
|Market||Large cap performance YTD*||Small cap performance YTD*|
|Europe ex UK||-9.6%||-13.4%|
But that’s to be expected, according to FundCalibre’s Darius McDermott. “It’s what tends to happen when investors are worried,” he said.
“In normal market conditions – when markets go up or sideways – smaller companies usually do better, particularly over the long term. They have room to grow and are often easier to manage and control.
“But when investors are worried and move into less riskier assets, smaller companies are usually the part of their portfolio they sell first.”
In the short term, the outlook isn’t great for smaller companies, because if anything, uncertainty is increasing. There are even concerns that we could be heading into a recession. “But we may look back and see now as having been a good time to invest, as current valuations are a lot cheaper, and these funds and companies should do well over the long term,” said Darius.
“There are also fewer financial analysts that cover small caps, and thousands of companies to pick from, so it’s a fertile ground for a good active manager,” he continued. “UK smaller companies in particular are one of the few sectors where the average fund consistently beats its benchmark – and the good ones smash it.”
Of course, this area of the market could continue to get cheaper as the world works through its problems, so one way to invest early in smaller companies without risking a large sum of money, is to invest little and often through regular monthly savings.
Smaller companies can be an excellent long-term growth engine for a portfolio. They typically deliver some of the best long-term returns, but they do come with higher risk.
“If you are a moderate or balanced equity investor, you may still want an allocation of around 10%,” said Darius. “If you are more aggressive, you’ll want more. We find that some investors also tend to invest more in smaller companies for their children as they have a longer time frame.”
“If you are looking to invest in a smaller companies investment trust, like BMO Global Smaller Companies, you ideally want to buy it on a discount when sentiment is depressed,” said Darius. At the time of writing (9 June 2022), this Elite Rated Trust happens to be trading on a discount of 11% to its net asset value**, for example – much lower than its long-term average.
“That said, watch out for tiny illiquid trusts trading on a permanent discount,” continued Darius. “Above all though, avoid paying a big premium.
“For both funds and trusts, make sure they are well diversified, look for a manager with a good long-term track record and a decent sized or experienced in-house research team as small caps are not well covered by external analysts. Your team needs to do company meetings and have bodies on the ground.
“Smaller companies are higher risk though, so investors need to be prepared for periods of volatility.”
FundCalibre has 21 Elite Rated and Radar funds and trusts which invest in smaller companies. Here is a selection:
Using a powerful screening tool called ‘Matrix’, which co-manager Harry Nimmo helped create, the managers of this fund identify smaller companies from all around the globe – including emerging markets – that they believe to have the best growth prospects. The portfolio is concentrated in 50-60 names.
Launched in November 2018, this is a pure smaller companies fund run by two very experienced and highly regarded managers, Paul Marriage and John Warren. It focuses on smaller companies, avoiding micro-caps and mid cap stocks and meeting company management is integral to the investment process.
This fund is pan-European, also investing in the UK. The team’s universe of stocks is less well covered by the asset management industry giving the manager plenty of scope to find unloved and undervalued companies. Buying early or in a contrarian fashion with a long-term view allows him to compound his winners.
While stock selection is paramount on this fund, the overall shape of Artemis US Smaller Companies will reflect the manager’s view of the US economy. Investing mainly in US small caps, but also with a tilt to mid-caps, manager Cormac Weldon uses multiple sources of information to generate ideas and to validate and test candidate companies for investment.
This fund focuses on small and medium-sized companies across global emerging markets. The manager looks for quality companies that are exhibiting compound growth and that earn more than their cost of capital over the long-term. Alongside this, he will want talented management, who act responsibly towards clients, stakeholders and minority shareholders.
This trust aims to provide long-term capital growth by investing in smaller companies listed on the Japanese stock market. Shin Nippon means ‘new Japan’ and this trust focuses on emerging or disrupted sectors, where the manager sees innovative growth opportunities. The team are prepared to bide their time while these companies reach their full potential
*Source: T. Rowe Price Weekly Market Recap, 6 June 2022. Using the following indexes: S&P 500, Russell 2000, Euro STOXX 50, MSCI Europe ex UK Small Cap, FTSE 100, FTSE Small Capitalisation, TOPIX, TOPIX Small
**Source: The Association of Investment Companies, 9 June 2022, over 10 years