SVP and Portfolio Manager explains why an approach geared toward well-selected smaller names can help institutions now
US-listed mega-cap companies have been the dominant force in equity markets for at least the past 18 months. The fortunes of these companies have increasingly made or broken the fortune of the S&P 500. Their concentration has grown and they have bucked repeated forecasts of their demise. That may be changing now, however, as equity markets pull back amid fears that the AI-trend was overhyped and the US economy may be headed towards a recession. In that environment, one firm is highlighting what global small-caps might be able to offer investors.
That firm is Foyston, Gordon & Payne Inc. (FGP) . Andrew Aucoin, SVP & portfolio manager, global equities at FGP, explained exactly what they mean by global small-caps. He highlighted the tailwinds and risks in this space, and why it dovetails with an active management strategy. He offered some insight, too, into how institutions may be able to access small-cap names, despite the relative breadth of this investable universe.
“The universe of companies out there is pretty vast, but the set of companies that actually have the characteristics we want is a much smaller subset of that group,” Aucoin says. “We’re looking for resilient businesses that have the ability to generate high returns. We’ve been doing this for a while and that knowledge base of businesses just compounds over time.”
Aucoin and FGP define a global small-cap company as anywhere under the threshold of $10-$15 billion (USD) in market capitalization. They take a globally agnostic approach, preferring to focus on the business first before looking through the lens of geography. That said, Aucoin notes that their universe tends to skew towards developed markets and significantly to the US. Even if they start by looking at a US-listed business, however, they will compare it with similar names listed on different global exchanges to determine the company with the best potential.
Small-cap names are compelling now, Aucoin says, for the same reason that investors chased after mega-cap names for so long. The discount between small-caps and mega-caps is now one of the widest we’ve seen in over a decade. That more attractive valuation makes the entry point more compelling.
Add to that, the mega-cap names are beginning to struggle under their own weight. The law of large numbers means that to justify their high valuations, these companies need to beat tougher and tougher comps every quarter. It becomes harder for these companies to sustain their growth expectations, while certain smaller-cap names may be better set up to beat expectations. Incremental dollar revenue increases, Aucoin notes, has a bigger impact on a smaller-cap name than it does on a behemoth.
One potential risk in small-caps is the fear that in a major recession or downturn, these firms lack the competitive moats or liquidity to sustain themselves through a weak period. While Aucoin acknowledges that liquidity can be a risk in small-cap names, the underlying resilience of individual businesses selected through active management is expected to manage those risks. Moreover, he notes that his firm’s approach is less about timing the market and more about the ability of these businesses to grow and compound over the long-term.
For Aucoin, active management fits neatly into a global small-cap strategy. The inefficiencies found at the lower end of the market can be turned into an advantage with the right strategy. Perhaps more importantly, the fact that investor focus is increasingly honing in on large-cap and mega-cap names means an active manager may be able to better identify opportunities in small-caps that others don’t see.
As asset managers consider rotations in their equity strategies and look at the significant concentration now present in mega-cap names, Aucoin believes that there may be a case for adding global-small cap exposure on a simple risk-return calculus.
“It’s about balancing those risk and return levels, and it’s an asset class where you’d want to consider these macro trends, but from my experience most investors at any level have a mixed track record for predicting the future,” Aucoin says. “That’s why we think about it from a longer-term perspective, having a balanced portfolio and thinking about where valuations sit relative to historical norms, and that sort of plays into whether you slightly over allocate or under allocate to a given asset class.”
