Global Small Cap Stocks: Benefits & risks

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  • 08 mins 53 secs

Trevor Gurwich, Vice President and Senior Portfolio Manager for American Century, discusses the benefits and risks that investors should know when it comes to global small cap stocks, a product that American Century have delivered almost 14% returns on average within 17 years.

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PRESENTER: Hello, I’m here in studio with Trevor Gurwich. He’s the Vice President and Senior Portfolio Manager for American Century, and has been with the company since 1998. Today, we’re discussing the benefits and risk investors should be apprised of when it comes to global small cap stocks. So Trevor you’re the right person to talk to.

TREVOR GURWICH: Yes, thanks for having me here today.

PRESENTER: Of course. So what can global small cap stocks add to a portfolio?

TREVOR GURWICH: Global small cap stocks first and foremost deliver portfolio diversification. Over the long term we believe that global small caps deliver superior long-term risk-adjusted returns. You get access to a far more dynamic group of companies – dynamic in the sense that they grow much faster than their large cap brethren. You’re also getting exposure to M&A and IPOs. Over 90% of the M&As and the IPOs that happen, happen in our global small cap universe. And finally you get access to really cutting edge technologies, new products, dynamic CEOs. And these are the things that we believe ultimately drive the revenues and earnings of the companies, which ultimately makes successful investments.

PRESENTER: What are the advantages to taking an active approach to global small caps?

TREVOR GURWICH: There are many inefficiencies in the global small cap universe. And active managers who have a well-defined process, philosophy, and a well-resourced team and an experienced team, can really exploit those inefficiencies. As an example, in our universe, we probably have four to six analysts covering each one of our names. Out of those four to six analysts there might only be two that are very current on that company. So that creates an informational advantage. When you look at the large cap universe, there’s far more analysts covering those companies; Facebook has north of 50 analysts. So where can you find that informational advantage? Limited available information on companies and products means that in-depth research can create large rewards.

We at American Century on the global small cap teams meet over 2,000 companies a year, where we’re trying to understand what the companies are doing, where their strategies are going, what their competitors are doing, what their suppliers are doing, so we can really glean that market information that gives us an edge to understand where we can set our earnings targets versus the consensus, and provide that earnings gap or that earnings beat. And it’s that earnings surprise that ultimately drives the earnings upgrade cycle. And our philosophy believes that earnings drive stock prices. The market’s inefficient at identifying the inflection points. And when you invest as you start seeing those inflection points, you benefit from both that earnings growth rate, plus that P/E re-rating opportunity.

PRESENTER: Why should investors consider a global approach to small cap investing compared to a regional approach?

TREVOR GURWICH: A global small cap approach delivers a much more compelling risk-adjusted return than just a regional small cap approach. A global small cap approach also tends to deliver better diversification benefits, and helps to offset that investor’s country’s home bias. The broad opportunity set allows active managers to invest where we see the most attractive opportunities, and we’re not constrained by geographies. So we’re looking for the best companies, the best growth stories no matter where they reside. A global perspective can also help bottom-up managers identify business models in their early stage of growth, and replicate the model wherever you are.

A great example might be a company by the name of Shopify, which we invested quite early in its earnings growth cycle in Canada, and when we bumped into a similar company in Korea called Café 24, we were ready to make that investment because we understood how the business model worked. But we also realised that this was a company that had grew much faster than Shopify, and traded at a much lower multiple, suggesting that it still had quite a bit of catch-up to do in terms of the stock price.

So we strongly believe that having a global approach makes us much better investors, because we have a universe of stocks to select from. We have best practices to compare to across the world, and we have a much better perspective. We understand what’s happening in the different regions, and how to allocate dynamically the capital to where we think the best opportunities are.

PRESENTER: What risk factors should investors keep in mind about global small cap stocks?

TREVOR GURWICH: Small cap companies can be riskier due to the size, due to the liquidity, due to the information that might be out there, and also because of the stock specific risk. There is also macro risk that’s out there, political risk that’s out there, governance risk that’s out there, and these can potentially add more risk to small cap investing. But we believe the higher level of stock specific risk really actively emphasises the importance of active management, because you really need an experienced and well-resourced team to go out and analyse individual companies, and individual macro and micro situations of where these companies are doing business. So a rigorous fundamental bottom-up approach to small cap investing allows you to identify the upside and the downside associated with stock specific risk.

We want to try and avoid the companies that have that regulatory risk, or that might have concern on the environment or the social or the governance of the company. And we really want to focus on the companies that are really starting to accelerate their revenues and their earnings.

PRESENTER: We’ve been seeing a lot of volatility in the past few months, what are your thoughts on the current market, and what opportunities do you see?

TREVOR GURWICH: So the markets today are focused on many of the macro concerns that are happening out there right now. Whether it’s the trade wars with the US and China, whether it’s the political uncertainty with Brexit in the UK, or some of the issues that we’re seeing on the political side as well in Italy, whether it’s the global slowdown or recession fears, as we move closer to the end of a protracted business cycle we can find plenty of concerns out there, and we always do find plenty of concerns. Now we’re also seeing the concern of increased inflation, potential increasing of interest rates, leading to much more quantitative tightening. Factor-wise we’ve seen somewhat of a rotation against growth companies.

So what we’ve seen pretty much is the fundamentals have taken a back seat right now, and the valuation derating moving has hijacked the pilot seat. We are on the other hand seeing companies that we still think are very strong growers emerging, and at significant discounts. So it’s almost a baby being thrown out with the bathwater. We know that small things sometimes deliver big results, and that’s really what we’re out here looking for are those companies that have been sold off, but still demonstrate really great growth opportunities. And it’s these types of opportunities that we uncover by doing stock selection one at a time, really working through our process, identifying inflection, believing that earnings drive those stock prices, and then doing the fundamental analysis to make sure that our thesis comes true.

PRESENTER: Thank you so much for this valuation information, it was great to have you here.

TREVOR GURWICH: Thank you for the invitation, and I look forward to seeing you again.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice.

References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

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