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What UK investors need to know when investing in US small-caps

26 July 2017

Columbia Threadneedle manager Nicolas Janvier outlines the key differences between UK and US small-cap investing.

By Jonathan Jones,

Reporter, FE Trustnet

UK investors could be missing out on great returns from overseas smaller companies because of ‘home bias’, according to Columbia Threadneedle’s Nicolas Janvier

The manager of the Threadneedle American Smaller Companies fund said while UK investors tend to have a home bias when it comes to small-cap investing, US funds can offer an intriguing proposition that is completely different.

“UK investors have a home bias, but this is actually true in almost every country,” he explained. “If you look in the US, investors are disproportionately exposed to US-domiciled or -traded companies versus the rest of the world.”

The IA UK Smaller Companies sector has some £14.9bn in assets under management, as the below shows, some £11.78bn ahead of the next most bought smaller companies sector – IA European Smaller Companies.

Table of assets in regional smaller companies sectors

 

Source: FE Analytics

The UK sector has £12.7bn more in assets under management than the US smaller companies sector, which holds £2.3bn.

Yet there are a number of key difference between the sectors, Janvier highlighted, that investors might be overlooking and below he explains what investors need to take into account when looking at US smaller companies.

 

Differences to the UK

The first way in which the US small-cap sector is different to the UK is the sheer size of companies, with the Russell definition ranging between $5bn and $30bn for US mid-caps.

“We focus on the SMID [small and mid] cap: companies from $500m in market capitalisation to $10bn. That’s what we define as the small-to-mid cap space in the US,” Janvier said.

“But when a mid-cap manager talks about fishing in the mid-cap pond in the US they are really talking about $5bn up to $30bn.”


“By definition, if you think about this market cap range the reason we look at that cohort of companies is because these are companies that by the time you have reached $500m of market capitalisation you have a relative proven business model, you generally have a very experienced management team and you usually have a quite good balance sheet,” he added.

“For us one of the ways I like to differentiate that cohort of companies versus small caps in the rest of the world is that US smaller companies tend to be a little bit further on in their maturation.”

Indeed, he noted that a $5bn small-to-mid-cap company would place the equivalent firm at the bottom of the FTSE 100 in the UK.

The second area of difference is in terms of the domestic economy, with mid- and small-caps on average 80 per cent weighted to the US economy, according to the manager.

Indeed, smaller companies are more domestically-focused than their large-cap peers, which drive around 50 per cent of their revenue from the US and 50 per cent from overseas.

“By investing in the US you are getting exposure to effectively the largest and fastest growing large economy in the world today,” he said.

“Now over time those growth rates will be different around the world but the US continues to be the most vibrant capital market and the most vibrant economy in the world.

“And although as a UK investor you can build a portfolio and invest in companies who have exposure to the US, by owning US companies you effectively have much more exposure to the US domestic economy and policies.

“Keep in mind that the US economy is a $16trn economy with over 330 million people living in the country so it is obviously quite different in terms of scale compared to the UK both in terms of the economy and in terms of potential consumers.”

The final key difference is the vast diversity in the sector; with more than 2,500 companies to choose from, most major sectors are covered.

“When you look at the small-cap bucket in the US you have exposure to all of the different sectors in the economy and while some sectors are obviously larger than others you have decent exposure across the economy,” Janvier said.

“Whereas if you look at the UK or other countries around the world you tend to have concentrations around different sectors.”

 

Active vs passive

The other thing for investors to be aware of is the opportunities for active managers in the sector, according to the manager.

“When you think about efficiency there are two things that are required,” Janvier said.


“You need liquidity and naturally as you get into smaller companies there is less liquidity so by definition that means that the asset class is a little bit less efficient.”

His fund does not focus in the top 500 companies (S&P 500) or the bottom 500 firms, leaving it with a universe of 2,500 companies to select from.

“When you look in-between the S&P 500 and the small tail, it is 2,500 companies that, by definition. are less well followed, less liquid and therefore we think there is a lot of value-add to be had from active management,” he said.

While the average US smaller companies fund has underperformed the Russell 3000 ex S&P 500, Janvier’s £760m Threadneedle American Smaller Companies has outperformed the index over three and five years, as the below graph shows.

Performance of fund vs sector and index over 5yrs

 

Source: FE Analytics

It has been the best performer over the five years in the IA North American Smaller Companies sector, returning 154.47 per cent.

“The thing we really focus on in the fund is the consistency of returns. The reason we are able to achieve that is because we are really focused on building a balanced portfolio. What you are not going to find is a lot of big sector bets vis-a-vis the benchmark,” he said.

“We believe that we can source alpha across all the sectors in the market and over time that has allowed us to provide a more consistent, less volatile return than our peers.”

The fund has a clean ongoing charges figure (OCF) of 0.87 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.