US small-cap managers are “cheating” by investing in companies that would be described as mid- or large-caps in any other part of the world, according to Richard de Lisle, manager of the VT De Lisle America fund.
The fund's holdings have an average market cap of $402m, which sets it apart from the IA North American Smaller Companies sector – de Lisle has carried out research showing that only two of its funds have an average market cap of less than $2bn, and these have hundreds of holdings.
When asked why this is the case, the manager replied: “Because they cheat. Because if you’re running money in America, you're running billions of dollars.
“Therefore, you have to redefine what a small company is, otherwise you own too much of them.
“The Americans define a small company as anything less than $2bn, because otherwise it becomes unmanageable.”
De Lisle said this is important as investing in true smaller companies allows him to benefit from demographic changes taking place within the US.
Demographics are usually cited as a headwind for developed markets, with many analysts claiming that the populations of western countries are destined to follow Japan’s lead in ageing and declining.
However, de Lisle noted that between 2000 and 2010, the US exhibited its fastest population growth since independence in 1776, thanks to net immigration. And more important for the manager is migration within its borders.
“Even if you were to postulate that the US has a relatively standard population, with fertility rates declining, you can still make the demographic argument within the country because it still has great movement,” he said.
“I'm not suggesting we go buy in Detroit or so on, but there are plenty of dynamic areas. I'm always appalled when I look at places in Montana or Dakota that I visited about 40 years ago when they were just a crossroads with 10,000 people. Today they have 120,000.
“The growth is absolutely ridiculous and we Europeans can't really appreciate that: we have a place called Milton Keynes.”
One of the ways de Lisle is playing this theme is through community banks, which are defined as those with a market cap of less than $400m, typically with three to 12 branches.
The manager described community banks as “the quintessential value sector” in the American market as they are cheap and tend to outperform. However, he said they are too small to attract coverage from Wall Street analysts, while US-focused fund managers based in the UK don’t understand them.
“They cannot imagine them, because we don't have any equivalents,” he continued. “It would be like having a bank for the New Forest or something like that. It is a bank that just exists in your town and the next, seldom outside its county.
“But they have deep relationships with their customers, they lend for longer, their relationships and net interest margins are stickier and they're the only part of the US banking market that made increasing profits in 2020.
“This is the main way in which we play demographic change. If you buy in a town or a county people are moving to, Bob's your uncle, basically.”
The reason these banks did so well in 2020 was a low level of defaults. One of the measures the US brought in in response to the coronavirus-induced recession was the Paycheck Protection Program, which allowed small businesses to apply for low-interest private loans to pay salaries and other costs.
De Lisle said these were mainly administered by community banks as “the bigger banks didn't want to dirty their hands with such small beer”. There were also worries about the impact on these banks when defaults started to increase. However, the manager said this represented a misunderstanding of community banks’ key advantage.
“Going back a year or so, the initial response was the whole thing, including the housing market, would be a disaster,” he continued.
“Of course, the opposite happened. I was recently looking at the statistics on the Canadian housing market where all the experts were predicting it would be down 18 per cent and the end result was it was up 13 per cent.
“The difference between outcome and prediction was radical.”
He added: “Basically, Americans didn't default. There was all this analysis of how much the community banks were lending to the vulnerable industries, but it comes down to the fact that they were lending at a low loan to value, typically 40 to 50 per cent.
“To be simplistic, it’s really about the know-your-customer rule: they know their customers.”
Data from FE Analytics shows VT De Lisle America has made 434.75 per cent since launch in August 2010, compared with 405.26 per cent from the S&P 500 and 338.07 per cent from its IA North America sector. The IA North American Smaller Companies sector made 376.23 per cent.
Performance of fund vs sectors and index since launch
Source: FE Analytics
The £68.7m fund has ongoing charges of 1.1 per cent.