The reasons to invest in smaller companies are generally well understood, but abrdn Global Smaller Companies manager Kirsty Desson says the pros of the asset class are often under-appreciated.
Since its launch in January 2012, the £1bn fund has delivered “some impressive returns”, according to analysts at Hargreaves Lansdown, who include it in their Wealth Shortlist. However, performance has fallen short in 2022, when value outperformed quality, as shown in the chart below.
Here, Desson discusses why you should have at least 15% of your portfolio in global small-caps and reveals why she currently has no exposure to mainland China.
Performance of fund since December 2021 against sector and index
Source: FE Analytics
Can you summarise your process?
We are bottom-up, long-term stock pickers, with a portfolio of between 40 to 60 high-conviction names. The starting point of the process is our screening tool, which we use to whittle down the universe and concentrate our fundamental analysis on stocks with positive quality, growth and momentum characteristics. From there, we peer-review ideas, have a core ESG integration and overlay risk factors to then help shape the portfolio.
How do you identify momentum?
We look at positive earnings change. One lesson that we've learned over the past 11 years of running this fund is that sometimes it’s easy to underestimate the steady compounders, which can continue to deliver year-on-year for many years and often turn out to be the best investments over the long term.
How long do you usually hold a stock for?
The turnover in the portfolio is about 30%. On average, we hold a stock for about three years, but there are stocks in the fund that have been there for about eight years and are likely staying. They might have re-rated from the small-cap benchmark into the mid-cap index, but the investment thesis is still intact, so we'll continue to hold them. We are allowed to hold up to 30% off benchmark.
Why should investors pick your fund?
Our universe is constructed so that it takes the bottom 15% by market cap of all the listed companies. If you don't have 15% of your overall asset allocation in small-caps, then technically you’re underweight. And even though it's only 15% of listed equity, it’s actually two-thirds of the world’s companies, so it’s a huge opportunity set with over 6000 stocks.
An argument in favour of global smaller companies that is sometimes under-appreciated is the way in which sector exposure comes through, adding quite a significant amount of diversification. Also, by investing globally, investors open up to far greater returns than may be possible during short-term blips in any regional market.
Finally, it looks as though volatility has come back down from where it was this time last year and onto its long-run trend.
When is the fund likely to underperform?
Over the 25-year history of our process, what you see is that we tend to underperform in value-driven markets, which was the case in 2022, but we sharply outperform again coming out of that, consistent with what we’ve been seeing for the asset class in general. We think we’re at that point now where quality-growth momentum small-cap stocks will outperform.
Is there a market that looks particularly interesting at the moment?
We're still seeing strength in defensive growth companies with high recurring revenue, clear and predictable earnings streams and high single-digit or low double-digit growth names. So for instance Australian insurance play Steadfast.
At the same time, we've started to see a pickup in some of the European highly cyclical industrial names, but it will take a couple more quarters perhaps to get a clearer direction on where markets are heading. We still don't know yet how interest rate hikes will play out in the real economy or what's going to happen with inflation, and we're still waiting to see whether Chinese recovery really does come through strongly or not.
How come you have no exposure to mainland China?
There was a lot of hype and excitement at the start of the year and we did a lot of work around trying to find Chinese names, but from a bottom-up perspective we didn't find any names that quite met our criteria. But we’ll continue to work on that opportunity.
What was your best call of the past 12 months?
In terms of pure attribution, the best-performing stock in the fund over the last year has been a US semiconductor stock called Lattice.
Performance of stock over 1yr
Source: Google Finance
It is a niche player in Field Programmable Gate Arrays, a technology that allows products to communicate with the cloud.
Lattice specialises in low-power, low-latency products that can be highly customised, a real standout in the sector. It is also exposed to areas that are performing well such as artificial intelligence, 5G and the internet of things, as well as industrials and airlines.
It’s up 60% over the past year and continues to be one of our top 10 holdings.
And the worst?
That would be US standby generators manufacturer Generac.
Performance of stock over 1yr
Source: Google Finance
Climate issues and underinvestment in the US power infrastructure have led to more power outages in the US and to people requiring backup power. Generac is the leader in providing backup generators.
The stock started to de-rate at the beginning of 2022 because it was on a very high valuation and then we started to see some cracks in the fundamental underlying story. There was a question mark over the credibility of management and due diligence, after the company was left with a big write-off following a major client going bankrupt. We exited the name – share price performance was down 57% over the past year.
What do you do outside of fund management?
Life is busy, so spending time with family and friends is very precious. We do a lot of sport together, play golf, tennis, ski. We also have a dog so we do lots of walking.