Investors willing to delve into the small-cap space may be able to find the next generation of FAANG stocks – the fast-growing technology giants that have led markets higher in recent years – at more attractive entry points, according to Liontrust Asset Management’s Robin Geffen. 
Geffen (pictured), who manages the five FE fundinfo Crown-rated Liontrust Global Smaller Companies fund, noted that the so-called FAANGs – Facebook, Apple, Amazon, Netflix and Google-parent Alphabet – have become some of the most highly valued companies in the world.
“The company Cadabra was incorporated in July 1994 in Washington state,” he said. “This might mean very little, if anything, to you until I say that a few months later the name of the company was changed to Amazon.
“Twenty-six years later, the founder Jeff Bezos is now the world’s wealthiest person and Amazon’s shares are each worth more than $3,000.”
And the group of mega-cap tech companies to which it belongs has become an ever-increasing proportion of stock market as investors and passive funds have allocated more money to them.
Nevertheless, Geffen questioned whether investors could find more attractive opportunities to be found in the small-cap space where some of these companies originated.
The valuation gap between large- and small-cap stocks has been growing for some time, the manager explained, with global small-caps underperforming their larger peers more recently.
Over four years, the MSCI Small Cap index has risen by just 27.84 per cent compared with a 49.82 per cent gain for its large-cap counterpart.
Performance of indices over 4yrs
Source: FE Analytics
However, such short-term perspective runs against longer-term trend of outperformance, said Geffen.
“We believe the underperformance of the past three and a half years has presented buying opportunities among global smaller companies on valuation grounds,” he said.
“This opportunity is enhanced by the fact that global small caps have relatively few followers among brokers and therefore are often underappreciated.”
Geffen said that smaller companies often lead economic recoveries, seen most recently after the 2008 global financial crisis.
“And we have no reason to believe it will be different this time when the world finally moves beyond Covid-19,” he added.
“The unprecedented technological change we have been experiencing during the pandemic creates the chance for investors to find the future FAANGs.”
Geffen said there are several filters that the team behind the Liontrust Global Smaller Companies fund use to determine which companies could be the FAANGs of tomorrow.
"We want to invest with innovators and disruptors, not followers,” he explained. “Companies must have management that will successfully grow the businesses when they become mid and large caps, not just when running a small company.
“We look for companies with a discernible edge and those that are responsible with their cash.”
One of the favoured hunting grounds for theses companies is in the software space, Geffen said, where the products have allowed businesses to continue operating during the lockdown conditions demanded by the pandemic.
An example in the Liontrust Global Smaller Companies portfolios – and a long-term holding – is RingCentral, a US cloud-based communications services provider.
“The company has been thriving off a trend to shift processes to the cloud and avoid unnecessary equipment capex by allowing employees to use their own, more familiar, devices for work purposes,” said Geffen.
Another long-term holding in the portfolio is Twilio, which provides a communications API (application programming interface) for software developers.
“If you’ve received a text, call or email from a company through an app or webpage, it is likely that it used a Twilio plug-in solution,” said Geffen. “With the rising need for an online/virtual presence for all businesses, Twilio stands to benefit by providing the necessary tools that developers need to be able to provide this service.”
The manager added: “The potential reward of finding such companies when they are small is shown by the growth of Twilio.
“In December 2017, Twilio’s share price was $26.07 and [as of] 31 July 2020 it had grown over 10x to $277.42.”
He concluded: “We believe global small caps are also worth considering now because of their relatively cheap valuations, the fact that far fewer brokers follow them than mid- and large-caps and their potential for economic growth as we come out of this crisis.”
Performance of fund vs sector & benchmark over 5yrs
Source: FE Analytics
The £14.4m Liontrust Global Smaller Companies fund – formerly known as Neptune Global Smaller Companies – has made a total return of 87.95 per cent over the past five years, compared with a 73.59 per cent gain for its average IA Global peer and a 70.27 per cent return for the MSCI World SMID Cap benchmark. It has an ongoing charges figure (OCF) of 1.15 per cent.