The adage that bigger is better is often associated with America. But over the last few years, the global investment community seems to have embraced the concept when mapping out their portfolio tactics. As a consequence, commentators are voicing expectations of a redefinition of the shares of global mega caps as the qualitative differences between them and their smaller counterparts start to demand that they be treated as a separate asset class.
The big-is-beautiful trend of recent years shows no sign of abating. Small caps may have been resuscitated a little of late, but it is still their larger, more liquid brethren that capture the hearts and minds of most fund managers.
In fact, the cyclical rally which lifted the small-cap sector from the doldrums last year – particularly in continental Europe and the UK – has begun to fade. The small-cap star repeatedly wanes in the US, where they’ve trailed the Nasdaq composite since 1991 as fund managers in fear of an economic slowdown opt for larger high-tech stocks.
The FTSE 100, Euro 50 and S&P 100 all soared last year on the backs of the spiraling number of mergers and acquisitions – or the mere hint of possible behemoth creations – such as Vodafone and Mannesmann, Royal Bank of Scotland and Natwest.
However, the recent mouthwatering gains in the US, European and Japanese markets are not only tied to investors’ interest in takeover rumors but also to their obsession with potentially lucrative technology stocks. Fundamental economic forecasts and corporate earnings have been temporarily forgotten. Instead, momentum investing has taken hold, which indicates that investors are hoping to catch the crest of the next fashionable technology wave before the trend has passed.
Going with the flow
Of course, small company indexes are often associated with high-tech growth companies, but these actually only account for a relatively small proportion of the constituent companies. And although they are often the beneficiaries of any upsurge, they rarely lead the charge. This is particularly true of the rally toward the end of last year, which saw the Nasdaq market, laden with some of America’s brightest and biggest growth stocks – such as Microsoft, MCI Worldcom and Cisco Systems – hit daily highs.
‘It has definitely been a high-tech story of late,’ says Trevor Greetham, global strategist at Merrill Lynch. ‘Earlier last year, manufacturing and cyclical stocks benefited from a recovery in Asia and falling interest rates. This is because in good times you can make a lot of money from this type of company. However, in the last few months, there has been a switch back into blue-chip stocks due to fears that the US economy might be slowing. Investors prefer these companies because they are thought to be able to better weather the harsher economic conditions than the cheap recovery and cyclical stocks. Also, in this environment, people do not focus on how much money a company will make today but on its long-term potential. Technology companies, with their long lead times and heavy capital expenditure programs, are perfect examples.’
Narrow path
Matt Dennis, European strategist for ABN Amro, agrees with Greetham’s sentiments, adding that the major winners are in the IT hardware or telecoms sector. But this fixation with tech shares is not expected to last. They may remain a dominant theme, but global strategists believe investors in the eurozone, at least, will start looking toward utility, media and retail stocks, which are now just beginning to bite the restructuring bullet.
Moreover, there could be a broadening out in the tech sector itself to include more than just the hardware and telecoms sub-sectors. We could see investors increasingly turning their attention to ‘e-commerce as well as the content on the web, rather than just the internet site itself,’ says Michael Hughes, director of UK equities with Scudder Threadneedle.
Sectors apart, however, the heavy footsteps of investors flocking to large caps as safe havens in the run-up to the millennium are likely to go on being heard. The order for more of the same throughout 2000 seems already to have been heard far and wide. Moreover, smaller firms may suffer more than big companies in an economic downturn. Research from Deutsche Bank shows that the risk premium applied to companies sitting on a market cap of e1.5 bn or less is double that of stocks above this threshold.
Given this background, it is perhaps no wonder that the minute the euro hit the trading screens at the beginning of last year, fund managers wasted no time shifting to the mega cap asset class. Some 27 of the region’s heavyweight stocks appeared in all the major European indices; and they attracted about 42 percent of all eurozone market turnover, forming a eurocore class of companies. And this is still the case.
Exploitation time
‘Fund managers preferred the big blue chips because they knew these companies would be able to better exploit the opportunities thrown up by the euro in terms of production, distribution, logistics and pricing,’ explains Rajesh Shant, European strategist at Credit Suisse First Boston Asset Management. ‘Also, the larger European companies are adopting international accounting standards as a stepping stone for US Gaap. This in turn makes them more transparent and easier to compare than smaller companies.’ And therefore also more attractive to investors worldwide.
Not surprisingly, international investors also crowded into household brandnames and easier-to-trade European names when embarking upon their diversification strategies. As Nizam Ahmid, director of portfolio and index research for Deutsche Bank, puts it: ‘Fund managers as well as retail investors went for companies like Nokia and DaimlerChrysler because they knew what they did and the products they made.’
The bottom line, according to ABN Amro’s Dennis, is this: ‘Just as in the US, where no-one will fault you for holding General Electric, large caps are highly liquid stocks and continental European and UK institutional investors can move in and out of them without having a material impact on price. The same cannot be said of small caps, whose fate can fluctuate wildly with the ebb and flow of funds.’
This is what lies behind the current push to treat the truly mega-cap multinationals of the world as a separate asset class, distinct not just from small caps but also from stocks that by any ordinary measure would be regarded as large but which fail to make the grade of the General Electrics, Nokias and BP Amocos. Such companies can no longer usefully be treated as domestic stocks; they are genuinely global, to the extent that their fortunes are not tied to any national economy. That in turn helps them weather regional economic downturns, which contributes to a virtuous circle of desirability and liquidity, making them qualitatively different as investment prospects. That means in turn that they command premium valuations, thereby exacerbating further the relative difficulties of the small fry.
Growing up has never been harder to do.
