Market evolution can favor small-cap companies that have the ability to evolve quickly, according to Malte Heininger, European equity fund manager at Paris-founded asset manager Carmignac Risk Managers.
‘With the structural shift away from the old economy towardthe new economy, many industry champions whose model has become outdated are feeling the cold wind of disruption,’ he tells IR Magazine as he views small-cap trends in 2018.
‘A number of European smaller companies, however, naturally adjust faster and more flexibly to a changing environment and may even play a disruptive role themselves. The trick is to find the truly innovative, visionary companies that can proactively adapt so as to benefit from the changes unfolding. We believe this disruption theme will be one of the main drivers of return dispersion not only for 2018 but also for the coming years.’
It is no surprise, therefore, to see that the largest holdings in the Carmignac Euro-Entrepreneurs fund have a theme of technological disruption and innovation in common. Other characteristics they share include a market-leading product, a huge addressable, underpenetrated market, and a management team strong enough to take advantage of opportunities.
Although Carmignac – which had €56 bn ($69 bn) in assets under management as of December 31, 2017 – is a pure bottom-up stock-picker, Heininger says of the current thinking: ‘The search for asymmetric risk-reward and long-term winners currently leads us to make technology and biotechnology stocks a larger component of our core holdings, while otherwise maintaining a diversified portfolio in terms of sector exposure.’
Looking at the wider, changing, macro perspective, he observes: ‘With the acceleration of eurozone growth and the strong macroeconomic indicator readings in the region since last year, Europe has without a doubt come a long way since the euro crisis and fears of a complete dislocation. But the support to risky assets provided by central banks’ asset purchases is receding.’
Meanwhile, interest rates that were maintained at historically low levels by ultra-accommodative monetary policies are now on the rise. This has implications for the investment outlook – and ultimately a beneficial one for small caps.
‘With inflation creeping up, there are lots of reasons for wanting to pull out of government bonds,’ Heininger says. ‘Thus, we will get rising interest expense and pressure on margins. At that point, all it takes is a shock to growth to throw the business cycle into reverse.
‘Beyond their sensitivity to the economic backdrop, we believe the outperformance of small caps has structural causes. Their higher presence in the technology space and better ability to adapt to a fast-changing environment will offer stock-pickers compelling investment opportunities in a low-growth environment.’
When it comes to coverage, Heininger says: ‘We believe small caps are structurally less covered than large caps by analysts. This leads to less efficiency in the small-caps market and more investment opportunities.’
Here, Heininger notes real prospects. ‘We still find many opportunities in European small caps, and we expect that to continue. Regulatory change, through Mifid II, is likely to reduce further analyst coverage of smaller companies in coming years, so stock prices are less likely to properly reflect the underlying business prospects. This increases the opportunity for an active manager who has done his or her analysis to generate great returns.’
