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Small cap positioning for 2016

Patrick Kuhner, client portfolio manager at Rosenberg Equities Asia, discusses the impact of a US interest rate hike on small caps as well as specific consumer plays in the asset class.

“The rate hike has been telegraphed, and comments from the Fed say it will be slow paced,” Kuhner told FSA. 

“The expectation is that as interest rates rise, it will reflect a better environment from an earnings and growth standpoint.”

According to the firm’s historical research on interest rate hikes, small value stocks do well in this type of environment relative to large cap peers, he said.

Kuhner is a member of the investment team for the AXA Rosenberg Global Small Cap Alpha Fund A USD, which gets a five crown rating from FE Advisory.

The fund invests in developed market small caps, with 60% geographic exposure to the US market.

He said the team uses a bottom up approach and doesn’t pick themes or sectors, but the stocks selected for the portfolio show that consumer discretionary is a sector that should conitinue to perform well. The fund has been adding retail names such as Footlocker, Sketchers and most recently, Dick’s Sporting Goods.

“This is on the back of better consumer spending in the US. Employment numbers are modestly better but improving,” Kuhner said.

Airlines are also a bet on consumer spending and Alaska Airlines has been added.

“The increased consumer spending is focused on travel and entertainment and [airline] fuel prices are at multi-year lows. Airline capacity is constrained in the US, so with higher demand and stable supply, we’ve been looking at airline groups.

In addition, the team has been gradually reducing an underweight to financial companies relative to the benchmark (the S&P Developed Small Cap Total Return Net). “Financials were one of our larger underweights and we’ve been adding into that space, primarily insurance and REITs.”

As for selling, he’s sold down positions in the chemical sector, specifically Huntsman and Sci-Tech Engineered Chemicals.

Filtering 12,000 stocks

The investment team starts with a universe of 12,000 small caps. Using a bottom up approach — for example, balance sheet examination and mis-valuation compared to peer group companies – they narrow the choices down so the portfolio holds 600-700 stocks.

“But what we’re not doing is trying to data mine or back test data, put in exposure that worked historically and profit from that. We’re a quant manager, but we’re looking through fundamental data and putting together portfolios to capture an earnings advantage.”

Small caps he defines as $100m up to $2bn in market cap. However, the fund favours the lower 15% of market cap in the small cap universe, where analyst coverage is modest.

“There are a lot more [valuation] mis-pricings in the bottom 15% compared to large cap peers.”

Every week, the team evaluates stocks in the small cap universe. Turnover of investments is about 80%, but Khuner said it involves adding or reducing of the weighting of existing stocks more than selling off positions.

Risk, he said, is diversified across the portfolio by keeping small positons in many stocks. The top ten holdings account for only about 7.5% of the fund’s weighting. The largest holding is technology firm Synopsys, which accounts for 0.93% of the portfolio.

“We’re always concerned that there will be a historically strong event that can knock even a modest exposure and impact on the portfolio. A strong reversal in energy, for example, is hard to call. So we focus on the earnings construction process.”



                                         The Global Small Cap Alpha Fund vs sector*

 Source: FE Advisory  *Data to end of November 2015

Part of the Mark Allen Group.