“From a fundamental standpoint, valuations are not necessarily cheap, but not expensive either — they are modestly inflated,” Kuhner, a member of the investment team for the AXA Rosenberg Global Small Cap Alpha Fund, told FSA.
The earnings growth in global small caps are expected to have a 2-3 percentage point advantage over large caps and the earnings quality is “on a fairly good footing,” Kuhner said.
The stock market rally in the past few years has proved challenging from an alpha standpoint, he noted. However, “this year, we saw a bit of the value growth idea change” with small caps generating higher returns.
For example, the MSCI USA Small Cap index has gained 9.32% year-to-date compared to 6.5% for the S&P 500, according to FE data.
Beating the S&P has been difficult over a longer horizon has been difficult. On a three-year horizon, FE data shows that small caps returned 19.1% and the S&P 30.6%.
Kuhner has been adding exposure this year to materials and energy companies that generate better earnings relative to peers, thanks to improving oil prices.
Some high-yield small caps, such as utilities and telecoms, despite a small percentage, also benefitted from investors chasing income, he added.
The yield, averaged at around 2% for small caps, can partner with earnings growth and cheap valuations. “These are the three elements that have been rewarded across all cap sizes, including small caps.”
The fund’s benchmark S&P Developed SmallCap Index has a valuation of 23 times price-to-earnings, while the fund’s stands at roughly 15 times, he said.
Volatility sensitive
The value-tilted strategy hopes to ride the fund through macro shocks, which Kuhner considers the biggest risk to the portfolio.
“When the risk profile is high, you do see more volatility in small cap stocks [than mid- or large-caps]. It doesn’t preclude them from having good performance, but it could be a headwind as investors tend to be more risk averse.”
Small caps do well in an accelerating earnings environment and markets have been in a fairly long positive earnings environment since the financial crisis and the US has had the longest bull market in the post-war era, he said.
However, “such a view might also trigger some investors to take profit from small cap assets,” he added.
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The performance of AXA Rosenberg Global Small Cap Alpha Fund, as compared to comparable indices other than its benchmark (S&P Developed SmallCap Index), on a three-year horizon.
