Scarce coverage of small caps by sell-side analysts, compared to that of large companies, gives an advantage to fund managers willing to do thorough research, said McSkimming, who is based in Edinburgh.
“Everything that can be known about Apple is probably known already,” he told FSA on a recent trip to Hong Kong.
Analysts covering smaller companies often use generic metrics that do not take into account specific circumstances of a company, he said. Those circumstances, for better or for worse, are not priced in by the market. Fund managers who analyse a company in detail, stand to benefit from these mis-pricings.
Evidence for a size premium, favouring smaller stocks, has existed since the 1980s. While some researchers dispute it, McSkimming points to it as one of factors contributing to the long-term outperformance of the firm’s Global Sicav European Smaller Companies Fund.
Launched in 2007, the fund has underperformed the index in three of the last five years. However, it has a cumulative performance of 132.2% since launch, compared to 63.4% for the benchmark, according to the fund’s fact sheet.
The fund manager’s philosophy is to “look for material change that’s happening on the company level”, said McSkimming. It could be internal, such as a new product, new market, new management, or external, for example regulatory or technological.
The management team, consisting of six portfolio managers and a quantitative analyst, who manage three small cap funds (UK, Europe and Global), aims to exploit market inefficiencies in pricing in those changes.
Staying with the process
The investment process involves a quantitative filter, a 13-factor matrix that reduces the 1000-strong universe of firms to 200, which then undergo fundamental analysis.
Value is the least important category, and that’s what contributed to the fund’s underperformance at the end of 2016, when value stocks rallied after the election of Donald Trump in the US.
The fund currently holds 47 stocks, with an average holding period between three and five years. Its biggest geographic allocation, 27.6%, is to the UK, even while the fund is underweight in the country with respect to its benchmark.
It is overweight in Germany, at 21.3% its second largest geography.
While Europe is facing potentially disruptive elections in France, Germany and Holland in 2017, the fund manager is not making special adjustments for the geopolitical risk. He believes the fund’s philosophy and process has been well established since 1997 and is not subject to changes with geopolitical or market shocks.
“You have to stick to your knitting,” said McSkimming. “You don’t change your process just because the market has changed.”