Quality small caps still underrepresented asset class

Oksana Patron

5 April 2023

As investors are looking for consistency and with earnings risk expected to become the primary concern in 2023, revenue and earnings growth can be still found at mid-caps which fit into ‘quality at a reasonable price’ style of investing.

Bell Asset Management pointed to the ongoing inflation conundrum, which continues to create challenges across global markets, making Central Banks, in response, to keep on driving up interest rates and putting underestimated pressures on vulnerable equity markets.

“In this environment, if valuation risk was the primary challenge in 2022, it is our view that in 2023 earnings risk will take over as the primary concern, and with that “Quality” investing is king,” Bell AM’s co-portfolio manager, Adrian Martuccio, said.

The manager also noted while this asset class offered comparable to other growth asset classes revenue and earnings increase but with lower volatility.

“Small and Mid-Cap companies sit perfectly in a portfolio driven by a QARP (‘quality at a reasonable price’) style of investing.  Hunting for quality can be affected by the preconceived notion that quality must equal a large premium in pricing,” Martuccio added.

“In recent years, investors have bought into Large or Mega Caps which has resulted in unwarranted volatility as well as expensive valuations.

“Alternatively, the P/E of global SMID Caps currently trade at a 33% discount than that of the MSCI World Large Cap Growth index which highlights that global SMID caps represent one of the last areas within equities where the balance between fundamentals and valuations is relatively unscathed.”

According to the manager, the global SMID Cap market was represented not only by its liquidity but also by its incredible variety, for example across a market cap range of  less than $7.5bn there were approximately 650 stocks which offer flexible Mid-Cap positioning with higher return on capital as well as stronger ESG (environmental, social governance) leadership.

“At Bell Asset Management our QARP philosophy, has seen our active style outperform in markets that favour value and growth.

“It’s also important to highlight the low leverage of the portfolio when compared to the benchmark. Only a small premium is paid for this high-quality portfolio, which is justified by the attractive quality metrics such as earnings predictability and resiliency which are paramount in this uncertain economic environment.