Trends Watch: Concentrated Small Cap Equities

EisnerAmper’ s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Matthew Swaim, Executive Chairman and Portfolio Manager, Advisory Research^® Investment Management.

What is your outlook for investing in concentrated small cap equities?

For the last two years or so, the small cap market niche has been providing opportunities for concentrated active managers which we have not seen in decades. These opportunities lie in the bottom 2000 of the top 3000 listed companies. 93% of market value and most of the trading is in the top 1000 companies.  Only 7% of capital is left to cover the bottom 2000 stocks.^[1]

• The reason we see opportunities is that many days, no one seems to be home.  For the thousands of U.S. small companies, most capital has moved to private equity and ETFs, leaving few active managers and very little sell-side coverage for the bottom 2000 public market names. That is a terrific research opportunity.

Where do you see the greatest opportunities and why?

The main opportunity is to act as an engaged investor. An active manager can minimize downside risk by choosing durable companies with strong balance sheets which will thrive for decades. If we can them partner or “engage” with a management team which is unlocking operational and strategic improvements, we believe the reward/risk ratio becomes asymmetric.

• Governance is a piece of this, especially in the companies below $1 billion in market cap, who have fewer resources. Engaged minority investors can make a vital contribution to governance. If “no one is home” in today’s market, engaged investors may need to encourage their management teams to take actions which will be recognized by the larger numbers of passive investors in the market.

What are the greatest challenges you face and why?

Market inattention means that research opportunities are increasingly numerous. Our team is doing a lot of sifting as it attempts to filter down to the best ten or so opportunities for our clients. The work of investment selection starts anew every morning. It takes a lot of team energy to maintain the process.

What keeps you up at night?

We are constantly “re-underwriting” the ten or so names in our portfolio.  When a stock price has appreciated, the risk is greater, and we may need to trim the position. When a stock falls in price, we need to assess whether we see the bottom correctly, and whether we should be adding to that position. These thoughts are constantly on our minds.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.

[1] Sources: FactSet Research Systems and FTSE Russell.