by Christian Bayer, Euro on Sunday
Dhe German medium-sized company is a globally recognized model of success. “Hidden champions” have often successfully found their place in selected niches. These are companies that are number 1 in their niche on their home continent or are among the top three players worldwide. An example of this is the Klais family of organ builders. The family-run company was founded in Bonn in 1882. The organs can be found not only in the Cologne Cathedral, but also in the National Theater in Beijing, in Auckland and Buenos Aires.
The products are often less spectacular, but all the more successful. Listed second-line stocks are considered to be particularly profitable, but also more risky than blue chips. It’s worth taking a look at the facts: The experts at the fund company Lupus alpha examined European second-line stocks and large caps in the period from the beginning of 2000 to October 30, 2020 and compared the Stoxx Europe 50 with the Stoxx Europe TMI Small.
Clear performance winners
With a view to the maximum price losses, a differentiated picture emerged. While small caps lost more during the financial crisis from 2007 to 2009, things looked different in the dot-com crisis. From January 2000 to December 2003, the blue chips posted larger losses at minus 61.5 percent than the small caps at minus 52.9 percent.
In terms of performance, victory clearly goes to the second-line stocks. Over the period under review, they delivered an annualized return of 6.3 percent, compared to just 0.3 percent for large caps.
Particularly interesting in the current situation: In phases of rising interest rates, small caps outperformed large caps by 5.4 percent per annum, as Sven Lehmann from HQ Trust calculated using the long data series available for US stocks. Many smaller companies have sound finances and are therefore less dependent on increasingly expensive external financing.
That is why the rotation from growth to value stocks is also an issue here. The SPDR MSCI Europe Small Cap Value Weighted ETF could benefit from this. The parent index is the market capitalization weighted MSCI Europe Small Cap. In the value-weighted variant, fundamental criteria such as turnover and profits are used for weighting in order to identify low-valued stocks. The more attractively valued, the higher a stock is weighted in the benchmark.
Fast-growing market leaders
Fund manager René Kerkhoff invests in companies from the DACH region in the DJE Mittelstand & Innovation fund: “My focus in the fund portfolio is on growth stocks from the second tier. The companies should be market leaders in their niche and show structural growth. One focus is on technology and health care stocks, but I also find what I’m looking for in industrial stocks with good growth prospects. These include, for example, companies that manufacture machines for chip production or provide the charging infrastructure for e-mobility. Smaller companies sometimes have 40 to 60 percent of the world market share in their niche.” From his point of view, the companies should grow in sales by more than ten percent in a cycle. “In the case of profits, the growth rates are then often 15 to 20 percent,” says the fund manager. When it comes to family businesses, the expert appreciates the long-term perspective: “Owner-managed companies tend to think in terms of decades rather than from now until the next quarterly report.”
The Threadneedle Global Smaller Companies is a classic among the global small cap funds. The investment approach is clear, the results are convincing. “I’m looking for high-quality companies with long-term competitive advantages that are generating increasing returns – relatively independent of the market environment,” explains fund manager Scott Woods. “In difficult market phases, we pay even more attention to quality and turn our attention to new buying opportunities that were previously too expensive.”
The investment approach is based on the fact that sustainable competitive advantages for companies are often underestimated by the market. Competitive advantages include sustainable cost advantages or trademarks and patents that form barriers to the market entry of the competition. One of the top holdings is, for example, Cargojet, a Canadian cargo airline with a quasi-monopoly position and a 95 percent market share. With a solid customer network and regulation, there is a strong moat against the competition. The company is also benefiting from the increasing growth of the e-commerce sector in Canada.
“However, with the end of quantitative easing, the environment going forward will be different from that of the past five years, which have already rewarded the prospect of growth,” Woods said. “This is unlikely to happen again. It will come down to finding the winners, the growing companies with a competitive advantage that can grow and do so profitably.” In addition, the fund manager makes sure that the companies are not overly indebted. There is strict discipline not only for purchases but also for sales.
INVESTOR INFO
The underlying index is highly diversified with over 1,000 stocks from 15 industrialized European countries. Great Britain is the most represented with 30.9 percent, followed by Germany and France. Industrials and financials dominate among the sectors. Spain’s Banco Sabadell and British utility Centrica are among the top positions.
Fund manager René Kerkhoff relies on small caps with innovative strength and strong growth from the DACH region. German stocks dominate the portfolio. Technology and healthcare stocks are the strongest. Top holdings include man and machine, hearing aid maker Sonova, and chocolate maker Barry Callebaut. The fund has grown by 17.5 percent over the past three years.
Small Cap Equity Funds Global
Fund manager Scott Woods invests worldwide in selected quality stocks from the second-tier segment. The industrial sector has the highest weighting in the portfolio at 31.0 percent, followed by information technology (19.4 percent) and healthcare (14.7 percent). The top-weighted stocks include Ritchie Bros. Auctioneers, an auctioneer of used farm and construction equipment, and Willscot Mobile Mini Holdings, a provider of mobile storage and office solutions. Over the past three years, investors have earned 26 percent from the Columbia Threadneedle fund.
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Image sources: Stuart Monk / Shutterstock.com, valerianic / Shutterstock.com
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