Capitalizing on inefficiencies in 'underowned' space

Mackenzie portfolio manager puts forward the case for investors owning global fund

Capitalizing on inefficiencies in 'underowned' space

A recently launched fund hopes to benefit from inefficiencies in the small-to-mid cap space.

Unveiled before markets were struck by the COVID-19 crisis, the Mackenzie Global Small-Mid Cap fund has been affected like the vast majority, although it has performed better than its peer benchmark, the Morningstar Global Small-Mid Cap Equity.

Despite a pandemic that has rocked the economy, the over-riding theory behind the fund’s introduction remains the same. Portfolio manager Phil Taller told WP that while the U.S. market has vastly outperformed other regions in the world, Europe and Asia have not delivered the same kind of returns.

“That’s been great for US equity investors but at the same time there is a logic to maybe considering a more globally oriented fund that might give you exposure to other regions that haven't performed quite as well,” he said, before the recent market downturn.

The small and mid-cap space, in addition, provides inefficiencies that Taller believes he and his team can take advantage of. He said that when mid-cap managers beat their benchmark, they usually do so by more than their large-cap counterparts.

Aiming to have around 40 holdings at any one time, $2 billion to $20 billion is the fund’s “sweet spot”. He believes it’s an area underowned by investors because of variability in returns. However, he added that the Sharpe ratio is actually increased from being exposed to the sector, while the return-to-risk payoff has been good globally.

Via forensic analysis of potential companies, Taller and his team identify firms whose businesses look attractive based on the notion they either are or can grow faster than the economy and have higher margins than average to generate significant levels of free cash flow.

He said: “Usually they have them because the product or service they offer, in our view, does something better, faster and cheaper for the customer. That's what we're looking for. Many businesses might satisfy those basic criteria and then the question is, can we get a good business at a reasonable price?”

Taller help up the example of Progressive as one of the fund’s bigger holdings. His team first bought the company, a property and casualty insurance company, back in 2013 when it was out of favour. At the time, however, it was about to roll out a usage-based insurance, collecting data from driversm whcih would give it an analytical edge.

“We believe they were almost a solid decade ahead of most of the industry,” Taller said. “They were about to use that as a criteria for risk, risk adjusting and insurance, whereas most of the industry would still be using credit data, which Progressive pioneered many years ago.

“We thought that it would give them an advantage like a poker player sitting at the table being able to see the other players’ hands. In insurance, that’s massively valuable.”

Growth picked up quickly and in 2018 hit more than 20%. For Taller, this example epitomises the opportunities in the space.

He added: “If you look at the very long term in the US, the small and mid cap category has outperformed – it’s had a great 10, 15, 20 years.  In the sector as a whole, there’s a little more volatility than with large caps. Large caps have dominated the past five years and had higher returns but typically that hasn’t been the case. So, I think there’s probably a snapback at some point in the wings waiting for small-mid caps in the U.S. relative to large caps.

“Mid caps in the US are also fairly sizable companies. They’re not front-page news items, they don’t show up in the headlines. But they are often very big category leaders.”