The Case for Buying Small Caps Now

SPEAKER_1 (0:02)

Bloomberg Audio Studios, podcasts, radio, news.

Merryn Somerset Webb (0:08)

So small cap value is the anti-AI trade, you think Stuart?

Stuart Widdowson (0:11)

Quite possibly. I mean, the only certainty is we don't know until it happens. If you look around the world, Merryn, small caps generally, particularly small caps are very cheap. UK is an outlier within that.

If you believe in reversion to mean they're still upside on rating.

Simon Evan-Cook (0:25)

If it's purely a rotation rather than an economic event or a war or something worse, there's no reason I think that movement of money out of the massive concentration in AI stocks into all the stuff that's been neglected for three years can't happen as well.

Merryn Somerset Webb (0:51)

Welcome to Merryn Talks Money, the podcast in which people who know the markets explain the markets. I am Merryn Somerset Webb and this week I am speaking with Simon Evan-Cook, who is the fund manager at Downing running a fund of funds. Also Stuart Widdowson, who is the co-founder and managing partner of Odyssean Capital who are the managers of the Odyssean Investment Trust.

Simon, Stuart, welcome to Merryn Talks Money.

Simon Evan-Cook (1:14)

Lovely to be here.

Stuart Widdowson (1:15)

Nice to be here.

Merryn Somerset Webb (1:16)

Simon, you have a history of investing in and talking about investing in, not just small companies, but small investment funds.

There's a particular reason why it is interesting you to look at not just small funds, but new funds. There's a history, isn't there, of new funds outperforming in the first couple of years of their existence. Can we tell us a little bit about that before we move on to small caps?

Simon Evan-Cook (1:43)

Yeah, for sure.

There's all sorts of belief out there amongst investors, and I sense it as well, that if you're going to buy a fund, you should buy a nice big safe fund because it's got an amazing track record and loads of other people are in it, and therefore that is the thing you want to buy. Occasionally this is true, but really those big funds only really got big because in their early years they smashed it out of the park. There are all sorts of reasons why holding and managing a smaller fund is considerably easier than managing a large fund. We're about to talk about small caps later on. That's one of the reasons for one, if you're running a smaller fund, you can invest in smaller companies. The last few years, that wouldn't have helped you a great deal because of the market dynamics, but generally speaking, we all know that kind of fact that smaller companies will rise more than larger companies over time.

And the best managers are able to winkle them out. That part of the market is also less efficient, so you can make more alpha because you're more likely to find a company that everybody else has ignored, has only got one analyst covering it rather than the 100 that are covering NVIDIA. And so you're able to find a company that is materially undervalued and that can potentially, even if it's not undervalued, still grow by 10, 20, even 50 times. Whereas obviously a company like NVIDIA, amazing as it is, shouldn't be able to grow by 50 times from here. I mean, the maths of that must be, yeah, I can't even imagine, but it must be impossible.

SPEAKER_1 (3:16)

Okay.

Merryn Somerset Webb (3:17)

So that's part of it, being able to buy smaller companies. A giant fund can't buy into a smaller company, obvious reasons. But that's not all, right? There's got to be more to it than that.

Simon Evan-Cook (3:26)

No, there's more to it than that. I mean, for starters, if it's an emerging fund, so let's call it a new fund that's just been launched, there are different reasons why it may be that. Put them into two camps. One might be that it's a new manager. So that's someone who is younger, maybe getting their first chance at running their own fund, having been an analyst somewhere. And the second one might be that it's a more experienced older fund manager who is leaving a bigger company somewhere because they've got annoyed with the red tape or the amount of extra work they've got to do and is establishing their own boutique and is starting their own fund. So if we take those one by one, starting with the experienced older fund manager, the reason why you'd want to back that particular fund is because now they're finally being let off the lead.

Whatever was kind of annoying them, holding them back before, it might be that the funder got too big, might be that they had an overbearing risk department or a CEO who wanted them to hug the benchmark. Now they don't have to do that anymore. If they are a good fund manager, that should mean that they can create better returns for you for doing that. At the point when their fund is still small enough for them to be able to maneuver it and buy smaller companies, all of that good stuff, they can still do that. So that's one reason why a smaller fund might be your friend.