Second, as elsewhere around the world, inflation has been rising, albeit it remains at historically low levels and actually saw a short-term decline in June 2021.1 There has been much talk in the US of the Federal Reserve looking through rising inflation, seeing it as a short-term phenomenon. That said, even if the US begins to raise interest rates it is unlikely Europe will do so to the same timetable or extent.
The continued case for small cap
- Smaller companies can grow more It is statistically clear that it becomes more difficult to generate extra growth the bigger a company is. An incremental €1 million of profits for a company which already generates €1 billion is no big deal, whereas for a company with only €5 million it means 20% growth.
- The market becomes less efficient lower down the market cap scale Research and media coverage tends to be thinner for smaller companies. So broader investor understanding of companies’ business models, corporate cultures and earnings potential is less. This creates a valuable opportunity for the diligent investor to identify mispriced securities – by accessing or developing insights which are tough to unearth and are not already headline news in the financial press.
- Smaller companies are less liquid Lower liquidity adds to the inefficiency of the asset class and can result in stocks being mispriced for long periods of time. In times of crisis or market corrections the active investor can take advantage of this market inefficiency – buying cheap or selling dear.
- Undiluted exposure to investment themes There are numerous product niches and investment themes to which large cap investors can struggle to get effective exposure. Large conglomerates find the value of their more interesting divisions diluted by other, less interesting divisions in legacy areas and by central overheads. Smaller company investing allows portfolio managers to gain pure exposures to the most attractive themes in the market.