Smaller companies will be better placed to recover in the event of a US economic recovery, as they get a larger share of their profits from the domestic market.
That is according to the Citywire A-rated James MacGregor, who manages the AllianceBernstein-US Small and Mid-Cap fund. Over the past seven months, the Russell 2000 Index of smaller-cap stocks has fallen by 22.5% and the manager thinks valuations look attractive.
‘While concerns about China, the oil price and global economic growth are real, abandoning all smaller US companies isn’t necessarily the right response, in our view. Smaller companies can adjust business models much faster than their larger peers and can position themselves to weather the current environment more effectively.'
‘Smaller US companies get a higher share of their revenue from domestic markets than do larger firms, so they can benefit from the relative strength of the US economy,’ MacGregor said in an investor update.
MacGregor thinks some investors are afraid of investing in small-caps as they are seen as more vulnerable to market turmoil than bigger companies.
‘Although US smaller-caps are risk assets that will be vulnerable in market drawdowns, if you choose the right companies, with solid fundamentals, they aren’t necessarily as dicey over the long term as many investors believe,’ he said.
‘Recent selling has been indiscriminate. Smaller stocks fell sharply across a broad range of sectors, even though individual company profiles are very diverse. Within the SMID-cap universe, there are a wide range of companies with different attributes in terms of valuation, free cash flow, quality and growth.'
MacGregor believes investors should focus on a bottom up approach when choosing small-cap stocks, rather than focusing on the wider macroeconomic picture.
‘When choosing smaller stocks, we don’t think macroeconomic analysis is the key to longer-term success. Bottom-up research into the sources of a company’s business advantages and earnings potential should be the focus, even when markets are fixated on economic trends,’ MacGregor said.
‘That principle is perhaps even more valid today. By focusing on a small slice of the market with much stronger fundamentals, active managers can scoop up stock with more resilient characteristics and better return potential at attractive valuations.’
The AB SICAV I-US Small and Mid-Cap Portfolio returned 19% in US dollar terms over the three years to the end of January 2016. This compares to a rise of 22.5% by its Citywire-assigned benchmark, the Russell 2500 TR, over the same timeframe.