Emma Wall: Hello and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Nick Williams, Head of Small Caps for Barings.
Hi, Nick.
Nick Williams: Good morning.
Wall: So, small caps is getting quite a lot of attention at the moment. It's a very popular sector and the contrarian investor might sort of play devil's advocate and say when a sector is popular that's not the time to invest. What do you say to that?
Williams: I think the devil's advocate often has a good point, but there are a few factors that are really quite positive for smaller companies at the moment. We only have to look at European GDP growth which after years of being virtually zero is slowly edging in the right direction. Business confidence is picking up. Valuations are not unattractive.
I'm saying that carefully because I don't want to overstate the attractions of valuations, but we are also seeing positive revisions to earnings forecasts. Now, this is an unusual thing in Europe. It hasn't happened for a long time. We're seeing companies actually upgrading their forecasts for this year's profits and that I think is the most compelling sign for European smaller companies.
Wall: How much is that sort of good news has already been priced in there because the last five years have been really exciting place to be in small caps, particularly in the U.K. but also the wider Europe. So, can we expect to see this rally continue?
Williams: Well, I would say the last five years in European small caps have been very good and indeed, the last 10 years have been very good. In fact, even if you look at the last 30 since the fund I run has been around for 30 years, we've been seeing annual returns of about 14% over the whole of those 30 years. So, it's a great place to invest, but I think that's partly a peculiarity of smaller companies themselves. If you can find the right ones then there are loads of opportunities and very interesting opportunities to make money.
Right now, are smaller companies attractive? I think they still are. I think that the valuations relative to larger companies in Europe are attractive and actually more attractive than they were a year ago because we are seeing these positive earnings revisions and this more positive turn in Europe.
And secondly, there are simply opportunities for smaller companies to grow their profits in excess of the speed at which larger companies can. So, the profit margins in smaller companies are still a bit depressed. They are still reflecting weak European conditions and that means that they have further to rebound and that's a positive sign.
Wall: You said a very key phrase there. You said if you can find the right ones. This is not to say, of course, that all small caps only go one way. It's one of those places where active management can really pay off, isn't it?
Williams: I think. I think when you look at the active managers in the space most of them have outperformed the index. In other words, unlike many other areas of the stock market investment you can see that the index is a tough competitor. Here my tough competitors are the other active managers. And yes, we all spend our time looking for the right bottom-up opportunities, partly because that's where you make money but also possibly just as importantly, if you get the wrong ones, you're going to lose a lot of money. So, it's certainly a dangerous place to be invested. And if you are not properly prepared, it could be a minefield.
Wall: You mentioned there that you're a bottom-up stock picker. That's not to say that you completely ignore what goes on in the macro, in the economy and of course, Europe is in recovery. Smaller caps do tend to be more domestically focused. So, are you looking for stocks that are going to benefit from this sort of Euro recovery story?
Williams: Only in a very general sort of way. As I said earlier and as you pointed out, what really matters are the companies themselves. If we find a company that has absolutely no relationship to the European economic recovery story but we like it and we think it's going to do well and its strategy is satisfactory and the company meetings are good, then we'll buy it.
So, we will take indicators from top-down macroeconomic themes or currency changes or for example, the development of the Internet in payment solutions. All those are potentially useful indicators, but how they get translated into the individual company is what really matters and that's why I always resist looking at themes because what I don't want to do is to be put into other people's buckets or chasing other people's ideas. What I want is for our portfolio to represent ideas that we think makes sense from a bottom-up perspective.
Wall: Nick, thank you very much.
Williams: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
