Emma Wall: Hello and welcome to Morningstar series 'Why Should I Invest With You?' I'm Emma Wall. I'm joined today by Andrew Paisley, Manager of the Standard Life European Smaller Companies Fund. Hello, Andrew.
Andrew Paisley: Hi.
Wall: So, lot's going on in Europe at the moment. Of course, we've had the French election, but there are more to come across the continent.
Paisley: That's right.
Wall: With smaller companies, certainly in the U.K., they tend to be more domestically focused and therefore, more sensitive to what's going on in the economy and what's going on at the macro level with politics. Is that the same across the channel?
Paisley: Clearly, there's a large element of the universe is domestically exposed, but actually the biggest chunk of the small cap universe is the industrial space and has very much an export-led part of the economy. So, what you get is really global economic exposure, but with all the benefits – so, a better regulation, better accounting standards and better auditing. So, undoubtedly, politics impacts the sentiment, but you know within small caps, very much a global end market exposure.
Wall: And with smaller companies as well, I think there is an idea as well as they are more domestically focused, whether that's right or not as you suggest, and that they are a little bit more risky. They tend to be a bit more volatile. Smaller companies perhaps are companies that are newer and therefore, perhaps, more of them fail or have hiccups, and the way that these big international names do not.
Paisley: Yes. So, we actually did some work in-house on this and undoubtedly, small caps are a bit more volatile over the short term. But actually on a risk-adjusted return basis, you're being more than adequately compensated for that additional volatility.
So, actually, the tradeoff is really a very good one in U.K. and in Europe in particular. I guess the second point is the way that we go about investing in small caps is very much a focus on higher quality companies, high return on equity and businesses that are not loss making and are not speculative business models. So, we're very much focused on these better quality businesses that we know have delivered over time.
Wall: Do you think it's fair to think that smaller companies are younger companies? And because I think that's why lot of people think they are risker, because they have only seen perhaps one market cycle and therefore a less well-equipped to deal with any bumps in the road.
Paisley: So, what you see is the whole lifecycle of a business. Now where we are focused are now on the very early stage companies. Are these binary outcome companies, you know, biotech companies or oil and gas E&P companies that don't have any production?
Those for us are not the right risk/reward tradeoff. We want companies are profitable, have turnover and preferably paying a dividend. So, at slightly later stage of their development, but we know that the risk/reward tradeoff is more attractive. So, you know, really not interest in these sort of binary outcome high – extremely high risk small cap investments.
Wall: So, the next logical question I suppose is where are they? It is it a country by country basis or on a particular sectors at the moment that are really offering those opportunities?
Paisley: Yeah, so one of the great things about the European small cap universe is, roughly, about 1,000 companies for me to pick from. So, it's a fantastic diversity of interesting company; some good but some exceptional undiscovered gems.
Now the process we have at Standard Life Investments has been in place now for 20 years, been tried and tested three-four economic cycles and it's got a great track record; the quant tool that we have of identifying or helping us identify these great investment opportunities.
Now where we tend to find quite a number of them is in Germany – these German Mittelstand businesses. So, companies that are typically set up by the founder, they still have a large shareholding in the business and are still involved with the managements of the business. They do one or two things, but they do it exceptionally well.
Start off in Germany, then Europe and then globally. So, very much a long-term growth trajectory and they tend to take a lot of our process boxes. So, it's not because we particularly favorably disburse towards Germany as an economy, but the bottom up does tend to lead us to some of these great Germany Mittelstand businesses.
Wall: What about sectors then? Which sectors are lending themselves to this sort of blueprint?
Paisley: So, again, that would be more in the industrial space. But if I can answer the question in a slightly different way, we tend – you know, apart from not investing in loss makers and speculative businesses, tend to find it difficult to find companies within financial segment of sufficient quality to meet our process and as a result, we tend to be underweight financials.
So, some of the banking stocks for example, where the report to the shareholders could be thousands of pages long, fairly dense detail and technical jargon, and actually, by the end of it, you are none the wiser as to what's going on. You know for us, over time to find out the best 40 to 50 long-term growth companies and the universe, so, you know, we part these to one side and move on to the next idea.
Wall: Andrew, thank you very much.
Paisley: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
