Analysis of the Europe small caps sector shows funds outperforming the index over the past three yea...
Analysis of the Europe small caps sector shows funds outperforming the index over the past three years have done so at the price of added volatility.
The arithmetic mean return over three years of the 42 funds in the sector is 80.85%, which breaks down as 59.83% over one year, -12.4% from June 1998 through May 1999 and 40.26% from June 1997 to May 1998.
One of the best performing funds over three years is Pictet TF Small Cap Europe. This has returned 111.22% in the three years to end May 2000. This breaks down as 95.34% over one year, -17.11% from June 1998 through May 1999 and 30.46% from June 1997 to May 1998.
Michael Treich, head of European small caps at Pictet, said: "We are bottom-up stockpickers and focus entirely on stock fundamentals rather than a top-down approach. We can invest in companies of up to e2bn market capitalisation, so our investment universe is fairly large.
"We use screens to narrow this universe down to a shortlist of around 500. In particular, we use price to appraise value and return on capital employed. More detailed primary analysis is done on the shortlisted companies. We look more closely at the company's finances and also examine the quality of management, business plan and so on.
"At this stage we rely heavily on company visits. The team makes at least 300 company visits per year. The top 100 companies from the shortlist then go into the portfolio."
The largest single stock allocation at present is 2.67% and the largest ever was 4%, according to Treich.
Sector weightings flow from the bottom-up positions, but at present the fund is overweight electronics, leisure, media, health and personal care, IT services and software developers. It is underweight financials, material commodities, traditional manufacturers and retailing.
Although Treich stresses the fund is not intended as a New Economy vehicle, selective holdings in the technology and media sectors last year led to strong performance in the fourth quarter and the first quarter of 2000.
He remarked: "We have been disciplined about taking profits out of stocks which had big rises, particularly those in the tech sector. Our models give us an indication of when fair value might be reached, but you cannot be too rigid about target prices. Much depends on earnings reports, for example. If we expect the earnings forecast to move, we will hold the stock through the target price."
The outlook for stockpickers remains good, Treich believes.
"There are many small companies in Europe that deserve to remain small. But, equally, there are a number of good stocks in this area and we are having no trouble finding ideas.
"The market has been boosted by the setting up of the Euro NM and the Neuer Markt, which have increased the willingness of venture capitalists to invest in this area because they now have a potential 'escape route' if they need to get out. This has added a lot of liquidity to the market."
The Schroder ISF European Smaller Companies fund, run by Dannielle Serruya, has achieved above average returns with relatively low volatility, having achieved a total return of 94.42% over the three years to end May 2000. This breaks down as 65.7% over one year, -12.24% from June 1998 to May 1999 and 33.69% from June 1997 through May 1998.
Serruya said: "The fund is run by a team of three investment professionals, each with responsibility for covering certain areas and sectors. Beyond that, we are backed by Schroder's sectoral analysts and use the resources of the company's broader Europe team."
She describes the investment philosophy as "growth at a reasonable price".
"Our approach is fundamentally-based. We do basic modelling on the outlook for a number of companies, but in-depth research and projections are saved for those companies we hold or are considering as investments. At that stage, we rely heavily on company visits and direct contact with the management," Serruya said.
At the idea stage, screening methodologies are used.
"We can see what our universe is and can assess relative P/E, momentum and earnings growth. Often we get ideas simply by looking at the figures and then we can investigate these further."
Although the fund's benchmark is ostensibly the Salomon EMI, this is not the only performance benchmark used.
"It is good to outperform that index, but I believe the reason people go into small caps is to outperform large caps rather than to outperform a small cap index. As a result, we have three benchmarks in effect - the competition, the EMI Index when it is better than the large cap index and, finally, the large cap index," Serruya said.
The portfolio is composed of 110-120 stocks, with the top 20 accounting for about 40% of the portfolio. The focus is on picking individual stocks but sectoral weightings are monitored.
"We are more New World-oriented than the index, with more New Economy stocks and fewer industrials and financials. Our aim is to outperform the large cap index over the long term, and that cannot be achieved by investing in small banks."
Although the fund is well diversified, most of the performance over the last 12 months has been the result of decisions on how it should be oriented.
"At the start of 1999, we made a decisive switch from the traditional small cap holdings into New World-type stocks. We did not buy indiscriminately, but we moved fairly heavily into telecoms, software and media stocks. Without jeopardising our 'growth at the right price' approach, the aim was to move up the curve in terms of growth prospects and valuations.
"This was the foundation of much of our outperformance last year, as many of the traditional growth stocks did very little. We still have New Economy exposure but we are being highly selective in this area, sticking with those companies we a
Slow progress in improving diversity
Share purchase deal with assets of £28m
Came into effect in January
Three examples of compensation rule issues
Buying in baskets