With so much media and public attention focussed on large-cap companies like any of the Magnificent Seven, it’s interesting to hear the case for investing in small and mid-cap companies. Those are market valuations, respectively, under 2 billion and between 2 and 10 billion US dollars. Henrik Blohm, who has run the BL American small & mid-caps fund since 2015, is a big proponent.
“It’s something that we believe is structurally undervalued,” said Blohm. “The mid-cap space is often forgotten.” Investors are positioned today with 10% in this mid-cap space, he said while speaking at a recent lunchtime event organised by Banque de Luxembourg Investments.
With investor risk rising for investing in smaller companies, investing in larger companies for the reduced risk may seem appealing. “But, at the same time, it gets much harder for the companies to grow organically.”
3-star Morningstar
The fund had 646.6 million US dollars in assets under management and has a 3-star Morningstar Rating in the 3-year category, rising to 5 stars in the 5-year category. It’s an Article 8 plus fund under the SFDR with a 30% minimum, currently at 60% in sustainable investments.
Smaller and mid-sized firms are “companies which are really profitable and can re-invest the cash at high rates of return, exactly where we create the most shareholder value over time.”
Looking at data allowing relative comparisons is revealing, he said. “It was actually mid-cap companies which historically showed the best performance, ahead of large-cap companies, ahead of small-cap companies.”
Volatility trade-off
On the perception of higher volatility in smaller firms, Blohm said mid-caps are just a “little bit” more volatile than large-cap companies, but much less volatile than small-cap companies.
“That’s exactly where I see the sweet spot in US markets, in these faster-growing, high-quality companies, and mainly from the mid-cap space.” He explained that his fund contains 50% to 75% of such stocks.
Perhaps anticipating an audience question, Blohm explained why he hadn’t just set up his fund as a mid-cap fund.
More investment flexibility
“I wanted to have a universe of companies which is a bit larger, but more importantly to be able to profit off a few companies, high-quality small-cap companies already at an earlier stage so I can keep them longer in the fund.”
Blohm explained his fund’s investment approach by emphasising the importance of long-term shareholdings.
“We only invest in companies we believe have a transparent and clear business model,” he explained. “So companies we can fully understand, companies we believe have a sustainable competitive advantage, which are therefore really profitable and – very importantly – that can reinvest their cash at high rates of return.”
No overpaying
Blohm stated that his team is “very disciplined” in terms of valuation. “We really want to make sure we don’t overpay our investments.”
Luxembourg-based Blohm explained his investment process, which involves travelling two to four times a year to the US, where he attends specialised investor conferences, where he meets about 90 companies meeting them at their headquarters. He works with US-based external analysts and their research houses.
“I talk to the analysts about different companies to make sure that I haven’t missed something, to better understand the companies,” he said. “But I really don’t listen to this.”
In-house research
“It’s really important that we do all the fundamental research in-house at BLI,” he added.
Once his team finds an interesting candidate, he said, they spend a lot of time on the competitive advantages and whether they are sustainable in the longer term. “For us, a company can have five different types of competitive advantages,” Blohm said.
This should be visible in the numbers, Blohm said “it should lead to much higher profitability ratios of the companies, to higher margins,” he said. “We don’t like debt, we like really clean balance sheets, we don’t like capital intensive businesses and very important also in the small mid-cap space, also the quality of management.”
On the same page
When he’s in the US he makes a priority of meeting all the management of the companies his fund invests in, “to make sure that they are on the same page as we are – so they have the same mindset as we have to create shareholder value and also making sure that they’re being paid on the right ratios.”
His fund has a very concentrated portfolio, investing in between 40 and 60 companies with a maximum market capitalisation of 30 billion US dollars, the threshold beyond which Blohm considers to be a large-cap company, significantly higher than the market consensus.
The fund’s prospectus guarantees the investor that it will be a minimum of 80% invested in small and mid-cap companies.
Pure-bottom up
Blohm explained where he looks for his firms to invest in. He said that currently he’s mainly invested in industrial, consumer discretionary, consumer staples, healthcare and technology firms. “No investments in the energy space, no real investment in the material space.”
“It’s not that we don’t want any investments in the other sectors, it’s just pure bottom up, we find the best companies in the other sector,” explained Blohm.