Small caps have shown stellar performance this year, helped by an improved economic outlook. Valuations have risen, so are there still opportunities for investors? We asked Jan Willem Berghuis, head of small caps at Kempen Capital Management.
In recent weeks, the €1.2 billion Kempen Global Smallcap fund has taken profits on the biggest risers, adjusted weightings and spent time on new investment ideas, says Berghuis.
Berghuis mentions the company Sleep Number as an example of a firm that has seen its share price rise extremely fast. The American manufacturer makes “smart beds”, which can measure a sleeper’s heart rate, breathing and agitation and automatically adjust the mattress temperature and hardness for an optimal night’s sleep.
The firm has benefited from the coronavirus lockdowns as this has made investment in home comfort increase. After recovering strongly from its low point in April 2020, the stock price has risen by another 50% in the first two months of 2021, to more than $120 in February. ‘So we have taken some profits, yes,’ says Berghuis.
The same goes for some other companies in the portfolio that currently consists of 64 names, which in more than half of the cases are from North America, with the remainder being from Europe and Japan.
Reinvest the proceeds
The freed-up assets have been reinvested in recent weeks, mainly in existing companies in the portfolio. ‘If you know your own companies well, you do not need to buy many new names’, Berghuis argues. ‘You can already create a lot of alpha by adjusting the weightings. We spend 80% of our time on the existing companies in the portfolio and only 20% on new investment ideas.’
Many of the stocks in the portfolio still have plenty of upward potential, he says, such as boat maker Brunswick, known for its engine brand Mercury. ‘This type of company has never been in such high demand; everyone wants to get out on the water. They are coming through the crisis well, and have a price/earnings ratio of 16, and a one-year forward P/E of 14.
The Kempen fund has a value tilt, and has therefore traditionally had a lower price/earnings ratio than the benchmark. ‘Last month, the benchmark was at 16 times next year’s earnings and we were at 14. I think the valuations in our portfolio are not too bad. It is not terribly expensive, which gives a safe feeling.’
Return
Year to date, the fund has returned more than 22% net of costs, compared to 15% for the benchmark (as of 15 March 2021). A welcome turn, after a relative underperformance in 2020.
‘The first quarter of last year was very difficult in absolute and relative terms because of our value tilt,’ Berghuis recalls. ‘Tech companies and expensive growth companies were doing well. It just got more expensive and more expensive, while we were overweight in other sectors that were hit hard.’
‘Since inception, we have been able to outperform strongly though, despite a somewhat more difficult 2020. Yet the 2020 underperformance has not been punished by clients. In fact, that year the fund had the biggest inflow since its inception,’ notes Berghuis. ‘From both existing and new clients. Roughly speaking, we grew from €600 million to €1 billion, without accounting for price increases’, says Berghuis about the client base that, besides Van Lanschot clients and local family offices, also includes a Swiss private bank, a Scandinavian bank and a British pension fund.
‘Fortunately, value and small-cap stocks recovered from the second quarter onwards and, thanks to the subsequent returns, we have made up for the underperformance and, on a five-year basis, are now in the top-three in our peer group with an annualised return of almost 16% compared to just over 13% for the benchmark.’
New ideas
Meanwhile, Berghuis and co-managers Maarten Vankan, Chris Kaashoek and Luuk Jagtenberg are looking ahead. After all, now that the earnings season is over, they have time to work on new ideas, such as in the health care sector.
‘We want to be sure that a story works for the next five years, and that we can add value somewhere. A purchase is preceded by at least a few weeks of research. Only when we are all convinced, we buy,’ says Berghuis..
The fact that the team has achieved their best performance in North America is due to the fund’s long-term value strategy, says Berghuis. ‘American investors are much more short-term oriented. As a result, the price falls if a company presents bad news, such as a drop in orders. If a company meets our quality standards, it can be extra attractive exactly at such moments.’
At the moment the funds is slightly underweight North America, and somewhat overweight Japan. ‘That’s a special region which we normally visit every year. Valuations have been attractive there for many years. The problem is that companies do not always reach their potential because of things like corporate governance problems, excess cash holdings or cross-holdings between different companies.’