Global SMID caps – the strong getting stronger

From

Ned Bell

Global equities boutique manager Bell Asset Management believes that the global SMID cap earnings recovery that investors want to see still has a long way to play out but will continue to drive strong performance based on how SMID cap earnings re-bounded after the ‘dot-com’, and GFC market drawdown.

At a virtual event held in Melbourne, Bell Asset Management CIO, Ned Bell, said that last year was tough for global earnings, with global small cap stock earnings falling by 50%, and global equities as a whole falling by 30%.

“The biggest earnings test of all time was last year. The pandemic last year really shook-up global markets, with earnings growth year-on-year falling 53%”, said Mr Bell

“When the markets tipped over in Q1 last year, we saw small and mid-cap stocks hit the hardest, the most illiquid parts of the market had the rug pulled out from underneath them. However, looking at this year, Q1 earnings were exceptionally strong for the companies we’re invested in, and we expect to see a strong Q2.

“Our SMID strategy generated good performance in the last 12 months – the earnings of our companies did not get crushed so the Fund fared well for investors. Not having exposure to the extreme growth end of the market, because of our valuation discipline, has meant a slight drag on performance. . However, going into an inflationary environment where very expensive stocks get beaten up will mean we’ll go from a headwind to a tailwind.

“Businesses are factoring in a more subdued outlook for next year, telling us that this upgrade earnings cycle still has a long way to play out. More broadly, we are still one year into a five-year recovery, so we can see that the projected steepness of the earnings recovery has a long way to go.” said Mr Bell.

Business bucking the trend during COVID benefitting in the future

Mr Bell believes that those businesses that grew last year benefitted from COVID and were able to take advantage of the environment and build on their strong franchises.

“The highest quality SMID names have emerged stronger through COVID – Pool Corp, Thule, Tractor supply, Yeti – all evolved and moved to be able to support consumers and employees alike.

“They are what we call, the COVID opportunists – high quality businesses, benefitting from positive sales and growth, their earnings growth is exceptional, and we expect to see high-level returns.

“The opportunity for them will be global expansion, and that is something we have not yet seen,” continued Mr Bell.

During the event, Mr Bell also talked about the strong ESG rating of the stocks in the Bell SMID portfolio vs the benchmark and how investors don’t generally consider global SMID stocks when considering ESG investing.  However, Bell believes they should look closely at those businesses that have a strong ESG ethic and how they addressed this during COVID.

“Most investors don’t assume to invest in SMID cap stocks for their ESG portfolio but that’s a mistake”, says Mr Bell. “We take a very active, pragmatic, integrated approach to ESG investing and we look at how each business addresses the ESG risks most prevalent to the company in question.  We look for companies that have the ability to pull a lever that reduces the ESG risk in question.

“COVID is a fine example of this – how businesses reacted to social issues, when employees and customers were at their most vulnerable. Things like additional leave measures for employees, steering customers away from stores to online, relying heavily on supply chain and an increase in jobs, that’s the kind of social governance we’ve seen from some of the businesses in our portfolio.

“Investors can have their cake and eat it too – you can invest in an ESG portfolio and get good returns”, added Mr Bell.

Looking forward – 2021 and beyond

Mr Bell believes we should expect more volatility in earnings as whole moving forward.

“Outside of our portfolio of high-quality companies there is a much bigger universe of companies that have a higher volatility of earnings.

“We can’t get too excited for earning expectations in 2022. Rising interest rates and inflation can be a jolt to earnings will affect the growth rate of some companies and will start to have a bigger impact on their bottom line.

“While COVID is still with us, it could be a handbrake to growth trajectory for companies that are economically sensitive, like consumer and industrials.

“We are paying close attention to the shape of the economic and earnings recovery and believe global SMID is well positioned to take advantage of a post COVID-19 world,” concluded Mr Bell.

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