Fund Manager Briefing: Allianz Global Small Cap Equity

Lipper’s Jake Moeller presents highlights of a presentation by Andrew Neville, Portfolio Manager, Global Smaller Cap Equities, June 4, 2014.

“First, furthest, and fastest” might sound like a variation of the Olympics motto, but it is in fact the small-cap equity (SCE) mantra of fund manager Andrew Neville. He advocates SCE investing with considerable gusto and some compelling facts. The bases of his mantra are that SCEs rise first among all equities in a recovering economic cycle, they rise furthest, and in the first 12-24 months following an economic downturn they rise considerably faster than large-cap stocks. He points out that this is also true in reverse as you approach within nine months of an economic decline, but he argues that good active stock selection can mitigate the relative downside.

REUTERS/Anthony P. Bolante

Mr. Neville has been with Allianz 15 years and now presides over the SCE franchise. Since May 2010 SCEs had been run by one team in San Francisco, but this resulted in a U.S.-centric bias in the overall portfolio. Now the fund is run by four regional teams in San Francisco, Frankfurt/London, Tokyo, and Hong Kong. Each team acts with a high degree of autonomy, with their influence in the overall portfolio being weighted by the relative weight of each region in the MSCI Global Smaller Companies benchmark (currently U.S. 58%, Europe 24%, Japan 11%, and Asia 7%). With each regional team running its own portfolios, it passes on its high-conviction ideas into the global portfolio. This results in a 180-stock portfolio with 95% active share and approximately 3% tracking error. Mr. Neville is primarily there in a risk-management role to ensure that no factor, style, or currency risks get above 20% of the portfolio.

For the SCE sector alone Mr. Neville points out that in every ten-year rolling period Allianz has examined, an investor would never have lost money from investing in SCEs. In the ten years to January 2005, for example, SCEs generated 100%—an amount generated similar to that of the ten years to January 2014. The worst ten-year return ever made was that to March 2009, when SCEs returned only 26%. Furthermore, in every ten-year rolling period SCEs have always outperformed global larger-cap stocks over the same period.

Table 1. 10 Year Performance of Global Large Caps v Small Caps

Source: Lipper for Investment Management

Mr. Neville believes the SCE field is so fertile for active stock-pickers because, by the Allianz definition of small-cap (<US$5 billion market cap), there are some 16,000 smaller companies globally, representing 90% of new listings. With only 4,300 companies in the MSCI World Smaller Companies Index, this gives enormous scope to generate informational advantage. Of the 16,000 SCE stocks, Mr. Neville points out that 5,500 are not covered by a single European or U.S. analyst. With 20% of these companies being Asian, local-analyst representation able to communicate with Japanese- or Chinese-speaking management is well placed to reveal potentially untapped alpha.

Table 2. Average Number of Analysts Covering Stocks in Major Markets

Source: JP Morgan, Allianz GI as of April 2011–reproduced with permission, Allianz GI.

Given that we are now five years into the current stock market cycle and, according to Mr. Neville, global SCEs are “fastest” in the 12-24 months after a downturn, what are the implications for a potential investor who has missed out on much of the action? There is still good reason to invest. Allianz sees no economic slowdown in the next two years, and if SCEs don’t turn until nine months before the next slowdown, then—although valuations are less supportive than they have been—global SCEs at 1.23x P/E to Growth are still cheaper than large companies at 1.33x P/E to Growth. So, for example, it is easier for an SCE to get from 30% to 35% growth than it is for a large-cap to get from 5% to 6% growth.

Table 3. Relative Performance of Allianz Global Small Cap Equity v Lipper Benchmark

Source: Lipper for Investment Management/ Eric Ho.

Mr. Neville and his team are confident they can find SCE stocks that are likely to grow considerably. Last year they had sold all exposure to SE Asia because of the effects of tapering, but they have re-entered the region via an Indonesian consumer stock. Within Europe they see attractive ideas in construction and the peripheral European consumer. In the U.S. they are looking at industrial exporters into Europe. Currently, the overall portfolio is procyclical, being overweighted in consumer, overweighted in industrials, and overweighted in technology.