"Sucess Demands singleness of purpose"
- vince lombardi

Why focus on Small Cap Deep Value? 

Multiple studies, perhaps the most prominent being Fama & French’s 1992 seminal paper, The Cross-Section of Expected Stock Returns, have convinced us of that the small cap deep value sector presents the best opportunity set for investment candidates over time within the public equity markets.  Indeed, Fama & French’s Three Factor Model not only showed that small-cap equities historically outperformed large-caps (“SML”) and that low price-to-book equities outpaced those trading at high price-to-book (“HML”), but also found that the smallest quintile of stocks in both categories performed the best*.  Our approach begins with this attractive subsector of the market and then, through deeply-researched, bottom-up analysis, builds a portfolio concentrated on the best investment candidates from within this group.   

It has been our experience that much of this investment universe tends to be underfollowed by financial institutions.   Sell-side analysts are often constrained by a lack of trading volumes and large institutional buy-side analysts are often constrained to owning larger companies. This is particularly relevant in the lower end of the market cap range we follow.  While quantitative firms are present in this market cap range, the algorithm-based strategies do not appear to be performing deep fundamental research – especially company-specific, qualitative research – and seem to take more of a basket approach rather than concentrating capital in a smaller number of investments.  

In addition to size constraints, the low price-to-book segment of the market, regardless of market cap, also tends to see much less institutional interest.  An independent academic study** of more than 2,900 mutual funds found a very significant bias towards the “growth” end of the spectrum and away from “value”, as measured by price-to-book.  Indeed, the study found that while it was very easy to find a “growth” fund, it was “virtually impossible” to find a true “value” fund and that the median “value” fund looked more like a growth/value mix, when measured by price-to-book.  We believe a lack of attention by large market participants increases the probability that listed equities in this market subsegment are significantly mispriced relative to intrinsic value, providing fertile ground for competitive returns. 

Our Competitive Advantage

We have chosen to predominantly focus our time and attention on a carefully screened subsegment of small cap value that historical research has shown contains investment candidates that have been among the most opportunistic risk-reward trade-offs offered in the market.  We have consistently focused on this deep value subsegment of the market for over two decades and have honed our understanding of this universe and the fundamental nuances of its companies.  Given the cyclical nature of many stocks in this subsegment, we often benefit from the return of certain previously-owned businesses to our watchlist, which further leverages our historical research experience, and on occasion we have invested multiple times in the same company.  With portfolio manager tenure of more than 20 years, the firm has developed a large cache of institutional knowledge and experience in this area of the public equity markets which we believe provides us a significant competitive advantage.

We have also chosen to focus our time and effort on understanding the long-term business fundamentals of companies and industries in which we invest, rather than concentrating energy on determining next-quarter earnings.  By choosing to look through short-term issues and setbacks, and concentrate instead on long-term value, we believe we can access companies at inexpensive prices and often avoid investment competition.   

Complementing these potential process/approach/informational advantages, management has also demonstrated a behavioral advantage, showing a proven ability to manage the strategy through a multitude of market conditions over the last 23 years, maintaining a patient, steadfast, highly contrarian commitment to the strategy.  This patience has been particularly critical during extended cyclical periods when the style fell heavily out-of-favor. We initiated the strategy in the late 90s just as the Telecom/Media/Technology bubble was expanding, damaging sentiment for “old economy” companies, and resulting in a grueling multi-year period of discounted old-economy valuations before markets finally normalized and our patience was rewarded.  Over the life of the strategy, we have managed through multiple periods of severe market volatility, including the Global Financial Crisis in 2008 and the Pandemic of 2020, in each case demonstrating the required mental fortitude to maintain our holdings and often opportunistically making increased investment while others were “panic selling.”  

We also believe that our detail-oriented and curiosity-driven mental disposition provides benefits to the investment process.  Both the Portfolio Manager and the senior analyst have demonstrated strong analytical competence, having both earned undergraduate Engineering degrees, enabling the team to think more systematically and empirically about the businesses we research, whether it be the success of a plant expansion or the interpretation of early-stage drilling results from a new orebody.  We believe these attributes as well help us deliver competitive returns to our clients.