Risks and opportunities

Investing in small-caps – like any form of investing – brings challenges. It is essential to understand what these might be, especially at a time when the world has experienced an unprecedented global shock that has been met by a raft of extraordinary policy responses.

“Obviously, the pandemic still presents a risk,” Esselink told the webinar. “We don’t see an imminent recession, but we have to accept there could be a taper tantrum or inflation spikes as we get further into this recovery. We also need to keep an eye on the very strong outperformance in the US and how we use currencies in risk-managing our overall strategy.”

For Hartsfield, too, the spectre of inflation cannot be ignored. “We’re already seeing wage pressure in the US, in part because government supplements have encouraged workers on the sidelines to stay there until their benefits expire,” he said. “It can be quite difficult for smaller companies to hire staff and grow their business when wage pressure really kicks up.”

As observed earlier, excessive valuations could present another problem as optimism over a successful recovery from the COVID-19 crisis intensifies. “We do have concerns that some highly rated stocks could see setbacks if we transition to an environment in which interest rates rise and discounts go up,” West told the webinar.

Yet set against such challenges is the opportunity to achieve attractive outperformance. In tandem, as figure 1 shows, small-caps can prove powerful in terms of diversification and overall risk reduction – especially if held in a portfolio comprised of regional components. “One of the most interesting aspects of small-caps is that you lose a lot of the volatility but keep the good performance when you put all these regional and local small-caps into one global portfolio,” Esselink told the webinar.

So is now really the time to give small-caps the attention they have frequently failed to receive in the past? “We see a number of good years for global growth ahead, and we believe this should make for an accommodating environment for small-cap investing,” Esselink said. “It may be that those who invest now have missed the beginning of the cycle, but we certainly don’t believe we’re at the end.”