Standard Life Investments

Through the Lens

Just the tonic

  • Finding small-cap opportunities that control risk
  • Where do we anticipate seeing share price momentum?
  • Our outlook for European small-cap investing

As part of our smaller companies research process we look for companies that exhibit quality, growth and momentum characteristics. That is because we believe that controlling risk is absolutely critical in small-cap investing. This approach was particularly pertinent during the volatile months of 2015 when we managed to avoid more cyclical sectors, such as commodities. We also have a preference for businesses that are run by founders or seasoned management teams with an ability to grow earnings or display business and share price momentum.

Recent examples from our research that fulfil these criteria would include Fever-Tree, which manufactures premium quality tonic mixers for the gin market. The gin market has seen a significant resurgence with the emergence of an increasingly popular premium gin segment. That said, the choice of mixers remains relatively restricted, with Schweppes continuing to dominate the mass market. However, Fever-Tree is successfully filling the gap in the premium market, with growth having been exceptional but, importantly, still at a relatively early stage. We believe the opportunity for the business is significant as the product is internationalised, with the outsourced business model reducing execution risk. In our opinion, the market has underestimated the growth potential of the business since flotation last year and we believe that remains the case.

Similarly, IT recruitment company FDM has a differentiated business which captured our attention. The company gives clients the opportunity to trial candidates for an initial two year period before deciding whether to take them on full-time. Demand remains strong within the financial services market, with increased regulatory change and investment in digital banking being two key drivers. The business is also highly entrepreneurial; the management team founded the business and retains a significant shareholding.

We expect many of the themes that characterised 2015 to remain to the fore this year. These include: concerns about global growth (emanating from a slowing China); divergent monetary policy (with the US and, perhaps, UK tightening, while Japan, Europe and China loosen further); and deflationary pressures thanks to lower commodity prices (notably oil). There are other factors to consider, including the Brexit vote in the UK, the US presidential election, Europe’s migrant crisis and ongoing geopolitical risks. As such, we forecast intermittent bouts of volatility throughout the year.

For the small-cap asset class, a lot will depend on the health of the global economy. Small-caps tend to do well when the economy improves and underperform when the economy deteriorates. However, there is incredible innovation and entrepreneurship in smaller companies, and the beauty of a European small-cap universe of around 1,000 companies, is that there are always companies doing well – regardless of the wider economy. The key is finding these stocks and taking meaningful positions in them. We believe our team structure, experience and robust and repeatable investment process should enable us to continue to find such stocks.

All information, opinions and estimates in this document are those of Standard Life Investments, and constitute our best judgement as of the date indicated and may be superseded by subsequent market events or other reasons. This material is for informational purposes only and does not constitute an offer to sell, or solicitation of an offer to purchase any security, nor does it constitute investment advice or an endorsement with respect to any investment vehicle.