Three top managers put a roiling market in perspective.
The conventional wisdom: Investing in small companies comes with extra risks but also greater rewards for active managers who can add value in a less efficient market. Yet assets are flowing to passive funds across the marketcap spectrum—while the strategic-beta industry is boiling down active management to simple sets of factors that can be packaged and sold at lower cost. Meanwhile, a weak dollar and global growth are benefiting large corporations more than smaller companies, and anticipated post-election policy changes that were expected to boost small caps haven’t yet panned out.
For insight, we turned to three leading small-cap portfolio managers who run funds rated Morningstar Medalists by our research analysts: Andy Adams, lead manager of Mairs & Power Small Cap
Adams, San Jose, and Taylor shared their thoughts on July 31. The discussion has been edited for length and clarity.
If a group of data scientists got together and tried to duplicate your process and make a strategic-beta or smart-beta fund to compete with your process, could they do it?
Andy Adams: I just got back from a conference where a number of the presenters talked about smart beta. I was pretty shocked by the factors being used for the smart-beta models at this point. A lot of the factors haven’t changed since I went to business school 20 years ago; I have degrees in math and finance, and worked on a quantitative factor model back then.
Where the rubber hits the road is how to weight those factors and when to shift the weightings. The jury is still out on whether smart-beta products can move from factor to factor at the right time.
I’d love to be able to just run models and spreadsheets but, especially in the small-cap space, it’s important to go out and visit the companies and understand what’s going on behind the financial statements.
As a case in point, return on invested capital is a great measure to look at. However, without visiting a company to understand what they’re spending for maintenance versus what they’re spending for growth, it’s difficult to draw much of a conclusion from that number.