Multi-asset managers believe having exposure to a diversified spread of market capitalisations can help deliver outperformance.
Diversification has the obvious benefit of helping withstand unexpected market events and minimising capital losses. But, Thomas Wells, multi-asset fund manager at Aviva Investors, highlights the benefit of mixing market caps. ‘By blending different market caps and equity styles, it is possible to construct a multi-asset fund that can benefit from exposures, without them dominating the return profile,’ he explained.
Wells says one benefit is being able to invest in small-cap names without the associated concerns of being dependent on the performance of this area of the market.
For example, in emerging market equities he has exposure to large caps via emerging market equity futures, and to small caps through an internal active fund. ‘This means our portfolios capture the rewards of the emerging market structural growth story in a controlled, yet diversified way,’ he said.
He also believes the difficulties of tracking small-cap indices means an active approach is the most sensible way to gain exposure to this part of the market. ‘It also ensures we invest in good quality stocks, which have a higher return on equity, and consistently deliver growth over the long term,’ Wells said.
Bill McQuaker, portfolio manager of the Fidelity Multi Asset Open Range, said a spread of stocks was one of the three pillars of equity diversification, alongside exposure to different regions and investment styles. ‘Small cap stocks can provide strong growth prospects and tend to be underresearched relative to large cap stocks,’ he said. ‘There’s potentially more value-add in terms of active management.’
He believes Japanese small caps are a great example of this approach, as there is a lot of potential for active managers to uncover value and obtain outperformance. ‘On average, there are just 0.14 analysts covering each Japanese small cap and an average of 12.7 covering those with market capitalisations of more than ¥1000 billion [£6.7 billion],’ he said.
McQuaker invests across a range of different managers for each region, giving him diversification across the market capitalisation spectrum and across different investment styles. ‘There won’t always be a dedicated small cap manager. Sometimes we can achieve good diversification by investing in active managers who invest across the cap spectrum,’ he said.
UK equities are one example. ‘It’s relatively rare to find a manager who is constrained to just large cap stocks in the FTSE 100,’ he said.
Nick Watson, multi-asset portfolio manager at Janus Henderson, said the market capitalisation tilt can affect the performance delivered from a regional asset allocation decision. ‘In our UK equities holdings, we have deliberately tilted towards large cap stocks, as the FTSE 100 should benefit from any potential sterling weakness. We also have concerns about the potential negative impact of political uncertainty on domestic stocks,’ he said.
In Asia, meanwhile, he has allocated to the Hermes Asia ex Japan Equity fund. ‘This invests across the entire region with an all-cap remit. It has outperformed the MSCI AC Asia ex Japan Index by 26% over the past three years,’ he said.
In the absence of a strong view on large caps versus small caps, he will adopt a diversified position in an attempt to capture outperformance.
Adrian Lowcock, investment director of Architas, believes stock size is an important decision for managers to get right.
‘There will be periods when small caps do better than large or mid, and vice versa,’ he said. ‘Each size category has its own characteristics and provides exposure to different sectors.’