Investment Podcast #4 – Small Caps – Transcript

James Whelan
How are you now and welcome to the Ensombl Investment Podcast brought to you by Morningstar. My name is James Whelan, VFS group investment manager on this day, don’t worry about that I represent you, the humble advisor doing their best to walk the line between client interests and asset classes that are not only appropriate, but also that work for those clients of yours as well. And this is important work that we do. And I’m really looking forward to, to helping you through this journey, and also to getting the feedback from advisors as we go through this, too. It’s fantastic. It’s fantastic idea by Ensombl. And thank you so much for Morningstar, for all the help that they’ve given us up to this point, and for all the help that they will give us going forward. So I hope that through this series, we can help answer some of those questions that we’ve come up with on the ensemble platform, keep the questions coming and keep the conversation going. Because that’s what it’s all about. And obviously, and here we go. All information contained in this podcast and all future podcasts is general in nature. You know, the drill. This week, were all about small caps, and I could not think of a better two guests to get into it with then first off Jody Fitzgerald, head of institutional portfolio management and solutions at Morningstar. And Liam Donohue, principal and portfolio manager at Lenox Capital Partners, but before that, he was the Portfolio Manager at Mac bank for about 11 and a half years. Lennox Capital Partners is a specialist small cap micro cap specialist, small and micro cap equities manager, one of the boutique fund managers under the for Dante partners umbrella. If you wanted some small caps experts, you want some experts. We got him for him if you wanted a good host. Well, he was busy and we had to get out. So Jody, Liam, how are you now?

Jody Fitzgerald
Good, thanks. How are you? Not too bad.

Liam Donohue
Liam, you’re doing very, very well. Thanks, James. And thanks for that introduction. That was one of the most exciting introductions I think I’ve ever had.

James Whelan
That’s, that’s where the script runs out. Now we’ve got nothing else to talk about. After that says, hey, let’s look just joking. Like I said, This podcast is about answering all the questions about small caps that are being asked on the ensemble platform, obviously keep those questions coming. Let’s start at the beginning. I’ve mentioned small caps. I’ve mentioned micro caps, what do we actually mean by small caps? And what does the small cap business typically look like? For example, other scooters, tech services, mining? Liam I, it’s one of my classic, open open ended questions might have at it.

Liam Donohue
Yeah, it’s a really interesting thing to think about, I suppose in terms of what a small cap actually is, because things tend to change so frequently in that part of the market. But the easiest starting point is that a small cap is any stock outside the ASX 100. So that’s, that’s the most simple classification. But then, if we think about what the average small company looks like, and some of its its typical features, the small ordinaries benchmark is a good guide for that sort of thing and that index tells us that the average small company has a market cap or equity value in terms of its size of almost two and a half billion dollars. So that’s the football by the way. So quite a big one a large business billion. Yeah, that’s right, the billions. And the business itself. Typically in industrial business, although there are some, you know, mining and energy businesses in there as well, they’ve typically got a founder or one of the initial investors that are still quite heavily involved in the business in some capacity. And generally speaking, it’s probably growing a bit faster than the broader market. So that’s, you know, when we think about small caps, that probably summarizes what the typical small company usually looks like,

James Whelan
thanks for that Lamb. Now, I just want to take a step back, talk about the macro context, a little bit bigger picture, the macro context for small caps, because it’s quite different to what we’ve seen over the last few years. So Jody, I’ll put this to you exactly. What is the macro context? What does it mean, for small caps? What does it mean for advice and portfolio construction? More broadly?

Jody Fitzgerald
Yeah, sure. So yeah, that is a very big broad question. You’ve asked that you will think so. I’ll take it in numerous directions, I guess. I think before we get into the where are we at and where we’re going, I think it’s good to reflect on where we’ve been. And the way portfolios have probably been built over the last decade, the shift needs to change effectively. So when you have a look at what happened prior to inflation, and interest rate rises occurring in the market cycle, we’ve had an extraordinarily long period of time of perpetually falling interest rates, and low market volatility. So what really won in that environment was effectively just having a market exposure. So having a beta exposure, and really passive investing won out over that last decade. But as we step into a period where the outcomes and markets are no longer being, I guess, ring, if we want to call it that by by central banks, by artificially holding interest rates low, we’re actually moving into what I’d refer to as a more normal market environment, the last decade or so was not normal. So we’re moving into a period where we actually have interest rates above zero, where we actually have some inflation, and we actually have volatility returning to the marketplace, it means that understanding total portfolio risk is more critical now than it has been for a really long time. And I think what’s going to be absolutely important for advisors to understand is that some risk exposures in portfolios, it’s going to be really important to make sure you’ve got those calibrated appropriately. You didn’t need to think about it a lot over the last decade, because basically all tides were rising effectively. But that’s not the case anymore. And this is really where we think active management and finding skilled managers who have capabilities in different asset segments is going to be really important, but then also understanding how to size different opportunities in a portfolio. So that’s kind of I think, understanding that context is important because talking about where we’re at in the rate cycle is only relevant in the sense of, you know, what does it mean for the way you construct portfolios? And Does anything need to change? Look, I think, I’ll tell you, one thing I know for certain is that any forecast I make will be wrong. So you can sort of bank that touch. What we do in understanding the macro environment is understanding the paths that we could take from here, and the impacts of those paths and portfolios. This is actually probably as far as I can remember, the longest, most widely accepted telecast recession, that hasn’t actually occurred, and most major market economies have been dodging that recession. So the question then becomes, where are we at in the rate cycle? Does do central banks need to keep increasing interest rates to fight inflation? Has the heavy lifting been done? And what is the probability of us moving into an economic downturn that would then out impact the way you allocate assets. From that perspective, a lot of discussion around inflation has been probably miss focused on supply chain issues and the impact of COVID and the impact of the Ukraine war. And while that certainly has played a role in some of the inflation, a lot of supply and demand imbalances eventually work their way out of the system. The issue that we’ve had in some major economies, particularly like the US, for example, has actually just been a good old fashioned overheating economy, where we’ve got extremely low unemployment. We’ve got more job openings than unemployed people who are able to actually fill those job openings, that then puts pressure on wages. Unfortunately, the only way to get wage inflation under control is to deliberately increase interest rates and slow the economy. And that’s effectively what most global central banks have been doing. Where we’re at from an inflationary perspective. The reality is even though headline inflation is coming down globally, and certainly the monetary policy moves that we’ve seen over the last 18 months that are having an impact corn elation is still elevated and is still above the target of most central banks. So core inflation is effectively it strips out those volatile items like food and energy. And it’s a more representative understanding of the general trend of prices. And it’s what the central banks will and you, including the RBI will focus on. So we thought core inflation above that typical two to three ban 2% down at most central banks will target it’s difficult to see how central banks could start cutting rates.

James Whelan
So do you think the markets getting it wrong? Or is it pricing in a possible recession?

Jody Fitzgerald
So what’s perverse about this right, is that the market is saying there’s going to be a recession, we’re going to start getting interest rate cuts, that’s going to be fabulous. And the stock market has charged ahead, which is really, really interesting, because effectively, you’re the overarching concern there is that even though interest rate risk may have repriced in markets, have the earnings expectations been repriced, for potential slowing of the economy? And that is a real question mark at the moment as to whether or not that is being appropriately considered across assets. And we’re here to talk about small caps today. And, and if anything, I think a lot of that valuation or earnings risk has probably been better priced in that part of the market than it has in the large caps. Most definitely. But what’s going to be important for advisors is understanding that not all risk is equal anymore, like it was over the last decade, and that it will be really important to understand how you calibrate your risk, making sure you have exposures to active managers that are specialized in particular areas, and that having capital at work in the market is simply not going to be enough.

James Whelan
Yeah, I think that we can declare the reign of Queen Tina over, we did enjoy investing during her reign. And and that was fantastic. But now that there are alternatives to being the there, there is no alternative, which is sort of the mantra for a lot of the advisory space, especially in the fund management space. For in that area of law, as you said, that passive area of just going and just buying the market and being the market was a fairly easy, safe place to hide and has been has been a good hiding spot for a lot of people for a long time, myself included, the now that that rain has gone, it is definitely time to start getting picky and fussy, it’s also time to sort of move, I try and do it sort of like a left and right and it’s not going to work for the interests of the podcast. But I’ve moved sort of on this left and right side left being the safest area, right being the riskiest area, I guess you could say and now that you can have more of a portfolio sitting in that left side of near risk free area with a return which actually makes sense, you can start to move more things out of that right side, it means that you do to summarize exactly what you said, God, that’s my expertise. The it means that it means that the things that you have on that right side, and in that middle side can be more picky about who it is that you choose. Now let’s now that every portfolio or most portfolios need to have some sort of an allocation to a diverse set of asset classes, one of those asset classes is small caps, that it could be depending on what is appropriate for the client. And I can’t say that, but the I can’t say what isn’t appropriate for everyone’s client. That’s sort of the deal that we do. However, many do have an appropriateness and a level for that in the small cap space. Where Where do small caps fit in on a standard long term profile, just so that we can all make sure that we’re on the same page. Now, we’ve got Ozzy Smokehouse and international so let’s just make it as easy as possible. And what we’re talking about just talking about local stuff here.

Jody Fitzgerald
Yep, sure. Yeah, I think I think it’s really important to understand that when you’re actually building out sort of your risk profiles, what you’re the key area that you’re concerned with is the path I guess, to the end destination. So assets with high levels of volatility, obviously more appropriate for those with longer timeframes and your higher gross asset exposures. And what you’re seeking in your more defensive areas or for investors with shorter timeframes is is a low level of volatility. So given that small caps are fairly well leveraged to a market cycle, and therefore can be expected to display higher levels of volatility through a cycle, it probably, you know, from our perspective, when we’re doing our allocations in portfolios, we tend to use small caps in the high risk profiles, and not so much in the low risk profiles in the low risk profiles will allow our sort of our large cap equity managers who might sort of like double down into that space when the valuation opportunities exist, but a permanent allocation to more volatile assets, like small caps in lower risk profiles, can sort of you know, is not necessarily wise using it as a tactical allocation. So if there’s a real valuation opportunity and having a small allocation potentially, but then you try to tie market cycles. So from our perspective, we think you know, sticking to the balanced and above tight profiles for for your small cap allocations,

James Whelan
or whatever got to do now. So we’ve now that we’ve sort of understood the framework in which we’re working. I’m gonna bring in Liam Donahoe Donohue sorry, principal and portfolio manager at Lenox Capital Partners. I interviewed him before, but we might as well do it again. He’s been he’s been listening in. I mean, there’s no secret is he was introduced at the top of the damn show. Sorry about that. Liam. Welcome back. Welcome back in now. Thank you. First off, let’s just go into your history and how you sort of managed to wind up I mean, let’s, let’s stay clear of the full origin story about some events in school, if you can sort of show your path, your path in the industry, I’m always interested in that, because there’s always something in there. That’s like, and now I’m doing this, and there’s always that little crux of aha, that’s, let’s let’s, let’s see if we can pick that over. Yeah, sure.

Liam Donohue
Absolutely. And thanks again, for having me, James, and good God as well. But in terms of my background, I was lucky enough when I was just finishing up my university studies to have a mate at the local footy club, who was a recruitment agent. And And just when I was finishing, he said, there’s actually a few jobs going on, I’ll put you forward to a couple of businesses that you might be interested in. One of those was Macquarie Bank at the time, it was still a bank, not a group and, and the role was in risk management. And initially, I thought that sounded a bit dry. But what I came to learn in terms of risk management in this particular role, which was in funds management risk, is that I got to see all that role, which ultimately, I did secure, got exposure to absolutely every different asset class. So equities, which is ultimately where I buy, I landed and found this specific interest, but Fixed Income Cash, private equity, currency, real estate, investing all of those areas, I got sort of behind the scenes access to in terms of that risk management position out of university. So it was a fantastic starting point, but ultimately confirmed what I’d always thought which was the equities was where I wanted to land. So moved across to the Aussie equities fundamental team at Macquarie where I’ve worked for 10 or so years bit over. And probably the Aside from learning the trade at Macquarie, which is a fantastic place to work a lot of very clever people and a lot of good friends coming out of that. Probably the most important connection for me was with what what ultimately became my business partner James Doherty, who I worked with for several years at Macquarie, who, at a point in time, both of our careers, we decided that the way forward for us was to go out on our own, leave the mothership of Macquarie, and try funds management as a standalone entity. So James and I both left Macquarie to start Linux Capital Partners in 2017. And and we haven’t looked back since. So

James Whelan
that was that was that was important. That was an important way of kicking that one off. And it’s funny that you mentioned that about risk, managing risk and being getting that kind of mutated that risk area. Because if there’s something that everyone learns, eventually, and not that I’m the old head of that, in any room that I walk into, I try not to be, I try to be the guy that’s asking the questions, not telling people. But I mean, managing money is, in effect, really just managing risk. And if you can get the handle on that, then capital preservation continues to be something that you can actually maintain, which is the first priority, or at least it is for me. And I’m sure that it is for you as well, the just spot on. So in terms of investment process, how do you go about assessing small cap stocks?

Liam Donohue
I suppose that just by way of background, our investment process overall is absolutely focused on bottom up stock selection. And, and it’s great to have Jodi’s view, and well spoken opinion in terms of the macro, because that’s absolutely something that, that I would put my hand up and say, I don’t have any sort of specialization in that area. I don’t form a view on interest rates, recession, inflation, those sorts of macro areas. There are people much smarter than me that have a view on those things like Jody, and I’m more than happy to leave that out of our process. But what we absolutely do focus on is some of those areas that are at times critical to certain businesses, how do they impact on a specific business? Because that’s really where we are focused? What are those areas due to the business? What does the market do to the business? What are competitors do to that business? How does that business respond? How do they turn a profit? And then ultimately, for us, what are they worth? And is there some valuation opportunity there for our investors? So in terms of in terms of taking that view, we are absolutely bottom up and how we, how we conduct that research, as a starting point for us is to get out of the office, which, again, as Jodi touched on the past decade or so when interest rates have been really low or falling to a really low state. It has been quite difficult to differentiate yourself again. You know, potentially index trackers, or computers, or just broad market exposure. But our view is that ultimately, by doing something a little bit different to those types of investors ultimately will get rewarded and our little bit different, I suppose, is to be out pounding the pavement, meeting people running these businesses, having face to face conversations with them sitting across a table, going out to see their factories, seeing their shop fronts, and understanding what makes these people tick, and how they are going to ultimately grow and build their business into a successful business that, you know, at some point in the future might actually become a very large company, as opposed to purely staying a small company.

James Whelan
So is the process you go through the due diligence you need to do is that different for different small cap companies. Because they don’t have the track record, it’s difficult to get the track record, or they don’t have as much data to look at as more established companies, obviously. I mean, that’s a pretty, it’s pretty obvious one. But sort of, I’d love to do some more of the detail behind that. And and, and this is a big one that we’ve got off the platform, what are the proxies that you can use for the likely success of a small cap business, you don’t have the data, but what’s a way that you can sort of have a measurement to to know, sort of just an alternative that you can have the proxy, I suppose this way of describing it? And yeah, there’s a few, there’s a few to unpack here for you. On a related note, are higher interest rates doing the job for you in terms of sorting the wheat from the chaff, forcing, the more marginal businesses out will come around back to that one again. But I’m really just looking at the data question to to tee off.

Liam Donohue
Short, short. Yeah. And that that is a very, very dense question there in terms of content. For the, for the last bit the interest rates, I think that probably is a fair comment in terms of higher interest rates are doing a little bit of that work in terms of, there’s no doubt when when money’s effectively freeze, you know, zero interest rates, probably lower quality businesses can survive, in that they have access to cheap funding. Higher interest rates, obviously make that a bit more difficult. But But I suppose coming back to sort of the main thrust of the question in terms of how we, how we work through the process, and you know, key areas that we’re looking to identify, to try and help us ourselves sort the wheat from the chaff, I suppose the main things that we do, and probably the you know, the main area that we spend time on as small cap managers is getting out of the office and meeting with businesses and management teams and people involved in small companies, we typically do over 500 of those meetings a year. So it is a big chunk of our workload. But that’s because in small caps, you absolutely have to get out there and do the work yourself. You compare it to large caps where there’s a lot of stockbroker or sell side research coverage, you know, for some businesses, you can just go back and look at their last 30 annual reports and, and understand the history of the business and the people involved. But in small companies, you tend not to have that luxury. So you actually need to get out of the office, be on the ground and meet with these people in these businesses. So in terms of what we look for, for small businesses, the the key points for us really relate to the people involved and how they’re incentivized and aligned. Because that can be a really good indicator for where the business is heading directionally in terms of earnings and profitability. The second point for us is, is sustainability or ESG. And for businesses, that’s really important now, because the ESG is absolutely a real part of any company’s future now, and something that has to be contemplated and plan for. So that’s a really important part of the business to understand. And then thirdly, the quality of the company’s earnings is really important in terms of our ability as investors to understand how powerful that business’s profitability is. And then, and then try and forecast that into future years, because that feeds heavily into our view on what we think the company’s worth those future earnings. So, so they’re probably the key areas that you need to understand in small caps. But as you mentioned, it really is something that you have to be out there doing yourself firsthand, because there’s, there’s not really anyone there that can do that sort of work for you. Yeah, that’s that’s

James Whelan
why that’s I suppose that’s why people pay you to do what you need to do. There’s no way that an individual investor, even an advisor could do that many do that many company meetings and actually sort of get to get to the bare bones of exactly what’s going on around the entire market and still do their actual job. That’s why exactly right. That’s why we have the funds doing what they do. Cheers, man. Okay, I want to talk briefly about performance strategy. So okay, Liam, I love the fact that we’ve got a small ordinaries index, I do love saying the small order rose index that makes you sound important. Tell us what that’s made up of. Because we’re going to talk about benchmarking. We’re going to talk about indexing. What’s the small ordinaries index? This is one of those classic questions. What’s the index made up of? How has it trended over the short and long term? And is it relevant? And then there’s the there’s the kicker question, so we’ll see how we go. The relevance of the small ordinaries index, that’s a very cutting question from one of our advisors. There.

Liam Donohue
It is, it’s a very pointed question. And I’ll try not to entirely TAKE THE BAIT there. But what I would definitely say is that just bearing in mind that I’m obviously a fundamental active small gap manager, I’ve got a pretty vested interest in in the discussion and, and, and whether the benchmarks relevant whether this part of the markets relevant, which I absolutely believe it is. But I suppose from my perspective, I think it’s a pretty difficult index to try and replicate in terms of, you know, an ETF or an index tracking investment for the small cap market. And there’s a range of reasons for that, like low liquidity that everyone knows exists in small caps, but actually also, the small ordinaries is a much more diverse market than you’d think. And if we look at large caps, as an example, it’s a it’s a really heavily concentrated market with about half of the market cap of the ASX 100, made up by the top 10 stocks. And we all know those businesses being the big four banks and a few commodities players and CSL, so you can pretty easily replicate that big chunk of that market with a really small number of holdings. But small caps, on the other hand, have a much more diversified index. Compared to compared to large caps for for smalls, we’ve got the 10 largest businesses in our benchmark only make up a bit over 10% of that index. So even though it sounds perverse, small caps is actually a much more diversified market than large caps. But that is obviously coupled with that lower liquidity so so it is a bit challenging from an index tracking perspective. But in terms of performance over time, the flip side, I suppose of having that larger number of companies, more diverse number of companies within the small cap market is that potentially there are also more ways to get hurt or lose money. So I guess in in small caps, there are more opportunities. But that cuts both ways. In that there’s potentially greater returns to both the upside and downside. So bringing all of that together, what that means is that if you’re actively investing and do the work and make the right calls, there’s definitely the opportunity for higher alpha or returns above the market in small caps, then then possibly other parts of the market, and I wouldn’t say large caps, but maybe large caps over time. But obviously, there are quite a few caveats in there. And I think that’s part of the reason why coming back to fundamental analysis and time spent on the ground, it is quite a laborious piece of work that you need to do to drive those returns. But there are absolutely opportunities there if you’re prepared to do

James Whelan
the work. Yeah. Okay. So active active preferred over passive for that index.

Liam Donohue
Well, that would be that would be my feedback, but again, flagging that I have a completely vested interest.

James Whelan
Yeah, that’s true. And I’m glad that you actually, you, you admitted that, which is, which is fine. Yeah, no, that does make a lot of sense. Now, what I’m going to try and do as Simone Biles style gymnastics to bring what you’re seeing in your pocket versus versus Jodi, what you might be saying, sort of broadly speaking, we’ll see if this comes off, and just we’ll just try something out here. But I mean, Liam, you must say, Jody chip in anytime you like with regards to anything that you see as appropriate. But, Liam, whilst you don’t have a macro view, which is which is fine and talking about, you know, the bigger picture stuff isn’t yours, because there are, as you said, there are different people who do those things, not necessarily smarter, just different. But the, you must surely see the sort of the sort of companies that are, are being included, or at least are being pitched with their growth prospects ahead of them. So is there is there any particular thing so I left that hanging out there, like I said, Simone Biles sort of flipping in the wind there, but the what, what, what sort of themes are you seeing being put towards you, and maybe we could sort of draw a pattern out there and see if that’s aligned, like I always give a reason for I’m doing, see if that sort of aligns with where potentially things are actually going or things aren’t. And then see if we can match that together with the risk the idea and I’ll let Doug, just let everyone know, and then I’ll ask you again, I’ll let everyone know, you know, that we all get BDMS pitches as as advisors and this is sort of what we do so so just just bear with me guys, because this, this will take half a sec, we get we get. We get BDMS and relationship managers throwing a pitch at us every now and then. The ones that don’t do a great job, you know who you are. No, you don’t actually but the they’re all still friends of mine. But the ones that don’t are the ones that always say that their product is the best, the best time to be in it. And that’s not always the case as we know because there’s a time and a place for everything that they should be the ones that The the ones that do great are the ones that say, This is what our product or sorry, this is what our asset class does. I know they’re out there, they are actually same products. It’s not that, but they say, This is what our thing does. And, and this is the time when it shines, and this is the time when it doesn’t. This is the time that you should look for when this particular thing shines. So maybe, Lee and let’s just see, without going too, specifically into let’s see what sort of what sort of stories you’re being sung. And then we’ll see maybe how they’re fitting into the landscape at the moment, see if we might be able to line up when when a small cap allocation might need to be overweight or underweight. And to see if we can just reach some sort of happy medium. We’ll try it out and see how we go. Yeah, sure.

Liam Donohue
It’s, it’s, uh, yeah, I’ll just jump into it. And that’s a really, really interesting question. And I suppose discussion point, and I’ll be interested to see how you weave it all together as well.

James Whelan
We’re winging it, like I said, there’s no script. Yeah.

Liam Donohue
Excellent night. Well, I suppose one of the things I would say turned to small caps is that and I’ll we’ll come back to specifically address that question. But one of the things I definitely say in terms of small caps is that we all know, it’s a reasonably volatile part of the market. And, and that’s why people probably, on average, would have a smaller allocation to small caps than they do to large caps, and amongst a host of other reasons, as well. But volatility is a big part of that. And it is a Yeah, it does move around a lot, no question about it. So one thing that I would definitely say is that, even though, you know, we try and sort of figure out where we are in the cycle, or when’s a good time, or a bad time to invest in small caps. Often those movements are so so quick and reasonably large, that even though you know, it is my bread and butter, I live and breathe small caps, and love that part of the market, I find it difficult to say, you know, tomorrow or next week or next month, you know, what’s going to be the the area that that people are interested in or, you know, is now a good time or a bad time. And one of the one of the comments that, that I recall from a friend of the quarry, in terms of small caps, is that the best way to play small caps is time in the market, as opposed to timing the market. And every time the market moves rapidly in one direction or the other, because it’s most likely an equal chance of of moving in either direction. Yeah, it’s just an interesting case study in terms of trying to pick particularly the small cap market, I think, personally is is fraught with danger and very, very difficult to time in both directions. Having said all of that, probably what what we’ve started to see over the past, let’s say six or 12 months, is that as everyone’s become a bit more comfortable, and again, I’m not professing to be a an expert on the macro side, but as everyone appears to have become a bit more comfortable with, when a recession or not, is inflation going to go up forever or not, or interest rates going up forever, or not? Everyone has sort of cool their jets a little bit and thought, Alright, we’re in at least some form of equilibrium or or, you know, things aren’t going to go in one direction forever. Where’s the market sit now in terms of valuation. And so what we’ve seen is a lot of the sectors or the, you know, types of businesses that we saw, sold off really heavily over the past couple of years, mainly around sort of that growth tech basket, have have really started to come back into favor, mainly because those are heavily undervalued, with the caveat that the business obviously had to survive. So there were questions around funding for a lot of those growth e textile businesses, as long as you were comfortable that the company was sufficiently funded, most of those businesses were starting to look reasonably cheap. So we’ve seen a real bounce in that part of the market. And in terms of probably the final leg of that that we haven’t yet seen is that the IPO market, which has been shut up for a couple of years realistically, hasn’t yet reopened anywhere near to the extent that it was opened prior to COVID, or a little bit post COVID as well. And so because a lot of people are nervous about the IPO market, and a lot of people obviously have a vested interest in seeing that market reopen, you know, right from vendors or potential businesses through investment banks and brokers. There’s a little bit of trepidation around the IPO market in that no one wants to be sort of the first you know, big deal to come through or if you are going to be one of those first few big deals. It needs to be a good one. Otherwise, that window that’s sort of just starting to creak open a little bit is going to be slam shot before we know it so. So we’ve seen Yeah, potentially some of those growth in more volatile parts of of small caps, find some support over the last six or 12 months. But for me probably the last piece of the puzzle, which hasn’t really yet opened up or kicked off is the IPO market. And again, as I said, there’s still a little bit of trepidation around that market. But it does feel like there are some businesses starting to come through to try and sort of squeeze that window open.

James Whelan
God chipping anytime you feel it’s appropriate. Otherwise, I’m just going to keep on talking about so no, that was a breath.

Jody Fitzgerald
It was a breath I’m coming in. Now, look, I we would agree, Lane with regards to timing, the market is just difficult for us. And it particularly for shorter term moves. So that concept of as we talked about earlier, people sitting on the sidelines during COVID, it was a six week drawdown if you’ve managed to tighten that six week drawdown then hats off to you. But the reality is, what’s important is having that longer term investment strategy and sticking to it. So we talked earlier about risk profiling, and in what risk profiles does small cap play more of a role? Because, you know, can you tolerate the volatility of that in the allocations, however, so even though we, you know, we’re not talking about short term market timing here, what we do, as investors is how we need to think in terms of probabilities, the future is uncertain. But what we want to do is stack the probabilities in our favor. And the way that you actually do that is by understanding risk and understanding valuation. So even in a portfolio where, for example, you’ve got an allocation to small caps, you there are points in a market cycle where you may want to think about the degree to which you might overweight or underweight that that’s not to say move in or out of the asset completely. And, you know, from that perspective, that’s where you start to have a look at sort of valuation, in an absolute sense, but also in a relative sense. And if you look at small caps over the last couple of years, they really have been a drag on relative performance in portfolios. And that’s predominantly because they’ve actually had more of a valuation adjustment than a lot of the larger caps, you know, both here, but also also overseas. So some of the US Small caps, for example, are presenting as decent valuation opportunities. And that’s because effectively, we do have very narrow leadership in the market at the moment. On a global level, obviously, with anything that’s got a high exposure, it seems to do well. But, you know, so, you know, as Liam said, you don’t you could go either way. But on the basis of probabilities, if an asset has had some level of repricing go through it, the probability of upside is bigger than the probability of downside and therefore, it might make sense to start sort of allocating a little bit more in this space. And that’s what we’re doing at the moment in some of our high risk profiles is, is tilting in a little bit more to the small cap area, not heavily, but just just just tilting a little bit.

James Whelan
Yep. And I do strongly Concur as well, from from my expertise as well, I’ve been in or out is a bad way to go. But a little bit, a little bit more in or a little bit more out is is usually the way of preferring to go with it. Now we’re running out of time, folks. So I need to just call last bids, as I call it last bids. So if there are any final points that you would like to make to our listeners, speak now or forever hold your peace.

Jody Fitzgerald
I think, you know, the the key for me in sort of like thinking about allocating to this space is it’s really important for whatever a capability or managing a go with is, you know, back to sort of an earlier part of that conversation is understand what you’re buying, when will it do well, what not, and particularly in small caps that are capacity constraint, it can be difficult to get access to good managers, etc. Understand that if it is actually doing what it’s supposed to do, if it’s doing what it says on the tin, leave it alone, even if it’s underperforming, understand that it’s a part of your overall strategy, etc. So monitoring the outcome relative to what you thought the outcome should be, and how that outcome then fits in with your broader investment portfolio strategy is absolutely critical, rather than trying to pick the best manager on any given day, because that will change day in and day out.

James Whelan
Yet should it show? Well, Liam, any last thoughts her?

Liam Donohue
Yeah, it definitely feels like small caps are in a good spot after a tough few years. And that definitely lines up with some of the emerging themes or trends that we’re starting to see through the small cap market, which typically is where those trends like technological advancement, and even things like AI, which is quite popular at the moment where those trends typically present first. So it is it is quite exciting to see that happening now. But I guess one area to look at for small caps is that small caps typically trade ahead of where the market thinks the cycles heading. So we usually see small caps sold off when the markets expecting any sort of economic slowdown, and then small caps typically bottom when either things start to look a bit better, or at least people get comfortable that things aren’t getting any worse. And that’s definitely what We’ve seen this cycle with small caps, extended periods of underperformance versus large caps. But what that does feel like now is that some of the leading economic indicators we’re seeing have leveled out. And at some point, that means they’re gonna get better in relative terms. And small caps will absolutely move along with that or possibly even ahead of that, given the equity investors tend to be probably perpetual optimist. So it is beginning to feel like even though it’s always a bit of a nervous call to make, that it might be time for for small caps to shine.

James Whelan
Yep, spot on. Well, I’m gonna wrap it up there, because I think that we’ve had a really good chat and I think it’s time to pick up the chips and push back from the table and take the dealer very much. Thank you so much. Jody Fitzgerald, head of institutional portfolio management and solutions. Not a mouthful at all, for Morningstar. Thank you. And Liam Donohue, principal and portfolio manager at Lenox Capital Partners.

Liam Donohue
Thanks, James. It’s been a pleasure.

James Whelan
No worries. If anyone wants to know that no problem or if anyone wants to know more about any of the things that we’ve discussed here, head to the ensemble platform. Go in and check it out. Everything will be linked to it. Check out for Dante partners, check out Linux Capital Partners, obviously check out Morningstar. My name is James Whelan, investment manager at VFS group and you have been listening to the ensemble investment podcast. Thank you so much for joining us, and I’ll catch you next time.