U.S. Small Cap Quality Value
Seeks superior total and risk-adjusted returns by investing in U.S. small-cap companies.
At a Glance
Our U.S. Small Cap Quality Value strategy pursues long-term capital appreciation by investing in a portfolio of 60-90 small-capitalization U.S. companies. As fundamental investors with a long-term orientation, we select companies based on their ability to generate free cash flow and allocate it intelligently for the benefit of shareholders. Our bottom-up security selection process balances investing in our convictions with diversification and rigorous risk control. We limit the market capitalization of the securities in the portfolio to that of the Russell 2000 Index at time of purchase.
The U.S. Small Cap Quality Value Opportunity
- Access to a diversified portfolio of companies with high return potential
- Minimal research coverage, creating opportunities to discover promising but overlooked companies
- Active management by an investment team with an average of over 20 years of experience
- Risk management integrated with the investment process to minimize unintended risks and reduce volatility
- Record of strong risk-adjusted returns since inception
- Cash-flow-oriented approach and relatively low correlation with benchmark complements other managers within an overall asset allocation plan
Epoch’s Distinct Investment Philosophy and Approach
The bedrock of our philosophy is that the growth and applications of free cash flow represent the best predictor of long-term shareholder return. As a result, our security selection process is focused on free-cash-flow metrics and capital allocation as opposed to traditional accounting-based metrics such as price-to-book and price-to-earnings. We look for a consistent, straightforward ability to generate free cash flow and to allocate it effectively among internal reinvestment opportunities, acquisitions, dividends, share repurchases and debt pay downs. An essential factor is the evaluation of each company’s management team to confirm their commitment to transparency and building shareholder value. The companies uncovered by this process have inherently less volatility due to their ability to generate cash flow.
This strategy incorporates qualitative and quantitative analysis to identify potential investments, taking into consideration factors that can lead to growing cash flow. Stocks are then subject to rigorous fundamental research. We develop an investment thesis as we assess the sources of the company’s long-term value creation and management’s ability to nurture it. We scrutinize management’s track record of allocating capital, looking for those with the discipline to use free cash flow to maximize return on investment, thereby creating shareholder value. Once a stock has been purchased, we continually revisit our thesis and sell the stock if our price target is reached, our thesis changes or we see another investment with a better risk-reward profile.
While the portfolio is constructed from the bottom up, decisions are made with consideration of the macro context. Epoch’s Investment Policy Group, composed of senior members of our different strategy groups, provides insight and guidance on the global market environment and macroeconomic and industry trends.
We analyze risk as part of the portfolio construction process to monitor portfolio volatility and better ensure the delivery of the strategy’s goals. A senior member of the Quantitative Research and Risk Management team is a co-portfolio manager on every strategy managed by Epoch so that portfolio managers are aware of unintended biases and the effect individual securities may have on the portfolio. The portfolio is diversified across sectors and the sizes of individual positions are limited.
The recent surge in start-ups and unicorns reflects the broadening of the digital revolution across industries, and suggests improving productivity and free cash flow. Further, although the digitization of the economy is still in early earnings, we expect digital platforms to represent the majority of market cap by 2025, with tech, health care and communications the most promising sectors.
The Pandemic Accelerant Part II: Turbo-Charging the Digital Economy
Inflation risks are at a four-decade high due to today’s combination of a generous Treasury, an overly tolerant Fed, and a reopening economy. While our base-case scenario assumes only a brief period of above-target inflation, investors should brace themselves for more inflation scares, which will likely remain a key driver of equity markets well into 2022.
During the past two years, CBDC has progressed from a bold speculative concept to a seeming inevitability and will soon be a core feature of our financial ecosystem. The rollout of CBDCs will further accelerate the digitization of the economy, which is the key defining feature of markets over the past decade. This paper explores the implications for monetary policy, the FinTech and payments sectors, and the potential disintermediation of significant swaths of the commercial banking system.
Money 3.0: Central Bank Digital Currencies (CBDC)
The Cambrian explosion of exciting breakthroughs in AI, autonomous driving, 5G, and cloud computing will drive double-digit growth in semiconductor revenues for the foreseeable future. Superstar firms have come to dominate all subsectors of the increasingly concentrated semiconductor industry, which implies pricing power and explains the sector’s attractive operating margins and return on capital. Valuations are reasonable, and we have a constructive view on the semiconductor sector and believe it possesses considerable upside.
Moore’s Law & the Race for the Rest of the Chessboard
Both sides of the political spectrum have been increasing their calls for regulatory action on the Big Tech companies. Here we explain why tech will continue to be the most dynamic sector of the economy, and why we expect greater breadth in tech market leadership and the emergence of entirely new sub-sectors.
Will Biden Take On the Tech Barons?
More than just our proprietary stock selection model, the Epoch Core Model (ECM) is a rules-based expression of Epoch’s free cash flow investment philosophy. Learn more about the components that make up the ECM and how it’s being used to enhance the firm’s investment processes across strategies, to surface ideas for further research, to prioritize our research queue, and to inform our portfolio construction process.
The Epoch Core Model: Our Proprietary Stock Model
In understanding the performance of any investment strategy, it is important to pay attention to how real economic events drove that performance, rather than fall back on a set of abstract factor returns as if they were somehow responsible.
Factors: Not Driving, Just Along for the Ride
The last six months have been profoundly transformational, with the COVID shock acting as an accelerant for the digitization of the economy. This radical transition is especially advantageous for asset-light business models. All companies will be acutely affected, although the biggest winners are platforms, with their economies of scale and low marginal costs.