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.
Of late, people are blaming a variety of economic ills on an unlikely villain: the desire of investors to earn good returns on capital. But, no industry can be expected to survive if it is not creating value for the investors in that industry. Earning good returns on capital is not an obstacle to satisfying consumer demands; it’s what enables companies to continue to satisfy those demands.
This Is Why We Can’t Have Nice Things
Until recently, we had been living in a disinflationary environment that started in the 1980s. We believe three factors – Deglobalization, Demographics and Decarbonization – have led us to a secular reflationary environment. As a result the next decade is going to look quite different than the 2010s, with a number of critical implications for investors.
The transition to net-zero emissions (NZE) involves a fundamental change in the structure of the economy, and will likely be messy, implying periodic supply shortages and even more volatile energy prices. Further, inflation and nominal interest rates will probably be higher and more volatile, especially relative to the levels of the last two decades. This has not yet been priced into markets.
Greenflation: The Energy Transition Will Prove Inflationary
China has launched a new policy framework, “Common Prosperity,” which escalates government steerage of the economy and features two critical initiatives. First, Beijing is taking action to tame the country’s real estate obsession. Second, the “summer blizzard” of regulatory actions has targeted a wide range of tech-related sectors including fintech, social media, online tutoring and gaming. Here, we examine the implications for investors of the pendulum swinging ever further in favor of the state.
China’s “Common Prosperity”: What Does it Mean for Investors?
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.