SMID & Small Cap Value – 1Q 2021 Review
Cambiar SMID and Small Cap Value portfolio managers provide an update on performance and expectations going forward.
Hello and thank you for joining our first quarter 2021 podcast to update our friends, clients and partners on the Cambiar SMID and Small Cap Value strategies. We continue to wish everyone well first and foremost, with continued optimism that 2021 will bring wider health, safety and resumption of normalcy to all. I am Andy Baumbusch, and I am Colin Dunn, co-portfolio managers of these two Cambiar products.
Wow. We continue to witness events inside and out of the equity markets that stretch basic logic and leave us with a growing sense of overall uneasiness. On the market front, evidence of speculative activity continues to build – disruptive story stocks reached heroic levels of valuation early in the quarter, only to give way to the unlikely explosion of value in various stocks egged on more by memes than a clear fundamental case for long term cash flow. The emerging and expanding crypto world also experienced a massive increase in economic value in terms of both the major cryptocurrencies as well as the even more frontier like instrument, non-fungible tokens. We also saw an incredible amount of equity issued into SPACs during the quarter, eclipsing the already record-setting entirety of 2020. Amidst all this, we witnessed distress at two large investment pools, one of which required a large capital infusion to continue and another liquidated at the expense of counter-party balance sheets. No doubt many factors are contributing to these events, but we have to wonder if the mind-boggling $3 trillion in stimulus paid out or agreed to during the quarter is playing a role, noting the record level of retail trading activity in the period. Simmering at the core of the market is a debate about the trajectory of inflation and its impact on benchmark interest rates, which doubled during the quarter. Away from markets, we witnessed the transition of presidential power from one group to the next, accompanied by the bitterness and conflict seemingly now inherent to any political discourse. This laundry list of happenings seems enough to fill a year, but we lived it all over three months, which remarkably followed a year that was historic itself in 2020.
In terms of the underlying small and smid cap equity markets, stock price momentum from late 2020 carried over into this year. For the quarter, the core Russell 2000 index increased 12.7%, while the Russell 2000 Value index rose an even stronger 21.2%, beating the growth component by over 16%. This robust performance brings trailing twelve-month appreciation to nearly 95% for the core index and 97% for the value group, the second best and top performance, respectively, since the Russell index inception according to investment bank Jefferies. Also similar to late 2020, the index gains were led by the smallest, least profitable, and most highly levered companies. Russell 2000 Value companies with market caps less than $500mm rose 29% in the first quarter, while those with market caps over $1bn rose less, at 19%. Those companies in the lowest ROE quintile increased nearly 35% in the quarter, while the most profitable rose just under 20%. Finally, the most levered entities increased 24%, well ahead of the 16% for the lowest leverage companies. All this data, also provided by Jefferies, further suggests strong investor risk appetite and is at least partly owed to the robust money flows into passive small cap ETFs, where volume tends to disproportionately benefit smaller index constituents.
These transitory market conditions, while they last, are seldom ideal for an investor, such as Cambiar, that believes superior long-term returns and capital protection are best delivered to clients by aligning with highly profitable companies with good balance sheets at prices that offer a skewed risk-reward.
Nevertheless, Cambiar’s Small Cap Value portfolio delivered a return of 13.4% in the first quarter and 80.5%, net of fees, over the last year. Though this trailed the value and core indices over both periods, we have regularly noted the potential for our portfolio strategy to lag in times of excess risk appetite, as seen today. This is in contrast with our expectation for greater resilience of our portfolio when uncertainty is high, as seen in early 2020 when the small cap value strategy held up better than the indices.
The SMID value portfolio delivered a positive absolute return of 15.9% for the quarter and 84.8%, net of fees, over the last year. These results modestly lagged the value indices in these times of exuberance, after holding up better than the benchmarks in the more challenging times of early 2020.
Both strategies experienced a performance headwind from our underweight to the consumer discretionary and energy sectors, the two best-performing industries in the quarter. With secular challenges coursing through the consumer sector and a history of poor returns and cash flow generation among energy companies, we struggle to find attractive medium to long-term investment opportunities here. However, as evidence of our attempt to mine these areas despite the obvious challenges, it is worth noting our best performing stock in the quarter in both strategies was a home goods retailer. The Small Cap portfolio also realized a strong positive contribution from a commercial electrical components supplier, airline, medical device supplier and auto software company. Weaker performers in the quarter included a drug company, a payments technology provider, cardiac medical device producer, commercial real estate broker and baby clothes apparel retailer. The SMID portfolio benefitted from bank and airline holdings, while experiencing a drag from a government IT business, as well as an optical laser producer for consumer electronics, a water utility, international payments business and a frozen potato supplier for restaurants.
With markets marching higher during the quarter and some recent acquisitions of our portfolio companies by other companies, we existed 10 positions in the Small Cap strategy during the quarter and 5 in SMID. Nearly all of the exits were driven by successful thesis realization and price discipline, though, in a few cases, we were less excited about the prospects for our holdings and decided to allocate capital toward better ideas. On that front, the idiosyncrasies of the small and mid cap equity universe continued to present us with potential opportunities for skewed upside return relative to our perception of downside potential. We purchased 9 new holdings in small cap and 3 in SMID during the quarter. The Small Cap portfolio saw larger turnover among healthcare holdings, with 3 sales and 4 buys, but otherwise activity was dispersed across sectors. The SMID actions were also spread across sectors.
Looking forward, unprecedented fiscal stimulus, a supremely accommodative Federal Reserve and the likely imminent unleashing of pent up consumer demand seem likely to drive impressive economic growth statistics and flatter company financials, regardless of underlying business strength. The tide is undoubtedly rising, so to speak, lifting many boats. The Cambiar Small Cap and SMID strategies own shares in plenty of companies set to see accelerating and robust results in coming quarters, though valued within justified bounds thus protecting against lower probability negative outcomes.
With excellent economic and company financial performance highly likely over the near term and still ample liquidity and loose financial conditions, the status quo could persist. Beyond the near term, the duration of robust demand, the amount of inflation and level of interest rates as well as proposed fiscal policy evolving from tailwind stimulus to headwind tax increases could all loom larger in investor minds than today. Recent market rotation has some wondering if this eventuality is already starting to be discounted. If and when rampant optimism gives way to a more balanced view of reward and risk, the cost of the speculative excess and lack of discipline listed earlier could become more apparent than now. It is then, not now, when the value of a commitment to a disciplined investment strategy will become apparent.
At Cambiar, we are committed to pursuing investments in equities of companies with a structurally advantaged position in a growing market which is converted into superior financial performance, including strong, consistent, and growing free cash flow, all while maintaining a durable balance sheet. We only pursue these stocks when we believe the price for the cumulative value we receive in return offers a skewed return opportunity, relative to the downside risk. This investment strategy is by its nature limiting, thus precluding us from participating in the frothy areas we all observe, even if we wanted to. We are committed to this way of doing things because we believe it is the best way to provide strong absolute and relative returns to our clients over rolling three and five-year periods, while protecting capital in adverse market conditions. We will resist the siren song of en vogue areas while still investigating the long terms trends and impact such developments can trigger for a wide array of stocks. While our investment strategy may not sound unique, we expect our discipline in staying the course to be differentiating. And we would not be surprised if our tenured and empowered stable of bottom-up sector research analysts uncover idiosyncratic investment opportunities in a volatile underlying market that could boost our performance in an environment that otherwise does not favor our style. We believe these are important considerations for any allocator of capital to small, SMID and/or value equities and are clear about where we stand against those variables.
We have flagged some concerns we observe in the financial markets, pointing out areas of potential excess. We do not flag these to be persistent doomsdayers or ignore many positives – there are no chicken littles here and optimism is a character trait we hold dear. We are thrilled to see the world climbing out of the COVID-induced doldrums we have all endured over the last year. It will be fun to evaluate the strong earnings coming from our holdings and we love to learn about the life-changing and disruptive technologies we all read about every day. Nevertheless, in allocating capital for our client partners, we must account for the risks we observe and reiterate our steadfast commitment to our disciplined investment approach in spite of temptation all around. We think these risks will eventually matter and believe the small and SMID value portfolios are positioned to weather them.
Thank you for taking the time to listen to our update on first quarter 2021 performance for the Cambiar SMID and Small Cap Value portfolios. We wish you the best, as hopefully your life returns closer to some level of healthy normalcy over coming months.
Certain information contained in this communication constitutes “forward-looking statements”, which are based on Cambiar’s beliefs, as well as certain assumptions concerning future events, using information currently available to Cambiar. Due to market risk and uncertainties, actual events, results or performance may differ materially from that reflected or contemplated in such forward-looking statements. The information provided is not intended to be, and should not be construed as, investment, legal or tax advice. Nothing contained herein should be construed as a recommendation or endorsement to buy or sell any security, investment or portfolio allocation.
Any characteristics included are for illustrative purposes and accordingly, no assumptions or comparisons should be made based upon these ratios. Statistics/charts and other information presented may be based upon third-party sources that are deemed reliable; however, Cambiar does not guarantee its accuracy or completeness. As with any investments, there are risks to be considered. Past performance is no indication of future results. All material is provided for informational purposes only and there is no guarantee that any opinions expressed herein will be valid beyond the date of this communication.
Performance: The performance information represents the respective Cambiar strategy composite and may be preliminary. Returns are presented gross (g) and net (n) of management fees and include the reinvestment of all income. Gross and net returns have been reduced by transaction expenses. Net returns are also reduced by actual investment advisory fees and other expenses that may be incurred in the management of the account. Gross returns for Cambiar’s Small Cap Value Composite (Institutional) and SMID Value Composite include accounts with both gross and “pure” gross performance. “Pure” gross, applicable to separately managed accounts that are part of broker-affiliated or broker-sponsored programs, including wrap programs, that waive commission costs or bundle fees (including commissions), has not been reduced by transaction costs and is supplemental information. Net returns for SMAs are calculated by subtracting actual SMA fees reported by the SMA sponsor. Cambiar negotiates advisory fees with each individual client or relationship. Please refer to our Form ADV Part 2A for additional disclosures regarding our investment management fees. Net of fees performance reflects a blended fee schedule of all accounts within the relevant composite. SMAs might also incur bundled fees that are charged by brokerage firms which sponsor SMA fee programs and that may include transactions costs, investment management, portfolio monitoring, consulting services, and in some cases, custodial service fees. Cambiar clients and mutual fund investors may incur actual fee rates that are greater or less than the rate reflected in this performance summary. Results are reported in U.S. dollars. Index returns include the reinvestment of all income, and assume no management, custody, transaction or other expenses. Each index is a broadly based index that reflects overall market performance and Cambiar’s returns may not be correlated to the index against which it is compared for a number of reasons including investment approach and number and types of holdings. Each index is unmanaged, and one cannot invest directly in an index. Cambiar’s past results do not necessarily indicate Cambiar’s future performance and, as is the case with all investment advisors who concentrate on equity investments, Cambiar’s future performance may result in a loss. The top/bottom contributors is for a representative portfolio in the strategy. A complete description of Cambiar’s performance calculation methodology, including a complete list of each security that contributed to the performance of the portfolios, is available upon request. Please contact Cambiar at 1-888-673-9950 for additional information.
SMID Value Benchmark: The Russell 2500™ Value Index is a float-adjusted, market capitalization-weighted index comprised of firms in the Russell 2500™ Index that experience lower price-to-book ratios and lower forecasted growth values. The Russell 2500 Index is a float-adjusted, market capitalization-weighted index that measures the performance of the 2,500 smallest companies in the Russell 3000® Index, which consists of 3,000 of the largest U.S. equities.
Small Cap Value Benchmark: The Russell 2000® Value Index is a float-adjusted, market capitalization-weighted index comprised of firms in the Russell 2000® Index that experience lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Index is a float-adjusted, market capitalization-weighted index that measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which consists of 3,000 of the largest U.S. equities.
Russell: Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Cambiar Investors, LLC. Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in Cambiar’s presentation thereof.