SMID & Small Cap Value – 2Q20 Review
Cambiar SMID and Small Cap Value portfolio managers provide an update on their portfolios and discuss outperformance for the quarter.
Hello and thank you for joining our latest podcast to update our friends, clients and partners on the Cambiar Small Cap and SMID value strategies – both second quarter performance and further clarity on how we have applied our steady investment process to these unprecedented times. We wish everyone well first and foremost. I am Andy Baumbusch, and I am Colin Dunn, co-portfolio managers of these two Cambiar products.
As has been well chronicled by numerous outlets, markets enjoyed a massive rebound in the second quarter, with the S&P 500 nearly cresting new all-time highs. While many have tried to capture the uniqueness of the year-to-date market gyrations, research shop Strategas Partners said it well in noting “There has never been a bear market associated with a recession that lasted only four weeks. Then again, there has never been a period in which the awesome economic power of the federal government and the central bank have been brought to bear so quickly.”
While the market rebound has indeed been a sight to behold, the gains have not been distributed evenly, with the fortunes of a few supremely advantaged companies looking brighter than ever – truly from a fundamental perspective, but even more so in the eyes of investors. This dispersion in perceived prospects of “winners” and “losers” has lead the now multi-year trend in “Growth” stocks beating “value” stocks to migrate into the realm of uncharted territory, characterized by 100th percentile type observations versus decades of history. We have offered some thoughts on the growth vs value debate, available on our website. Among other observations, we suggest that rather than obsess about a poorly defined style, we encourage investors to focus on the underlying attributes of an industry and company, and determine the right price to pay for what you get.
Though the upward sloping market trend of the second quarter was a mirror image of the plummeting first quarter, the relative performance of the Cambiar Small and SMID Value investment strategies similarly exceeded the benchmark value indices. The Cambiar Small Cap value strategy increased 25.2% (gross of fees) in the second quarter, well ahead of the Russell 2000 Value gain of 18.9%. The SMID Value strategy increased 21.7% (gross of fees) against the Russell 2500 Value’s 20.6% gain. This brings year-to-date outperformance (gross of fees) for the Small Cap Value strategy to 10.7% and 5.6% for the SMID Value strategy. Both strategies saw strong performance from technology holdings. Cambiar has long mined this sector for advantaged, unique businesses that offer superior financial characteristics and less GDP reliant growth opportunities. The heterogeneous nature of the sector’s constituents also allows for the creation of a portfolio that has diverse drivers of return, a central portfolio management tenet for us. The industrial sector is also a frequently trafficked area in our portfolios for similar reasons, with a large variety of high-quality business to choose from. Holdings in this sector have also been a solid supporter of year-to-date performance in both strategies. We have been less successful in the consumer discretionary sector, with 2Q and year-to-date holdings representing the largest drag on performance. The materials and energy sectors have also been a source of drag on 2Q and 2020 performance to date.
After a torrent of trading activity in the first quarter, amidst a sea on enticing opportunities for future value creation, trading activity was more normal during the second quarter. In the Small Cap strategy we exited six positions while buying four new holdings. In the SMID Value strategy we had five exits and three new buys. The actions spanned sectors, with buys in the technology, healthcare and discretionary sectors in small-cap and materials, real estate, and financial industries in SMID. Sells were also diversified, as were the rationale, from successful thesis and price target realization to the reallocation of capital toward better opportunities.
Initial underwriting of any position remains the most critical determinant of both forward return potential and risk mitigation. As always we look to identify businesses that possess a durable structural advantage – be it a differentiated product and/or market position. This should be verifiable in above-average financial metrics over time, such as margins, return on invested capital, and ultimately a pattern of consistent free cash flow. We also tend to avoid leveraged companies, with elevated debt potentially impacting the going concern realities of an ill-positioned business in a period of stress or simply disproportionately harming equity valuation in surviving businesses as an enterprise value based valuation metric compresses…both of these problems starkly evident as financial markets began to digest COVID-19 in early 2020. While the above represent hallmarks of good companies to us, it is the right absolute valuation for those attributes that provides both the above-average return potential and margin of safety against inevitable underwriting errors that ultimately govern our buy/sell decisions.
Understanding the potential paths of COVID-19’s progression has been the focus of much research across our team over the last five months, led by the thorough review of all the underlying science by our Healthcare analyst Charmaine Chan. While we have shared observations and points of view in postings on our website, our portfolios do not necessarily reflect an outcome one way or another. Our focus remains on owning the best businesses capable of delivering strong returns to our clients over the medium to long term. We always pursue balance across drivers of return, and risk. As such, some holdings will struggle more than others if economic activity remains subdued. That said, we have not taken on positions where an adverse COVID-19 scenario could imperil the going concern potential of a company. While great return potential could be embedded in some of those businesses, we will not proceed if we are not certain a company cannot make it to the other side of the chasm, however wide it may prove to be.
With COVID-19 developments and associated government support likely to remain open questions and a polarizing presidential election quickly coming upon us, we would not be surprised by more market gyrations through the remainder of 2020. As such, it should be a fertile time to be an active allocator of capital to the domestic small and SMID equity markets. Our deep bench of bottom-up research analysts remain comfortably focused on executing our stated strategy on behalf of clients. We are encouraged by the relative performance of the Cambiar Small Cap and SMID Value portfolios through the volatility, and excited by the stock-specific opportunities that have presented themselves for the benefit of our clients over a longer arc. Further, smaller-cap stocks are exiting one of the worst five year periods in their history and have led the market out of 9 of the last 10 recessionsI. That noted, now may be an opportune time to not just to consider exposure for a longer-term investor, but in particular gain exposure through a manager as focused on the specific characteristics of each individual holding and the aggregated ability to weather the inevitable downside periods in equity markets as Cambiar has shown.
Please feel free to reach out with any questions, and take care and stay healthy. Thank you for your continued confidence in Cambiar and we look forward to being in touch soon.
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.