Opportunities abound in global small and mid-caps

At a time of considerable concentration in markets and where “big tech has been the place to be”, several mid-size and smaller companies are being overlooked by the market, says Barry de Kock, portfolio manager at Denker Capital.

He co-manages the relatively new Denker Global Opportunities Portfolio along with veteran Kokkie Kooyman as well as Jacobus Oosthuizen. The portfolio was launched in August last year and focuses on global mid-size and smaller companies in developed markets.

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De Kock told Moneyweb in an interview that over the past decade, market flows have predominantly favoured large-cap companies, particularly in the tech sector and the US market.

Earnings growth at attractive valuations 

Smaller companies, which have been largely overlooked, still have substantial market share to gain from larger incumbents.

“In mature industries, larger companies struggle to exceed GDP growth, whereas smaller companies have the agility to grow their earnings at a faster pace.”

Denker Capital has a track record of investing in smaller companies globally, De Kock says.

“Our rationale is that in the long run you’ll probably get better earnings growth than the market – at a very attractive entry valuation.”

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Besides the earnings growth potential, smaller companies also provide diversification.

“The funds that South African investors buy into for offshore exposure [are] heavily concentrated in the Magnificent Seven – the average exposure across 100-odd funds was about 14%,” De Kock notes.

Essent Group and Atmus 

The Global Opportunities Portfolio includes 41 stocks, with an average forward earnings multiple of just under 14 times, compared to 17 times for the MSCI World Mid-Cap Index and 20 times for the MSCI World Index.

“Our forecasted earnings growth over the next three years is 12%, which is just over 1% better than what we think the market is going to do,” De Kock adds.

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The portfolio includes companies like Essent Group, a US-based mortgage insurance company with a market cap of $6 billion.

“Denker has held Essent Group since 2016. Their through-the-cycle return on equity is around 15% and the stock is trading below book.”

Although there are concerns about rising interest rates and mortgage defaults, Essent is prudent with its underwriting, according to De Kock.

“We think there may be a seasonal uptick in delinquencies which they will easily manage.”

Another notable company in the portfolio is Atmus Filtration, a highly cash-generative company with a strong competitive advantage in the filtration industry. It has high “R&D” scalability and a “solid” market position, according to De Kock.

‘Too much consensus’

John Gilchrist, chief investment officer at PSG Asset Management, agrees that there are good opportunities for investors outside the large-cap companies.

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There is currently “massive consensus” around the so-called US exceptionalism, he says.

“The consensus is the US is dominating and it’s going to continue dominating and that’s where you’ll need to invest. But consensus often leads to complacency.”

Speaking at a PSG investment outlook event on Tuesday, Gilchrist cited the recent Bank of America Global Financial Survey where fund managers have had the lowest cash allocation over 25 years.

“And they’re the highest overweight in US equities in the survey’s history [starting in 2000].

“Concentration is not super-dangerous if you get it right. But we get really excited if we find opportunities where earnings are low for a temporary reason and the valuations associated with those earnings are also low.

“When the earnings grow and the rating grows – that’s when you get exceptional returns.”

The investment case for AB InBev

According to Gilchrist, the multinational drink company Anheuser-Busch InBev (AB InBev) is an example of an “under-appreciated, quality” stock.

“Why? It has strong brands, strong pricing power, and superior margins. They have best-in-class management who think as if they are the owners. The balance sheet is strong and it’s the cheapest in history.”

A word on China

Saul Miller, portfolio manager at Truffle Asset Management, notes that although the US market is expensive, it “doesn’t mean it’s going to collapse”.

Miller was one of a handful of portfolio managers who shared their investment sentiments for the year ahead at an event hosted by Nedgroup Investments on Monday.

Predictions about a US recession in 2024 were wrong, Miller says, but in an environment of high multiples such as at present, there is always the risk of capital loss.

“Therefore, we are under-exposed to the US. There are other places to invest.”

Some analysts view Chinese Artificial Intelligence (AI) startup DeepSeek’s rise to prominence this week as the beginning of potentially renewed investor interest in undervalued Chinese AI companies.

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But Miller is cautious about China in general.

“The biggest problem with China is it does not have a free and open market, so it’s hard to put a value on Chinese companies. It’s already hard to put a value on a company in a first-world country that is free and open.

“So we need higher margins of safety when we invest in Chinese companies and we tend to limit our exposure in China as a result of that. We certainly do not invest in China at the same levels we would have historically.”

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