Institutional investors are developing a keen taste for microcap stocks such as Red Robin Gourmet Burgers Inc. and Tex-Mex specialist Chuy's Holdings Inc. as they seek higher-return pockets in global equity markets.
Managers said they've never been busier fielding inquiries from chief investment officers looking to active microcap equity as a reliable return source as they rebalance their exposure to large-capitalization stocks and as a proxy for private equity investments.
There isn't a standard market-capitalization size range for microcap equities, consultants said, but the upper limit can be as high as $1 billion. The average market capitalization is about $600 million.
Total assets invested in 76 active U.S. and non-U.S. microcap equity strategies increased 17.8% to $26.7 billion in the year ended Dec. 31 and were up 40% in the two-year period, data from eVestment LLC show. Growth in institutional investment in 67 active microcap equity offerings —18.6% — to $22.6 billion in the year ended Dec. 31 and was up 44.5% over two years.
A significant driver behind current institutional interest in the asset class is the alpha generation potential that comes from identifying and investing in some of the smallest companies in the public equity universe.
"There are tremendous inefficiencies in the microcap universe, which includes thousands of small companies about which there isn't a lot of information and which are poorly covered by sell-side research firms," said Aoifinn Devitt, chief investment officer of the $2.7 billion Chicago Policemen's Annuity and Benefit Fund.
"The smaller the company and the less well-covered it is, the higher the potential for alpha generation," Ms. Devitt said.
The Chicago uniformed officers' fund launched a search in January for one or more U.S. or global microcap equity managers to run $50 million in the fund's first dedicated investment to the asset class.
"Alpha generation by microcap stocks comes from the information differential that managers can exploit, especially given the lack of analyst coverage and low institutional ownership of these very small companies," said David A. Corris, managing director and head of disciplined equities at BMO Global Asset Management, Chicago.
"Over the long run, the size premium results in good long-term beta returns and alpha," he said.