Skip to main content
MENU
Subscribe
  • Sign Up Free
  • LOGIN
  • Subscribe
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Face to Face
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2023 Defined Contribution East
    • 2023 ESG Investing
Breadcrumb
  1. Home
  2. Custom Media
April 16, 2018 01:00 AM

Small caps: Blending quant and fundamental management to get better outcomes

Sponsored Content
This content was paid for by SPONSORED.
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print
    David Corris, CFA

    Head of Disciplined Equities

    Portfolio Manager,

    Disciplined Equities

    BMO Global Asset Management

    Thomas Lettenberger, CFA, CPA

    Portfolio Manager,

    Disciplined Equities

    BMO Global Asset Management

    What accounts for the higher returns of small caps?

    David Corris: There are two competing explanations. Some argue that it's a risk premium: The higher return is compensation for taking higher risk. The other is an alpha argument: Small caps typically have higher growth, and by investing in unrecognized companies when valuations are still reasonable, you can achieve alpha through earnings growth paired with multiple expansion.

    The tax reform bill seemed to give small caps a boost at the end of the year relative to large caps, but will valuations, potentially tight credit and increased volatility keep any gains limited?

    Tom Lettenberger: Improved capital investment, aided by tax reform, should benefit small caps. We don't think these benefits have been fully reflected in valuations. Also, small-cap companies on average pay higher tax rates. As we go forward in 2018, tax reform will be a big reason why small-cap earnings growth will finally start outpacing that of large.

    What impact might the Fed's rate policy and hikes have on small caps this year? In general, how do macro-factors impact small caps?

    Tom Lettenberger: As long as rate hikes coincide with an accelerating economy, this should be good for small caps because they tend to be domestically focused companies. Periods of rising interest rates are periods when small caps have historically stood out.

    Though small caps certainly can have periods of higher volatility, companies tend to be less caught up in broad market moves and more driven by their own performance.

    David Corris: Macro tends to have more of an impact in large caps, while in small caps risk tends to be more stock specific. Our process is designed to recognize that.

    Tell us more about your process and why it is distinct.

    David Corris: The core value proposition that really differentiates BMO in small caps is the way we've blended quant and fundamental investing. Neither style is perfect; each has limitations. Quant and fundamental investing complement each other when paired properly, and this is especially powerful in small caps.

    For starters, to help with small-cap investing, quant has four components that fundamental investing typically doesn't offer.

    The first is that the small-cap universe is very large and does not have a lot of analyst coverage. For both reasons, quantitative methods tend to work very well. Second, liquidity and transaction costs are incredibly important in small caps. Quant managers can quantify those and build them directly into their process. Third, risk is highest in small caps, and quants do a particularly good job of managing risk. And fourth is portfolio construction: Quants view building a portfolio as a scientific process rather than buying a collection of stocks they like.

    On the flip side, fundamental investing mitigates some of the risks of quant investing. By its nature, fundamental understands individual companies and reduces the risk of data mining. So you lessen the quant-side risks of being fooled into data mining — which can lead to models that don't work well out of sample — and reduce the risks of not necessarily knowing well the companies you're investing in.

    Our view is you do much better by combining these styles — and there are not a lot of firms doing this well.

    Why don't more managers blend fundamental and quantitative?

    David Corris: The reason something that seems so obvious doesn't happen more often is that it's very hard to implement in practice. Quant and fundamental investors have very different cultural beliefs, and they typically don't work well together.

    Because of this cultural mismatch, firms that have tried forcing the two groups together have ended up with one team getting the upper hand and the other being subjugated. We've fully integrated our team so that quant and fundamental are equal partners at the table.

    What happens when quant and fundamental indicators are moving in opposite directions?

    Tom Lettenberger: Just because a company looks attractive in the quantitative model, it does not mean that we add it to the portfolio. That's where the fundamental review comes in.

    We look to reduce risks, to make sure that we don't have companies in the portfolio where the quantitative process may be missing something material. That's one of the risks we look for in our fundamental review.

    What role can small caps play in an institutional investor's asset allocation?

    David Corris: The case for small caps as part of your strategic allocation is very strong because of the ability to generate higher returns. There's a small-cap premium, a beta. But they also offer greater alpha. It's generally accepted that the small-cap market is more inefficient.

    Also, we believe this inefficiency is likely to grow, as European regulation may lead global investment firms to scale back their fundamental investment coverage of small-cap names. This situation is ideally suited to managers like us who rely more on quantitative tools than on sell-side research.

    Tom Lettenberger: As David mentioned, there are more inefficiencies within small caps, which can generate alpha. We believe the market for small caps will become less efficient going forward: Small caps generally have much lower institutional ownership than large caps, and they also have much lower analyst coverage.

    How would you sum up the opportunity in small caps?

    David Corris: Small-cap investing is an important part of investors' portfolios. Our view is that every investor should be thinking about their small-cap allocation and using active management due to the inefficiencies in the market. We think our integrated quant-fundamental approach is ideally tailored to the nuances of small caps.

    Tom Lettenberger: Small caps appear to be attractive as investment opportunity. An accelerating U.S. economy, rising GDP growth and favorable tax reform all play into the notion of small caps outperforming large caps over the short and intermediate term.

    CO115093412.PDF

    BMO ii

    CO115093412.PDF >

    Reader Poll

    January 25, 2023
    SEE MORE POLLS >
    Sponsored
    White Papers
    The Future of Infrastructure: Building a Better Tomorrow
    Fulcrum Issues: Equity Returns and Inflation — Choose Your Own Adventure
    What Matters Most in Considering a Private Debt Strategy
    Why pursue direct lending in the core middle market?
    Research for Institutional Money Management
    Are Factors a Thing of the Past?
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    December 12, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2023. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Face to Face
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2023 Defined Contribution East
      • 2023 ESG Investing