10 November 2015, Stockholm, Sweden | News
Small companies have outperformed large companies over several years – and this will probably continue. This is according to Mikael Hanell, fund manager for the Catella Småbolagsfond small caps fund, which so far this year has risen by 23 percent (November 3, 2015). Among the fund's most successful shares are gambling companies Unibet and Net Entertainment, and pharmaceutical company Sobi.
Small companies are defined by the Carnegie Small Cap Index as those with a market capitalisation of up to SEK 40 billion. However, a majority of the holdings in Catella Småbolagsfond are smaller, in a range from SEK 1 billion to SEK 15-20 billion.
The fund now has assets under management of approximately SEK 4 billion and, because there is always a certain liquidity risk in small caps, it keeps a part of its capital in cash. The cash component is usually between 4 percent and 6 percent, partly to handle withdrawals, says Mikael.
"In addition, we supplement this with a number of companies that have much better liquidity than the smallest ones. Cash also makes it possible to buy into companies on weak days, if we believe they are good. We work actively with our holdings, and may sell a little on strong days in order to be able to buy on bad days," says Mikael.
Opportunities to adjust the holdings arise from time to time. Unlike large Sweden funds, movements in small cap funds are generally more fitful. This is because many of the shares are strongly driven by news and react when orders or other positive information are announced.
According to the fund manager, this was demonstrated clearly during the past quarter, when Catella Småbolagsfond performed very strongly.
"Our fund was then one of the best in Sweden, while in the previous quarter it did not quite achieve the same. This was because some of our companies delivered good results and exciting news during the quarter," he says.
The choice of industries in which the fund invests is determined not by the weighting of the various sectors in an index, but by company-specific stock picking. The fund has a leaning towards consumer-related companies since the Swedish consumer still has strong purchasing power and interest rates are exceptionally low. The fund holds, among other things, a large proportion of clothing companies, which are driven by domestic or Nordic demand, as well as gambling companies.
Gambling company Unibet's market capitalisation has grown steadily, and is today approximately SEK 15-16 billion. The value of this company has grown eightfold since 2009, making this share one of the fund's very best investments.
"Unibet has undergone a transformation over the years, from offering computer-based betting to now having mobile penetration of over 50 percent," says Mikael.
The fund has a number of holdings linked to gambling companies since Catella has closely followed this sector over the years. In addition to Unibet, which is already an established company, we have holdings in sub-suppliers such as Net Entertainment and Kambi, which was spun off from Unibet and sets odds.
One important holding in the pharmaceutical sector, and also a strong contributor to returns, is Sobi (Swedish Orphan Biovitrum). The company provides pharmaceuticals for rare diseases, and its drugs are very expensive. Sobi has a partnership with US company Biogen for haemophilia. This drug offers considerably shortened and simplified treatment.
"Biogen, which has marketing rights in the US, has shown amazing sales figures over a number of quarters, and Sobi itself now has the rights to the entire area of Europe, the Middle East and Africa (EMEA). It will hopefully begin its own sales of the drug in this region before the end of the year. It is several years ahead of the competition and, in particular, patients think it's fantastic," says Mikael.
Many companies have had an eye on Sobi. Investor is the largest owner, and the board rejected a bid this year.
Could there be a new bid?
"Sobi seems to think there is more potential in this. I believe there are still good prospects for a higher share price from here," says Mikael.
A sector where the fund has relatively few holdings is engineering, but there are even some attractive companies in this field. Some interest is starting to be shown in SSAB, which has been one of the year's worst shares and has been under intense pressure from price dumping by China.
"China has sold a lot of inexpensive bulk steel to the United States, which has caused margins to deteriorate despite falling prices for inputs such as iron ore. But the valuation of SSAB is lower than at the time of the Lehman crash, while the world market overall is relatively healthy, so I think that the stock may have bottomed out at just over SEK 30," says Mikael.
Trelleborg also gets a thumbs-up from the fund. The company is active in several strong markets, such as the airline industry, where it is a major supplier of rubber components. Trelleborg also supplies dampers for laptops and phones, and sells to the automotive industry, which is relatively strong.
The fund has also invested in Bravida, which provides services for electricity and ventilation. The company has stable earnings and, according to Mikael, share-price potential – although this share is unlikely to increase fivefold in three years, it has strong cash flows.
"It's very important when building a portfolio to not only stick with one kind of company. Otherwise you can do very well one year and then go right down the drain when a particular type of share is out of fashion. Some shares come to the fore while others take a backseat, which can happen when companies have performed very well," he continues.
Since small caps have outperformed large caps for a couple of years, their relative valuations have increased. But this does not necessarily mean they are expensive. Small caps have p/e ratios of around 20 for 2015 and 17 for next year, while large caps are around p/e 16.
Is the difference in valuations justified?
"Many small companies have much greater potential to deliver profits than large ones. Then, of course, there are companies like Fingerprint Cards, which has risen 1,300 percent this year and has contributed to the outperformance of the small caps index. But this also helps to make the p/e ratios much higher," says Mikael.
Company reports for the third quarter of this year have shown strong organic growth by many small companies. And, in addition, the positive impact of currency fluctuations is less pronounced for small companies than for large companies
"They may even have a lot of purchasing in dollars, or manufacturing in countries that are dollar-based. Large companies have had a currency tailwind and, as we enter the fourth quarter, they will find the comparisons tougher. This is another thing to be said for small companies," he continues.
The fund is up 23 percent this year (November 3, 2015) and 30.7 percent if we look back one year (November 3, 2015). Do you think the ECB will start to reduce its support purchases in the market?
"The ECB has actually increased its stimulus recently. This will continue for some time, but I do not believe that small caps are driven by this, other than possibly in terms of market sentiment. Small companies live somewhat in their own world, and should be able to deliver well despite reduced stimulus. And if stimulus is reduced, it's because the situation looks better."