The Case for U.S. Small Cap Equity

By: Tony Genua • June 15, 2018 • Product Insights

U.S. small-cap stocks have had a rewarding year so far but here are four additional reasons you may want to consider them in a well-diversified portfolio: 

1. More protection from trade worries – With the recent worrisome trade headline, U.S. small caps are more domestically focused as compared to their large-cap multinational counterparts. As such, if stronger trade actions are taken from the U.S. or other countries, U.S. small-caps have the potential to be better insulated from the fallout.  

2. More direct beneficiaries of tax reform – Being more domestically oriented companies, small caps have also been a more direct beneficiary of the recent tax reform and the corporate tax cut. Combined with soaring small business confidence and an overall strong macro backdrop, the ingredients are there for robust earnings growth in the quarters ahead, as reflected in consensus expectations in the table below.

Source: Jeffries Research as of June 2018

3. Strong M&A environment – M&A is a critical component of small/ mid cap performance as smaller companies that are disruptive to incumbents can be acquired at premiums. Small caps have historically done better in strong M&A environments. With large cap companies receiving a bonanza in cash from tax savings and repatriations, the prognosis for a continued strong M&A environment is good, a continuation of recent M&A strength. In terms of number of deals, 2017 was the 3rd strongest year out of the last 25 years, while 2016 was the strongest.

Source: Citi Research, as of June 2018

4. Investors have taken notice – Since President Trump’s first announcement of steel and aluminum tariffs on March 2nd, small caps as represented by the Russell 2000 are up 12%, as compared to the S&P 500 which is up 4%. Flow data has also shown a shift towards small caps as trade worries have intensified.

Conclusion
With highly uncorrelated returns to other asset classes, U.S. small-cap equity presents a unique opportunity for investors to add alpha to existing core global or U.S. equity portfolios without significantly increasing overall risk.

AGF U.S. Small-Mid Cap Fund has reaped the benefits that this space has to offer, being up over 20% year-to-date and achieving top quartile performance across nearly every performance period.

Source: Morningstar Research Inc., as of June 15, 2018.Morningstar Rankings reflect performance as of June 15, 2018 and are subject to change monthly. For greater detail see www.morningstar.ca. The quartile ranking and number of US Small/Mid Cap Equity Category funds for the AGF U.S. Small-Mid Cap Fund for each period are as follows: one year 1st quartile (265 funds), three years 1st quartile (184 funds), and five years 1st quartile (123 funds).
*PSD = Performance Start Date: June 9, 1993 (Series MF), April 27, 2000 (Series F), index return based on the PSD for Series MF.

1 On December 1, 2013, the Fund’s benchmark changed from the Russell 2500 Total Return Index to the S&P MidCap 400 Index. The benchmark change was applied form this date forward. The benchmark performance is as the nearest month end to the performance start date of the Fund.

 

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in share and/or unit value and reinvestment of all dividends and/or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated. The information contained herein is designed to provide you with general information related to investment alternatives and strategies and is not intended to be comprehensive investment advice applicable to the circumstances of the individual. We strongly recommend that you consult with a financial advisor prior to making any investment decisions.

Commentary and data sourced from Bloomberg, Reuters and company reports. The commentaries contained herein are provided as a general source of information based on information available as of June 14, 2018, and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. References to specific securities are presented to illustrate the application of our investment philosophy only and are not to be considered recommendations by AGF Investments. The specific securities identified and described in this commentary do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable.

©2018 Morningstar. All Rights Reserved. The information, data, analyses and opinions contained herein (1) include the confidential and proprietary information of Morningstar, (2) may include, or be derived from, account information provided by your financial advisor which cannot be verified by Morningstar, (3) may not be copied or redistributed, (4) do not constitute investment advice offered by Morningstar, (5) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (6) are not warranted to be correct, complete or accurate. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, this information, data, analyses or opinions or their use. This report is supplemental sales literature. If applicable it must be preceded or accompanied by a prospectus, or equivalent, and disclosure statement