Leading the way with US small-caps

The US stock market went on a tear after the US presidential election, with the month of November especially beneficial for small-cap stocks. The Russell 2000 Index, the broad market index used to represent small capitalization US stocks with weighted average market capitalization of around US$2 billion has gained 18.4% in for the one year period ending July 2017, outpacing the S&P 500 Index (representing US large cap equities) return of 16.0% and the MSCI AC World Index (representing global equities) return of 17.7%.

US small-caps have outperformed the broader US large-cap and global equities for the one year period ending July 2017

US small-caps have outperformed the broader US large-cap equities and Global equities for one year period ending in July 2017

Source: Bloomberg, as at 31 July 2017. Past performance is not indicative of future performance.

Why invest in US small-caps?

Compared to familiar mega caps stocks such as Apple and Microsoft, their smaller counterparts are often not as well-known or even understood by the average investors, to the extent that investors often shy away from the small-cap stocks. At Legg Mason, we believe small-caps can make a good tactical play as part of a diversified portfolio.

Small and micro-cap stocks represent an under-owned and under-researched segment of the market, and are therefore a much less efficient asset class than large-cap stocks – providing great scope for active managers to outperform.

Small and micro-caps: Under-researched and inefficient market segment

2016: Percentage of Companies with No Analyst Coverage

2016: Percentage of Companies with No Analyst Coverage

Source: Furey Research and FactSet, as at 31 December 2016. Micro-caps: <US$500 million. Small-caps: US$500 million - US$4 billion. Mid-caps: US$4 billion - US$10 billion. Large-caps: >US$10 billion. The definitions applied by Furey Research differ from Royce & Associates.

Since small companies are more dependent on their domestic market than larger companies, small- and micro-cap stocks represent an excellent way to participate in a resurgent US economy. Moreover, they are less impacted by the strength of the US dollar since majority of their revenues are generated domestically.

Over 80% of revenue from small and micro-caps are derived domestically

2016: Average Foreign Sales as Percentage of Total

2014: Average Foreign Sales as Percentage of Total

Source: Furey Research and FactSet, as at 31 December 2016. Micro-caps: <US$500 million. Small-caps: US$500 million - US$4 billion. Mid-caps: US$4 billion - US$10 billion. Large-caps: >US$10 billion. The definitions applied by Furey Research differ from Royce & Associates.

The investment universe of small companies is both large and diverse. The ongoing evolution of this asset class, which includes the entrance of new companies and Initial Public Offerings, makes small companies an evergreen source of investment opportunities.

Micro cap and Small cap universe

Source: Reuters, as at 31 March 2017

Post the US election, there has been a great change in outlook and sentiment, with more pro-business, pro-growth strategies which should bode well for small businesses, especially those in the cyclical sectors such as consumer discretionary, industrials, energy, materials and financials. Tax cuts could also boost earnings by 8% to 16%1. Moreover, small caps have historically done well in a rising rate environment due to stronger economic activity.

Cyclical sectors expected to have faster Earnings per share Growth (EPS) than Defensive sectors

Russell 2000 Sector & Index Annual Earnings Growth (%) for 2016 and 2017 (Estimates)2

2017 Median Estimated EPS and Sales Growth by Sector as of 30 November 2016 (%)<sup>1,2</sup>

1Source: Furey Research Partners, as of 4 April 2017. Estimated % increase to net income in the event of cut to corporate federal tax rate to 15% or 25%. 2 Source: Furey Research as at 10 August 2017 (sector medians).
EPS: Earnings Per Share

Small-cap value names have come off the lows of 2014 and 2015 and despite the rally, there is a good chance for higher valuations if we continue to see positive news and better Gross Domestic Product. The Russell 2000 Index, representing US small-cap stocks, has historically staged a strong recovery after a market decline of 15% of more since its inception.

Small-cap up market performance after a decline of ≥-15% since its inception

Small-cap up market performance after a decline of ≥-15% since its inception

Source: Royce, as of 30 June 2017. Total return is denominated in USD. 1The median calculation includes only full recovery period; the most recent statistics only indicate the data as of 30 June 2017 and do not represent a complete cycle. Past performance does not guarantee future results. Inception date: 29 December 1978

Legg Mason Royce US Small Cap Opportunity Fund

The Legg Mason Royce US Small Cap Opportunity Fund is a bottom-up, actively managed fund that seeks long-term capital growth via investment in a broadly diversified portfolio of US small- and micro-cap stocks, with market capitalization up to US$2.5 billion. The Fund adopts a theme-based, opportunistic value approach.

Why Invest in Legg Mason Royce US Small Cap Opportunity Fund

  1. Performance Track Record

    Since its inception over 14 years ago, the Fund has returned 11.9% vs the Russell 2000 Index return of 10.9% (as at 31 July 2017)

    Small-cap up market performance after a decline of ≥-15% since its inception

    Source: Legg Mason, as at 31 July 2017. Performance is calculated on a NAV to NAV basis (in USD terms), with income and dividends reinvested, if any, reflecting annual management fees. Performance for periods above one year is annualised. Past performance is no guarantee of future results. Inception date: 8 November 2002

  2. Distinct Investment Themes

    Invests in companies within four value themes: unrecognised asset values, turnarounds, undervalued growth and interrupted earnings

  3. Opportunistic Approach

    Focus on turnarounds that possess a catalyst for change, focusing on companies with low price-to-book and price-to-sales ratio

  4. Large and Diverse Opportunity Set

    Selects securities from the entire small-cap universe, not just the "value" portion. Fund typically holds 245 – 320 holdings, helping to mitigate stock-specific and liquidity risk.

  5. Meaningful Manager Continuity

    Portfolio managers Buzz Zaino managed the Fund since its inception in 2002 while Bill Hench managed the Fund since 2006 and prior to that contributed as an analyst. Both portfolio managers have a combined total of over 70 years of small cap investing experience between them.

"We would expect that, if rates are going up because the economy is improving, then the portfolio should do very well." – Bill Hench, Portfolio Manager


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This document, prepared by Legg Mason Asset Management Singapore Pte. Limited ("Legg Mason"), is for information only and does not constitute an offer nor solicitation to buy or sell any units of the Fund. The prospectus of the Fund is available and may be obtained from Legg Mason or its authorised distributors. Investors should read the prospectus prior to any subscription. All applications for units in the Fund must be made on the application forms accompanying the prospectus. An investment in the Fund is subject to investment risks, including the possible loss of the principal amount invested. The value of units and the income accruing to the units, if any, may fall or rise and past performance is not necessarily a guide for future performance.
All opinions and estimates in this document constitute Legg Mason's house view as of the date of this document and is subject to change without notice. Legg Mason, its affiliates, officers or directors, may have an interest in the acquisition or disposal of the securities mentioned herein.
Distribution of this document may be restricted in certain jurisdictions; persons into whose possession this publication comes should inform themselves of and observe such restrictions. This document does not constitute the distribution of any information or the making of any offer or solicitation by anyone in any jurisdiction in which such distribution or offer is not authorized or to any person to whom it is unlawful to distribute this document. This Fund is not available to US citizens, residents or greencard holders and may not be available in all jurisdictions.

 
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