A frequent topic of discussion in the investing world is
idea generation — how do you best come across great investing opportunities? Among
the typical avenues that institutional investors explore are conferences,
management roadshows (where a broker brings a management team to see investors
in a city), screening tools, and their own professional networks.
All of these avenues have their advantages and disadvantages
and merit their place in the investor toolkit. Excluding screening tools for a
moment, an important characteristic that these avenues share in common is that
investors do not take part in the initial filtering process. Conferences typically
feature a subset of companies selected by the conference’s host, management
roadshows are arranged by brokers and favor those companies with (a) a greater
focus on investor access and (b) a routine need to access capital markets; and
a professional network provides you with a set of companies filtered by someone
else’s unique likes and dislikes.
Coming back to screening tools, while investors set the
parameters that filter the companies on-screen, the input data are purely
quantitative and not always reliably accurate — which means good investment
opportunities can get filtered out. Long story short, investors outsource a lot
of the filtering in their investing process, which (especially in the small-cap
universe) may lead to some great companies with less investor outreach or no
need to access capital markets falling through the cracks.
Going A through Z and
investor road trips
On our Global Small Cap team, we cast our net very wide to
put a large number of companies through our filtering process. Naturally, the
more that goes into your filter, the pickier you can be, and we are very picky!
For this reason, we do not solely rely on the traditional idea generation
channels mentioned above, but also employ the cumbersome process of going “A
through Z” in any given country. Earlier this year, we went A through Z in
Germany for every company between about $150 million and $10 billion in market
capitalization, which was in the vicinity of 300 companies. From there, we
narrowed our list down to about 30 companies that fit our stringent criteria. We
then arranged an investor road trip, travelling through four states in Germany,
to visit a subset of the selected companies. The process was undeniably
intense, but it led to three key takeaways.
Of the companies that we visited, roughly
40% did not attend a single international conference in 2018. Furthermore,
approximately 40% were not covered by a single bulge bracket broker (a term that refers to the
largest brokers whose research reports have very wide circulation, thereby
reaching lots of institutional investors). To zero in on the overlap,
25% of these companies neither had bulge bracket broker coverage nor presented
at an international conference in 2018. This detective work has borne fruit as
Select Opportunities Fund has now invested in one of the companies
falling into the 40% bucket.
Access to management is usually of
higher quality via an investor road trip than via a conference. In a conference
setting, meetings often have to be shared with a small group of other investors
and usually run for about 30 to 60 minutes. In contrast, during our recent road
trip, we had one- to two-hour meetings with top management — without having to
share the face-to-face time with anyone else. On top of that, we got to see
management in their own environment. No matter what the annual report says, we
believe few things tell you as much about how tightly a CEO really holds the
purse strings than to see the environment where they go to work every day.
versus passive investing
Another interesting insight raised
by this exercise is the merit of active versus passive investing. To use
Germany as an example, only about 10% of the companies in the $150 million to $10
billion market capitalization range passed our stringent quality criteria. This
highlights that even in a country as economically strong as Germany, the high-quality
companies (as per our criteria) are in the absolute minority. But what about a
country like the US? In our view, the S&P 500 comprises an extraordinary
group of companies, which makes it a benchmark that’s very hard to beat over
the long term after the burden of fees — and thus a frequent topic of
discussion in the active versus passive debate. However outside of the S&P 500,
and especially in countries outside of the US, investors have to be a lot
pickier when it comes to business quality, which makes the merits of active
management outside of the US that much greater.
While a lot of work to set up, investor road trips together
with an A-Z filtering approach can be a very useful tool in the investor
toolkit, especially in a global small-cap fund. In addition to the immediate
investing opportunities yielded by our Small cap team’s recent trip to Germany,
this exercise has allowed us to add some great German companies to our wish
Note: While we referenced the Invesco Global Small Cap team
in the examples above, we employ the same investor road trip approach for the Invesco
Select Companies Fund, usually on a city-by-city basis.
Blog header image: Christian Bisbo Johnson /Unsplash.com
The investment techniques and risk
analysis used by the portfolio managers may not produce the desired results.
The risks of investing in
securities of foreign issuers, including emerging market issuers, can include
fluctuations in foreign currencies, political and economic instability, and
foreign taxation issues.
Stocks of small and mid-sized
companies tend to be more vulnerable to adverse developments, may be more
volatile, and may be illiquid or restricted as to resale.
To the extent the fund
invests a greater amount in any one sector or industry, there is increased risk
to the fund if conditions adversely affect that sector or industry.