For over 20 years, Opus has been investing in small cap stocks. During that time, we have developed an expertise in evaluating companies that are underfollowed, misunderstood, and undervalued. The increasing interconnection among the world’s economies has led us to researching U.S. small caps within a global context,as often domestic small cap companies have operations, customers, and competitors located outside the U.S.
Opus International Small Cap
What we found in looking at many of these non-U.S. competitors is that they were better businesses than their U.S. counterparts. The combination of this investment expertise with the operational and trading capabilities from our emerging and developed market strategies allows us to offer an outstanding solution for clients looking to exploit the inefficiencies in non-U.S. small caps. Our International Small Cap Strategy is built on the same framework that has helped us achieve top-decile returns for our U.S. Small Cap Value Plus strategy since its inception.
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Michael Mauboussin's notes from his presentation at the 2020 Morningstar Investment Conference, held on September 16th and 17th. Q2 2020 hedge fund letters, conferences and more Michael Mauboussin: Challenges and Opportunities in Active Management Michael Mauboussin is Head of Consilient Research at Counterpoint Global in New York. Previously, he was Director of Research BlueMountain Capital, Read More
To learn more about Opus’ International Small Cap strategy, Mike Knapke, Manager – Marketing and Client Service spoke with Adam Eagleston, CFA, Principal and Portfolio Manager.
Q&A: Opus International Small Cap
Why international small caps?
The inefficiencies we see in domestic small cap stocks are amplified outside the U.S. Not only is there a much larger universe of stocks, but also there is even less sell-side coverage. In many cases, there is no coverage whatsoever. This is what provides us the opportunity to find great businesses at inexpensive valuations. For us, we look at both developed and emerging markets, and are finding attractive opportunities across the globe right now.
Describe the process for identifying and vetting ideas for the portfolio?
Like oysters, many companies look similar from the outside. We apply our craft to find those that are the most likely to have a pearl inside, and the only way to do that is by doing the hard work of primary, fundamental research.
Our process is simple. It is just like the Picasso quote on the difference between art critics and artists. Critics talk about form, shape, etc. while artists talk about where to find cheap turpentine. We are like the artist, and just try to find high quality, growing companies trading at value prices. We think casting a wide net maximizes our chances for success, and find ideas in lots of different places. In some cases it can be from meetings with company management, in others from researching a competitor or supplier. We also attend conferences, talk with our industry peers, and use factor-based analysis to find companies that look attractive.
In terms of our research process, we are trying to find the one or two things that a company can successfully accomplish to generate superior growth. We assess how likely the company is to achieve these objectives, and compare those to the risks associated with the business.
In conducting our research, we evaluate each company’s growth profile, quality, and valuation. Growth is a by-product of the company’s economics, industry dynamics, and macro environment. Our assessment of quality includes assessment of management and its capital allocation decisions as well as the company’s financial condition. The last thing we consider is valuation. We think if you start with valuation you can end up spending too much time looking at value traps, though on the flip side we do not want to overpay for any business.
How would you describe the ideal Opus stock?
We love companies with an owner-operator mentality. Incentives for these businesses are typically very favorable for shareholders. We also like companies that operate in a fragmented industry, have high switching costs, or a high degree of recurring revenue. It is always nice when the company converts a large portion of net income to free cash flow, too.
We are also big proponents of inversion, and thinking about what does not typically work. At some price any business can be attractive, but for us businesses that are commodity-oriented or have low barriers to entry have to be selling at a low multiple to even pique our interest.
How do you think about risk?
We really like Charlie Munger’s definition of risk, which is a permanent loss of capital or failing to generate an adequate return. We think things like tracking error and standard deviation are inconsequential in terms of delivering strong returns for clients. Likewise, we are not concerned about our weights in various countries, regions, or sectors relative to some arbitrary benchmark. Of course we are cognizant of how different companies we own may be affected by the same phenomenon, and own a diversified portfolio of 25-45 great companies that are broadly representative of the global economy. We size our positions based on our level of conviction in the company, which encompasses the risks associated with the holding versus the upside potential.
How does this strategy compare to your other strategies?
Opus’ investment philosophy is consistent across all strategies. We are looking for high-quality companies with growth potential that are trading at good valuations. In terms of our process, international small cap uses the same successful framework that has helped us generate top-decile performance for our domestic Small Cap Value Plus strategy.
Why do you think this strategy will be effective for non-U.S. small caps?
Analyzing a business is no different whether you are researching a U.S. company or one based outside the U.S. We apply the same criteria as we use for domestic holdings. The key for us is understanding the economics of the underlying business and whether the company and its management team are capable of generating superior returns on investment.
We think there are three sources of edge for the strategy. First, as we discussed, there is not much coverage on many of these companies. We often garner an information advantage by being one of few, if any, investors talking with company management. It is amazing how receptive many of these companies are to speaking with investors, and we ultimately become the expert on many of our holdings.
We also believe our vast experience and disciplined framework provides us with an analytical edge. Thoreau famously said, “it’s not what you look at that matters. It’s what you see.” What we are trying to find differs from what most value investors seek. We are not looking for cheap ice cubes that are melting a little more slowly than people think, but rather for snowballs gathering momentum.
Finally, we are patient investors, and take advantage of the market’s focus on the short-term to opportunistically position the portfolio.
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