Don Smith
The combination of emerging markets and small caps can deliver an enduring premium for patient investors. That is certain, or as certain as anything can be in the investment world. Some big global managers, such as BNP Paribas Investment Partners, are combining them with interesting results.
According to Donald Smith, who was recruited from Turner Investment Partners along with his colleague Rick Wetmore last year to head up BNP’s emerging markets team, based in Boston, emerging markets (EM) small caps have similar attributes to their larger-cap brothers, but with the added complexities of liquidity, lack of information, access difficulties and governance. Hence, the additional premium when you get it all right.
Smith, a former Olympic rower who towers above everyone in most rooms, presented a paper at the annual CIE Equities conference in Victoria last week. BNP launched only a few weeks ago – in late May – its emerging markets small-cap strategy for US investors. Its emerging markets all-cap strategy was made available in Australia in June.
The challenge for Smith and Wetmore is to harness the knowledge and contacts of its affiliated managers. BNP has associated – either fully or partially owned – firms all around the world, 15 of which have on-the-ground investment teams. It is those 15 which are linking up to produce the required stock-specific and strategic analysis that combine in the BNP emerging market strategies.
Smith says that the 10-year information ratio numbers for EM small caps are slightly superior to EM generally, but the small caps have a “meaningful idiosyncratic” benefit, whereby stock-specific analysis is a critical driver for returns.
“BNP has an exciting story with its emerging markets platform,” he says. “That is one of the strongest reasons which attracted me to the job [as CIO emerging markets]. One of the mandates is to better integrate all the firm’s resources and utilise the capabilities. Apart from picking off the low-hanging fruit, we want to get their insights into governance and other knowledge of the companies.”
Smith adds that the affiliates have no conflict because they are all managing money for the firm. “There is a very strong push for collaboration [within BNP],” he says. “Every interaction I’ve had has been very positive.”
As an example, Smith was concerned to get an update on the recent Turkish election and was able to do so, over the crucial weekend that it occurred, to enable a timely decision on BNP’s exposure. The western world breathed a sigh of relief after Turkey voted for a more democratic leadership and the markets reacted accordingly.
BNP’s main EM strategy is an all-cap product with about 70 stocks, looking for high-quality stocks with strong growth potential. The new EM small-cap strategy has about 75 stocks with market caps of less than US$5 billion, but mostly under $3 billion.
Both strategies are broadly diversified across country and sector but Smith says the managers want stock selection to drive the majority of returns. Typically, the portfolio will be tilted towards technology, health care and some areas of consumer products given the leaning towards growth.
“We want to have multiple ways that the companies can win and we want to avoid those which may have a permanent loss of capital.”