To most Australian investors,ย small to mid-sized stocksย are synonymous withย subscale and speculativeย ventures with inadequate balanceย sheets or a weak market position.ย But for the portfolio managers ofย the Fidelity Global Future Leadersย Fund, the global small to mid-capย sector is a different beast altogetherย โ and more attractive than the usualย blue-chip giants.
In short, theyโre the equivalent of Goldilocksโ porridge: not so wellย loved enough to be overvalued,ย but well established with marketย leading positions.ย โThey do come with moreย volatility โฆ but the additional returnย you get from investing in that asset class has shown to more than compensate for that,โ says Fund co-manager James Abela. Co-manager Maroun Younes addsย there are โstructural advantagesโ to pursuing such stocks, including less analyst coverage which increases the opportunity for mispricing.
While there are no hard and fastย rules in defining the global small/midย cap sector, the Fund targets stocksย outside the top 10 or 20 on theย major bourses.ย From an โinvestible universeโ ofย 4000 stocks, Fidelityโs managersย whittle down the potential selectionsย to 100 or so, using a core โbottom upโ approach of assessing the companyโsย fundamentals.
Filters include return on capital, earnings consistency and reliability, the structure of the market and โย increasingly โ compliance with goodย environmental, social and governanceย (ESG) practices.
The Fund also seeks companies with structural tailwinds, either because of the industry itself orย because the individual company isย gaining market share.ย The fund currently holds 40 to 70ย investee companies at any one time, ranging in market cap from $US3ย billion to $US50bn ($5-80bn), with aย median valuation of $US20bn.ย โWe are not talking about conceptย stocks,โ Younes says. โBy and largeย we are talking about well-established businesses that in many cases haveย been around for 10 years or more.โ
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Around two-thirds of the Fundโs circa $300 million of holdings are US based, which is not deliberateย but no accident either. โUS companies tend to do wellย in their own market and then go
global,โ Younes says. โThey generallyย have higher returns on equity andย returns on capital and are moreย investor friendly.โย The Fundโs biggest investment is the New York Stock Exchange-listed
Cheniere Energy, which exports LNG to a gas-hungry world.
โThe company owns theย infrastructure, but it doesnโt own the gas itself, sourcing it from third party suppliers. It has access to enormous volumes of low-cost gas from the Permian basin in Western Texas,โ Younes says. Another key holding is the mid-tier US insurance broker Arthur J Gallagher, which โownsโย its customer while not bearing theย underwriting risk of an insurer.ย Ultimately, proof lies in performance and the small/midย sector has comfortably outshone theย global large caps over the last threeย to four decades, as measured byย annualised returns.
The Fundโs benchmark, the MSCIย World Mid Cap Index NR, returnedย 8.74 per cent per annum betweenย 1994 and 2021, compared with 7.96ย per cent for the large caps index.ย The Fund itself has delivered anย annual return of 10.80 per cent sinceย it was established in September 2020,ย compared with the benchmark ofย 8.84 per cent.ย โWe are looking for companiesย that will double in value over the next decade,โ Maroun says. โThatโsย really the core of what we are looking to invest in.โย He says the managers are ableย to tap Fidelityโs global network ofย hundreds of analysts, who have directย access to the senior management ofย prospective investments. โThat makes the job easier for usย located here in Australia to coverย the entire world.โ
Originally published by Fidelity International