7 min read

Good things can come in small packages

With the anniversary of our CWB Wealth Small Mid Cap Equity Pool upon us, we reflect on some interesting learnings along the way. The pool was launched just over a year ago and invests in companies with market capitalization of $10B or less.

With more than 20 years of investment experience, Edward manages the Small-Mid Cap Equities portfolio at CWB Wealth. Working closely with colleagues, he finds investment opportunities in innovative companies with strong growth potential and good management, that the market misunderstands or underestimates.
  • The case for investing in smaller companies
  • Unique considerations in the small-mid cap space
  • Diving deeper into the CWB Wealth Small Mid Cap Equity Pool

Anniversaries are milestones that usually invoke a time to reflect. That said, we’re celebrating our own anniversary milestone with our CWB Wealth Small Mid Cap Equity Pool (SMID), which launched just over a year ago, a strategy that invests in companies with market capitalization of $10B or less. Although all our equity investment strategies have some exposure to companies of this size, this is the first strategy to have exclusive focus on these smaller companies. It’s been an interesting ride with lots of lessons along the way.

Figure 1: CWB Wealth Small Mid Cap Equity Pool AUM by month
 CWB Wealth Small Mid Cap Equity Pool AUM by month
Standard performance for >1 year is not available for the Pool.
Source: CWB Wealth

The strategy was seeded with about $7 million. Assets under management (AUM) has grown steadily to its latest size of $38.5 million (as of April 30, 2024). As AUM has grown, we are able to deploy more capital to the stocks we believe will yield better returns and also average-in to positions at favourable prices.

The case for investing in smaller companies

The bar for starting a new strategy for our clients is high, but simple. We must believe the strategy will provide an attractive risk/reward. In other words, it would have to add something to our client portfolios that wasn’t already there.

In building a business case for a small-mid cap strategy, we concluded that it met these criteria and it was also an opportune time:

  • Small-mid cap stocks underperformed large caps for over a decade and their relative valuation compared to large caps is at the lowest level since 2000.
  • Though their correlation with large caps is high, their beta (measure of volatility) is higher. This means that the potential for excess returns is higher in small-mid cap stocks compared to large caps (the opposite is also true).
  • Small-mid cap companies have stronger growth potential since they start small, compared to large caps that have to invest a lot to grow off an already large sales base.
  • Fewer investors are looking at these companies. This means better opportunities for pricing mismatch as the market may not know these companies well, thus potentially valuing them cheaply.
  • These companies should benefit more from recent onshoring trends. Studies show that for every job that returns to the U.S., seven supporting jobs, mostly in smaller companies, are created locally1.

Unique considerations in the small-mid cap space

Smaller firms have some unique challenges and require a specialized analysis focus. For example:

  1. Management analysis is one of the tenets of our investment process. In small-mid cap companies, management becomes even more important than in larger companies as a small business doesn’t “just run itself”. As such, we research management’s past performance with other companies, their capital allocation track record, what they promised and what they delivered in much more detail and critical view.
  2. Market data is not as readily available as with larger companies, since these smaller businesses, especially those with no debt, have very little brokerage coverage. We invest more effort in obtaining market data ourselves.
  3. We’re able to find unique companies that are not available in the large cap space. These companies can grow much faster than the large caps, and therefore can produce substantial returns. A few interesting companies that we hold are Medpace, NMI Holdings, Savaria, Western Alliance, Globus Medical and Ultra Clean Holdings.

Diving deeper into the CWB Wealth Small Mid Cap Equity Pool

We launched this investment strategy on March 9, 2023. From launch until the end of April 2024, the strategy has outperformed the benchmark (Russell 2000 Total Return Index) by 5.5% (Figure 2).

Figure 2: CWB Wealth SMID Cap Equity Pool vs the Russell 2000 Index
CWB Wealth SMID Cap Equity Pool vs the Russell 2000 Total Return Index
Source: CIBC, Bloomberg

Several stocks helped us achieve this performance, both positively and negatively. Figure 3 shows the contribution of our five top performers and our five largest laggards (as of April 30, 2024). The returns show the impact on total portfolio return. Below we share a deeper dive into some of the holdings.

Figure 3: Stocks that added and detracted from CWB Wealth Small Mid Cap Equity Pool performance
Stocks that added and detracted from CWB Wealth SMID Cap Equity Pool performance
Source: CWB Wealth

EQB Inc.: One of the largest Canadian alternative mortgages providers. They offer mortgages to borrowers that are unable to borrow from the large banks. This might be due to a lack of stable income or short credit history, with many of their customers being small business owners and newcomers. They generate a high return-on-equity and since their valuation is low, this high return propelled the stock to be one of our best performers this past year.

Medpace: Helps mostly small biotech companies conduct drug trials. With this company, we get exposure to the growing drug development pipeline, but without the risk of trial failure since Medpace gets paid whether the trials are successful or not. The biotech space experiences the fastest growth, resulting in the stock increasing substantially in the past year.

Western Alliance: A specialized commercial real estate bank. The stock declined due to the regional banking crisis in the U.S. last year. We were specifically impressed with how their management handled the crisis. The stock increased as the crisis abated and management improved the balance sheet substantially.

Pediatrix: Provides neonatal services in U.S. hospitals. The company has been struggling with revenue generation and margins over the past few years, especially due to lower birth rates. We believed that new management can turn the company around. After several quarters, we saw that they are unable to deliver, so we sold the stock.

Wilscott Mobile Mini: Rents portable office and storage facilities that predominantly caters to the construction industry. The company underperformed this year since construction starts declined, which led to a decline in the square foot they rent. The company also benefits from “mega projects”, however, many were pushed into the future and their start time is difficult to assess, which also contributed to the underperformance. We still own a position in this company.

Malibu Boats: Manufactures some of the strongest brands in the recreational boating segment. This company is caught in a perfect storm. The industry is down, its long time CEO is retiring, and one of its dealers allegedly committed fraud and is now suing the company. This industry is highly cyclical, therefore we believe that the best time to own such a name is when all the bad news has already happened. We still own a position in this company.

Conclusion

We are excited to mark the first year of the CWB Wealth Small Mid Cap Equity Pool, and are pleased with the results. New and unique businesses are being introduced to client portfolios that aren’t available in larger cap stocks. This helped us achieve the performance-to-date. Through adhering to our investment philosophy and process, we believe we’ll continue to add value to client portfolios over the long-term.

1Source: American Century Investments

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