Five Big Questions for Small Cap Growth Investors

Transcription

1 Five Big Questions for Small Cap Growth Investors

2 Five big questions for small cap growth investors In bull markets investors can t get enough of small cap stocks. But in bear markets or periods of economic uncertainty, investors often grow skittish, fearing underperformance and preferring strategies typically associated with capital preservation. Although such investor psychology reflects human nature, is it justified? At RS Investments, we believe that small cap growth investing and capital preservation are not mutually exclusive. Rather, done skillfully and within a comprehensive risk management framework, small cap growth equities can offer diversification benefits and generate alpha in all economic climates. Of course, all small cap growth funds are not created equal. Success in this style box requires uncommon discipline and skill. We have studied the art and science of investing in small, innovative companies over the past 26 years, and our experience has taught us that small cap equities can play a role in virtually all equity portfolios. This Little Guide identifies five critical questions to ask your small cap growth manager to ensure that the strategies and funds you recommend can meet your clients needs.

3 TOP-QUARTILE SMALL CAP GROWTH MANAGERS OUTPERFORM OVER THE LONG TERM Small Cap Growth Large Cap Growth Returns (%) year 15 year Source: Morningstar Inc., 25th percentile of active fund managers, annualized returns as of 12/31/12. For more information, please contact your RS Regional Vice President, or call or visit RS investments 2

4 1 on Is your small cap growth manager relying too heavily the tech sector? Small cap growth does not need to be a synonym for tech. All too often, actively managed small cap growth funds overallocate to technology stocks, but that type of narrow approach can prove costly. In fact, a 2012 research report from Bank of America Merrill Lynch suggests that small cap growth managers who have had recent performance issues may have been among those overweight in technology and underweight in health care. A better approach is to cast a wider net beyond the tech sector to include financial services, energy, health care, consumer products, and industrials. Screening for factors such as earnings quality and growth sustainability and applying rigorous risk management discipline across all sectors help drive alpha from stock selection. THE RS EDGE The RS Growth team covers all of the Russell 2000 Growth sectors. Our team of experienced analysts seeks to add alpha by finding innovative, growing companies using a sector neutral approach Big Questions for Small Cap Growth Investors

5 THERE IS MORE THAN ONE SECTOR IN SMALL CAP GROWTH Consumer Staples Energy Materials & Processing Returns (%) Consumer Discretionary 8.00 Health Care Producer Durables 8.56 Technology 6.5 Financial Services 6.22 Utilities 4 Source: FactSet Research Systems, Russell 2000 Growth 10-year annualized returns, as of 12/31/12. For more information, please contact your RS Regional Vice President, or call or visit RS investments 4

6 2Are your clients abandoning domestic growth opportunities? Many investors are wondering where to look for the best risk-adjusted growth opportunities. We believe that ample opportunities exist to find high-growth companies domestically, right here in the world s most liquid, mature, and transparent markets, where political and currency risks can be kept to a minimum. By focusing on small, innovative companies with sustainable earnings growth, investors can benefit from the next generation of mid or large cap companies early in their growth cycle. Moreover, by adhering to strict valuation metrics and only selecting those small companies with favorable risk-reward profiles, investors are better able to manage the risks inherent to opportunistic small company investing. THE RS EDGE Our deep fundamental process helps us find companies poised for sustainable earnings growth. Our strict valuation framework filters companies to ensure at least a 2:1 return-to-risk ratio in the portfolio Big Questions for Small Cap Growth Investors

7 DOMESTIC SMALL CAP GROWTH OPPORTUNITIES STILL EXIST Absolute forecast price/earnings ratio 15.1x Q79 1Q83 1Q87 1Q91 1Q95 1Q99 1Q03 1Q07 1Q11 Source: BofA Merrill Lynch Small Cap Research, Russell 2000 Growth returns, as of 12/31/12. For more information, please contact your RS Regional Vice President, or call or visit RS investments 6

8 3 capture Does your small cap growth manager innovation? Conventional wisdom holds that small cap stocks are overly sensitive to the macroeconomic environment. And because fast-growing companies often carry rich valuations, investors may worry that this makes them vulnerable in times of declining risk appetite. However, we believe that some small cap companies can use innovation and flexibility to extend their advantage in times of economic tumult. In addition, small cap companies generally grow organically, whereas larger corporations often grow via cost-cutting or acquisitions, both of which can be difficult to execute in economic downturns. Low-growth environments can be constructive for the right small caps. Therefore, we believe that small cap growth stocks should be considered far beyond their role as typical early-cycle recovery plays. The secret is finding managers with a systematic approach to identifying innovation and acting on the right opportunities at all points of the economic cycle. THE RS EDGE Our analysts focus their fundamental research on finding the innovation in products and services that leads to competitive advantages and sustainable growth Big Questions for Small Cap Growth Investors

9 INNOVATION DRIVES GROWTH IN SMALL CAPS THROUGH A VARIETY OF MARKET CYCLES 8 6 US GDP Growth Russell 2000 Growth GDP Growth (%) 2 20 Return (%) Year 40 Source: Bureau of Economic Analysis, FactSet Research Systems, Russell Investment Group, as of 12/31/ GDP figure is estimated. For more information, please contact your RS Regional Vice President, or call or visit RS investments 8

10 Is fund size becoming a performance drag for 4your small cap manager? If a small cap manager rapidly gains publicity thanks to strong near-term performance, the fund is likely to attract many new investors and assets. But will that manager be able to put the increased assets to work with equal success? Fast-growing hot funds may be compelled to relax their stock evaluation criteria or even their definition of small cap. Suddenly, the portfolio includes stocks that previously would have been filtered out. This type of style drift can have an adverse impact on future returns. We believe that performance can suffer when small cap funds grow beyond a certain point. Many fund managers recognize this as one of the realities of small cap investing and often close funds to new investors. Your clients not only need to monitor whether a fund is outgrowing its success, but also whether it will close before they commit capital. THE RS EDGE The smaller asset size of the RS Small Cap Growth Fund and the RS Select Growth Fund keeps the funds nimble so that fast-growing companies at the smaller end of the capitalization spectrum move the performance needle Big Questions for Small Cap Growth Investors

11 SIZE MATTERS: 40% OF LONG-TERM TOP PERFORMERS ARE ALREADY LARGER THAN $1 BILLION* Nearly 17% of active small cap growth strategies are closed** Percentage of 4- or 5-star ranked funds over the 10-year period $1 2B+ $2 3B+ $3B+ * Based on total AUM of funds with at least one 4- or 5-star ranked share class over the 10-year period. ** Closed active small cap growth managers in all share classes. Source: Morningstar Inc., as of 12/31/12. For more information, please contact your RS Regional Vice President, or call or visit RS investments 10

12 5 growth Are you limiting clients by indexing small cap strategies? Indexing has gained popularity among small cap investors, which is evidenced by the substantial growth in assets managed by ETFs in this sector. But the herd mentality is not always a good thing for investors. Fortunately, your clients need not be held captive by the sharp moves of indices, which are often driven by sentiment and institutional money flows rather than underlying fundamentals. A strong fundamental active manager can offer investors a better riskadjusted approach to take advantage of inefficiencies inherent in small cap growth investing. Consider that some of the smallest, most promising publicly traded companies are relatively illiquid and underfollowed by Wall Street. These stocks often are inefficiently priced given their growth prospects, and alpha opportunities may exist for those managers who are best able to exploit this dynamic. THE RS EDGE Our risk management framework helps us consistently quantify risk and return in the portfolios by marrying the best of the team s fundamental research process with sophisticated quantitative analysis Big Questions for Small Cap Growth Investors

13 SMALL CAP GROWTH ACTIVE MANAGERS OUTPERFORM INDEX $60,000 Morningstar Small Growth, Open End Funds net of fees Russell 2000 Growth $50,000 $40,000 $30,000 $20,000 $10, Year Source: FactSet Research Systems, Morningstar Inc., Russell Investment Group, as of 12/31/12. For more information, please contact your RS Regional Vice President, or call or visit RS investments 12

14 About RS Investments Founded in 1986, RS Investments is a research-driven investment management firm. For more than 26 years, we have provided investment solutions to meet the diverse needs of our clients. We believe the best way to add value over time is by investing with discipline, committing capital to our best investment ideas, and ensuring that the risks we take are deliberate in every fund we manage. The RS Growth investment philosophy is centered around the belief that sustainable earnings growth drives long-term stock price appreciation. Our team of senior investment professionals average more than 15 years of experience. We have developed a comprehensive risk management process to guide us from idea generation to sell discipline. Our flat team structure leverages the expertise of our analysts, who are all sector specialists as well as investors in the Growth Funds. For more information, please contact your RS Regional Vice President, or call or visit RS Growth co-portfolio managers, from left to right, Steve Bishop, Melissa Chadwick-Dunn and Scott Tracy Big Thoughts for Small Cap Growth Investors

15 MANAGER CHECKLIST Risk management Diversification Manager stability Style drift Performance Ask your manager what protocols are in place to ensure that risks are carefully measured and appropriately scaled. Risks need to be managed systematically on individual positions, as well as holistically for the entire portfolio. Does your small cap growth fund have the research capability to analyze company fundamentals across a broad range of industries? Some management turnover is inherent to this business. However, the loss of entire investment teams can impact the stability and performance of a fund. If key personnel are headed for the exits take a closer look. Make sure your manager does not stray from its stated small cap growth parameters. Abandoning discipline to chase returns or hot sectors is not a recipe for sustained growth. How has your actively managed fund been performing versus its benchmark? Is it built to deliver in both rising and declining markets? For more information, please contact your RS Regional Vice President, or call or visit RS investments 14

16 Important Information Investing in small- and mid-sized companies can involve such risks as having less publicly available information, higher volatility, and less liquidity than in the case of larger companies. Funds that concentrate investments in a certain sector may be subject to greater risk than funds that invest more broadly, as companies in that sector may share common characteristics and may react similarly to market developments or other factors affecting their values. Overweighting investments in certain sectors or industries increases the risk of loss due to general declines in the prices of stocks in those sectors or industries. Foreign securities are subject to political, regulatory, economic, and exchange-rate risks not present in domestic investments. Investments in technology and Internet-related sectors may be highly volatile. Not all funds or share classes are available at all firms. Please check with your financial advisor or representative for details. RS Funds are sold by prospectus only. You should carefully consider the investment objectives, risks, charges, and expenses of the RS Funds before making an investment decision. The prospectus contains this and other important information. Please read it carefully before investing or sending money. To obtain a copy, please call or visit RS Funds are distributed by RS Funds Distributor LLC, member: FINRA, SIPC Not a Deposit Not FDIC or NCUA Insured May Lose Value No Bank or Credit Union Guarantee RS Investment Management Co. LLC. LB1241G_FC12v5RSBD EB This brochure was printed with soy-based inks on ECF (elemental chlorine free) materials containing 30% post-consumer fiber and created with Green Power.