Brown Advisory US Smaller Companies 23 December 2024

Brown Advisory US Smaller Companies (BASC) targets capital growth through a diversified portfolio of US smaller companies. The team managing BASC have managed an identical strategy for c. 18 years, led by Chris Berrier and George Sakellaris, and over the long term they have outperformed the benchmark and the wider market. The period since they took on BASC, from March 2021, has been marked by a strong divergence between large- and small-cap US equities.

As a result, the team believes that smaller companies’ valuations are at a significant valuation discount to large-caps, driven in large part by unfavourable macro conditions over recent years. They note that large-cap index performance has been driven by a very narrow range of stocks and, in reality, many large-caps have also been left behind. The team believes that the medium-term outlook for sticky inflation and interest rates will favour its preference for quality growth stocks with pricing power. Further, they believe that the evolving landscape for small-cap investing in the US, with a growing proportion of passively managed strategies potentially creating greater valuation anomalies, is creating conditions that will favour active management. Since 2021 the strategy has been out of favour and we look at performance in more detail in the Performance section. In the very short term performance has responded very strongly following the US election, giving us a hint of the recovery potential for BASC.

The team manages a Portfolio of c. 80 stocks with a median market cap of just over $7bn. The trust has seen relatively low turnover since Brown's appointment in 2021, with many of the top ten holdings purchased in the first few days of their tenure. The trust does not pay a dividend, with its sole focus on generating capital growth, and has not employed gearing in the last three years. BASC trades at a 13% discount and holds a continuation vote every three years, with the last one passed in 2023.

BASC’s share price rose c. 15% in the month following the US election, as part of a wider positive move for US equities. However, this price move doesn’t really change the fundamental valuation gap that exists between large- and small-cap equities, and investors still need to face the fact that the S&P 500’s concentration risk, with over 35% of the index in ten stocks, is at long-term highs.

BASC, then, provides investors with several things. First, exposure to quality growth companies that, on average, trade at much lower valuations than the upper echelons of the S&P 500. Manager Chris Berrier notes that both candidates in the US election had policies with an inflationary edge to them, and he expects rates and inflation to be a little stickier than consensus was hoping for. Companies with solid balance sheets and pricing power, which form the bedrock of the BASC portfolio, should be much better positioned than more geared, less profitable growth companies to perform well. Second, it provides that ever-more important diversification in a market that has become ever more concentrated, and, third, active management at a time when much of the concentration risk is driven by weight of money in passive investment strategies, including in small-cap. We don’t dispute that passive investment has a role to play but, as Chris notes, over 50% of small-cap strategies in the US are now passive, not something that we in the UK have experienced in our domestic small-cap market, and he thinks this has created distortions in the market that only an active manager can navigate.