This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
Broad indices, such as the S&P 500 Index, mask a huge variety of markets and business niches. Within the gloomy outlook for average earnings, some companies are experiencing strong headwinds and others are finding a more supportive environment. This divergence is, undoubtedly, repeated across different stock markets and different political and economic areas. In our view, this divergence suggests that the coming year is likely to suit stockpickers best, as they are able to select niche businesses which can navigate a very changed economic landscape and grow earnings, despite the economic headwinds.
Trusts in the small and mid-cap sectors may fit the bill, both of which have seen significant NAV falls, as well as discounts widening. Managers of trusts and funds investing in smaller companies can pick fundamentally attractive businesses and take a long-term view, based on fundamentals and specifics, rather than being dependent on broad economic trends. In our view, this is a key attraction, not just for the growth opportunities, but also the fact that having a variety of idiosyncratic risks within a portfolio provides genuine diversification. This results in higher risk-adjusted returns.
What applies to public markets also applies to private companies and, in this way, we believe the listed private equity (LPE) sector is exposed to exactly the same dynamics. Like the small-cap space, underlying companies tend to occupy very different niches than those that represent listed markets, especially on a market cap-weighted basis. The evidence we have seen so far is that, because of their idiosyncratic nature, private equity portfolios are not seeing significant earnings’ declines. LPE managers have made much of their portfolios’ defensive growth characteristics, but their claims seem to be holding water in this most testing of choppy seas.
In our view, current discounts in smaller company and private equity trusts offer an opportunity for long-term investors to pick up conservatively-valued and strongly performing companies at a significant discount. At the same time, they will also add diversification to portfolios, giving exposure to companies and management teams which are able to be more dynamic and better masters of their own destiny, rather than the companies that represent large parts of equity indices.
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